Propane Price Insider
  
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Call Cost Management Solutions today at 888-441-3338 for more information about how Client Services can enhance your business or drop us an email at info@propanecost.com.

Trader's Corner

This week’s Trader’s Corner projects potential 2014 summer propane prices using an historical reference.

In recent Trader’s Corners, we have focused a lot on inventory and propane prices. Have we gotten oversold? Is it a good time to buy? Will production be so robust this summer as to rebuild U.S. inventories from near record lows while meeting export demand? The way propane is trading right now there are a lot of people who must think so.

The honest truth is no one really knows at this point. No one in our industry is sitting in every boardroom of every company across the globe and making decisions that will affect propane supply this summer. All of us will have to make decisions without all of the information.

No decision will ever be made if one is waiting for answers to every question. Propane retailers across the country will make decisions on next winter’s supply with only part of the story. The inability to know the future makes hedging an essential part of managing the supply side of a retail propane business.

Hedging allows us to substitute knowns for unknowns concerning what we will pay for propane. That knowledge helps us make decisions and move forward with growing our business and meeting customer needs. Most importantly it helps us manage the risk of extremely high prices that can break our customers and ruin our business.

Assuming you have decided to hedge some of your supply, the next logical question is how much to hedge. That will be our focus in this Trader’s Corner.

Below is the spreadsheet we developed for this discussion.

In our discussion, we will look at a million-gallon-per-year propane company. It is important to know that you do not have to be a huge-volume company to hedge. No matter the size of your propane company, the opportunity to hedge is there.

Hedging is about establishing a known price for the propane you will actually sell to your customers. Therefore, you really don’t want to be over-hedged, where you have more hedged gallons than physical gallons that will be sold to customers. The amount you are over-hedged becomes speculation. If you want to be a speculator, better investment choices than propane probably exist.

Since we don’t want to be over-hedged, we really need to establish the low-case volume scenario for our company. We should not hedge more than that amount until we have a clearer view of demand. History shows a really poor demand year can result in 25 percent less sales for our fictitious company. So our initial hedging maximum would be 750,000 gallons, not our million-gallon average.

Now that we have established how much potentially to hedge, let’s turn our attention to pre-buys as a hedging tool.

When managing supply side risk, it is important to understand the strengths and weaknesses of each type of hedge. A traditional pre-buy from our supplier is a hedge and has an important place in our risk management portfolio. The strength of a pre-buy is the ability to pull the gallons over a period of time. When we use financial hedges, the volumes per month are rigid. Therefore, there is no ability to account for the variation that winter demand can cause to our demand budget.

For our example, we assume summer demand is fairly steady and predictable. It is the winter months that require volume flexibility. History shows our retailer that his demand in the winter months can fluctuate as much as 20 percent, depending how winter plays out. Therefore, we would target 114,750 gallons of pre-buys from our suppliers as our first layer of hedge.

We know that some suppliers are now offering ratable pre-buys for a lower cost. But at least for this gallon amount, we should be willing to pay the premium to have the flexibility to pull gallons from October to March.

For the remaining gallons, we believe financial hedges are the superior choice. By financial hedges, we mean swaps, options and physicals (paper barrels), which provide flexibility in terms of getting in and out of the positions. It may be hard to get out of a pre-buy, but closing a financial hedge is easily done.

This comes back to us not knowing the future and needing the ability to respond to new information as it becomes available. Financial hedges give us that flexibility. To close a swap or physical, we can simply make the opposite transaction for the same month and volume we own.

For example, let’s say in March 2014 we buy an October 2014 swap with a volume of 25,000 gallons. But by June we see propane supplies building faster than expected. We believe prices could be falling in October, making our hedge unneeded. Therefore, we would sell an October swap during June for 25,000 gallons. At that point, any gain or loss on our position is locked in. The two positions will simply counter each other until they settle after the monthly average for October is known.


So we established our low-demand scenario of 750,000 gallons and then covered 114,750 gallons of that with a pull anytime between October-March pre-buy. That leaves us 635,250 gallons to potentially hedge with financial tools.

How much of that we actually hedge initially should be determined by our market view. Perhaps we are bearish on supply/prices – meaning we believe there will be plenty of supply for next winter, resulting in lower prices. Perhaps we think propane inventories will struggle to build this summer from their low position and we are bullish supply – meaning we see it as potentially short and expensive. Perhaps we don’t have a bias and feel neutral on the outlook for supply right now.

Even if we are bearish, we will probably need to cover at least 35 percent of our supply – to cover fixed price or cap programs. And even if we don’t offer those kinds of programs, having at least 35 percent of our volume hedged using flexible financial tools to eliminate some upside price risk is probably warranted.

On the other hand, even if we are bullish, we probably wouldn’t be more than 65 percent hedged early on. Our bullish outlook could be wrong and we will need the ability to buy supply at market prices during the winter to make sure we can average down our supply cost and remain competitive.

The goal of any supply risk management strategy is to establish pricing where we can remain competitive no matter what pricing scenario plays out. Too often retailers get caught up in buying at the lowest price of the year. If that is the goal, you will never hedge because you will never know. It is all about positioning and flexibility.

Regardless of your pricing outlook, you would buy a series of swaps, options or paper barrels in some combination to establish your financial hedge position. To cover a whole year, you would need to own, say, 12 swaps. We will discuss how swaps and other financial tools work in other Trader’s Corners. Also, don’t forget we have hedging seminars coming up this spring and summer that could help increase your understanding and comfort level with all of the tools and strategies you can use to protect your customers and business from high propane prices.

You can make your hedging volume calculation as simple or as complex as you want. Today’s example was just one way to work through the hedging volume process. The types of programs you wish to offer to customers or the particular supply risk management issues you have will determine what particular hedging tools you would use to make these hedges.

Call Cost Management Solutions today at 888-441-3338 for more information about how Client Services can enhance your business, or drop us an email at info@propanecost.com.


WEEK IN REVIEW
Propane prices continued their steep correction, moving far below what we think current conditions warrant. February propane ended with a slight gain on Friday. We are bullish going into the week.

LAST WEEK'S DAILY HIGHLIGHTS
Monday: Propane prices continued to go backward as traders looked to the end of this winter with relief. Crude moved higher on expectation of another draw in Cushing crude inventory. Natural gas prices hit a five-year high and then plunged 11.2 percent.


Tuesday: Another major drop in propane prices as sellers continued to be aggressive on expectations inventory will hold up through this winter and that last week’s inventory draw would be light.

Wednesday: The U.S. Energy Information Administration reported essentially no change in U.S. propane inventory. That caused prices to continue lower. Crude bounced on a lighter-than-expected build in U.S. inventory and on a million-barrel draw in Cushing.

Thursday: February propane gave up more chunks of value as prices moved to sub-50 percent of West Texas Intermediate crude. Expectations that production will be adequate to replenish inventory this summer kept the downward pressure on prices.

Friday: As February closed, it looked as if we were finally seeing a bottom in the propane price correction. At report time, we were looking at February Mont Belvieu up a quarter-cent and Conway up a half. March Mont Belvieu was pegged at 112 cents, a quarter-cent below February, and Conway March was trading at 114 cents, 3 cents below February.

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COST MANAGEMENT SOLUTIONS
Cost Management Solutions LLC (CMS) is a firm dedicated to the analysis of the energy markets for the propane marketplace. Since we are not a supplier of propane, you can be assured our focus is to provide an unbiased analysis.

Market Information Services
The Propane Price Insider, an e-mail service that provides:

  • Three Daily Price Flash Wires
  • Periodic Option Quotes
  • Wednesday Inventory Data Updates around 11 a.m. ET
  • Evening Report with Executive Summary, Trader's/Hedger's Corner, Weather maps and complete review of energy prices that are based on Propane's Btu Equivalent

Free trial!
For a free 10-day trial subscription by e-mail, sign up online here or call toll-free at 888-441-3338.

Client Services
Many retailers simply don't have time to analyze the large amounts of data to make an informed purchasing decision.

We offer:

  • Detailed market recommendations on hedge and pre-buy entry points
  • Prompt market execution of hedging strategies
  • Supply cost analysis and recommendation as to effective hedging strategies
  • Because of the volume of transactions we place annually, we receive large volume consideration when we place your hedges

Visit us online at www.propanecost.com. Or e-mail info@propanecost.com.

Contact us today to see if you can benefit from having the Energy Price Watchdog working for you.

Dale G. Delay 888-441-3338, ddelay@propanecost.com
Mark Rachal 888-441-3338, mrachal@propanecost.com

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