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Click here for a free, 10-day trial of The Propane Price Insider!
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 will continue filling a hedger’s toolbox.
It’s the third week filling a hedger’s toolbox with the tools any propane retailer can use to manage supply-side price risk. A toolbox full of the tools necessary to manage supply-side risk is essential for the success of a propane retailer in today’s high-priced, highly volatile marketplace.
Our goal with this series is to introduce these tools, tell you when to buy and sell them, explain how they are best used and reveal a few things about how each works.
We may not provide all you need to know to use a tool, but you will at least know the tool is there and what you can do with it. Later, we can help you use the tool and explain more fully how it operates. So the goal here is to fill your toolbox and let you know what “project” the tool can help you accomplish.
So far, our hedger’s toolbox has a financial swap buy and a financial swap sell. Today, we will add a call option.
Tool: Call option
Action: Buy
Sell when:
- To protect against rising prices
- You are concerned prices could fall after purchase
- You desire flexibility to lower prices
- You are not confident in your ability to make sales against position before the month of delivery, creating a need to be able to respond to competitive pressure in the future
Best used to:
- Back up programs, such as cap programs in which the highest price customers will pay is set but their price can be lowered if prices fall
- Give maximum flexibility to respond to competitive pressures
Other considerations:
- Unlike swaps – in which risk is shared and no upfront cost is incurred – with options, risk is transferred and an option premium is paid at the time of purchase
- Options are like insurance; the premium you pay represents your total risk
- Options settle on the monthly average at the particular hub location owned. Just like a swap, the strike price of the option is compared with the monthly average at the hub. If the monthly average is greater than the strike, the holder of the option is paid the difference.
- If the monthly average is lower than the strike, nothing happens; the option simply expires
The key advantage of options is the flexibility they provide. With swaps and pre-buys, the cost of supply is fixed at the strike price of the swap or the purchase price of the pre-buy. Therefore, the holder of those positions can’t lower their sales price to customers without taking a hit to their margin. Of course, this could increase the risk of losing some customers because the holder’s sales price is higher than their competitor’s.
With an option, the holder has no obligation should prices fall below the strike, so they are free to lower their sales price to the customer to remain competitive. This reduces the risk of losing customers because of being priced out of the market.
The pricing issue with an option occurs upfront. Because options have a premium cost, this expense should be included in the cost of supply and passed on to customers. Right now, options to cover this winter’s supply season – from October 2014 to March 2015 – would be around 8.5 cents in Mont Belvieu and 9.25 cents in Conway.
Let’s say retailers covered all their winter demand with call options and their competitor did nothing and was simply buying at market price. When winter comes, if prices are exactly where they were when the first dealer bought the options, they would be at an 8.5-cent to 9.25-cent higher street price than their competitor because of the option premium. If prices go down, they would be able to follow their competition down, maintaining the same price premium and not losing any margin.
They would be at a definite advantage if prices went higher. They could hold their price firm, maintaining a competitive advantage, or they could raise prices and make more margin.
Like other financial tools, one of the key advantages of an option is that it gives the holder a known cost of supply to sell against. In the scenario above, the retailer who does nothing can’t offer a winter price to his customers without taking a huge risk. On the other hand, the holder of the swap or option can be an aggressive marketer of fixed-price, cap and budget programs.
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
Crude prices started out strong, but then turned lower after the August contract expired. The geopolitical issues that threaten crude supply remain. However, there is a general feeling the world is well-supplied.
Mont Belvieu propane resisted the fall in crude, despite reports of issues with high storage positions causing concern for potential brine contamination. Conway prices slipped as inventories in the Midwest improved over the past three weeks.
LAST WEEK'S DAILY HIGHLIGHTS
Monday: Crude prices continued the rally started last week. Propane was quiet, staying out of the rally in crude. The failure of a deal to be reached on Iraq’s nuclear program by its July 20 deadline was a key support for crude.
Tuesday: Mont Belvieu propane inched higher and Conway recovered the previous day’s loss on defensive buying ahead of the Energy Information Administration’s (EIA) weekly update on inventory. The upward momentum in propane inventory waned with a slight loss on the day.
Wednesday: Propane prices moved higher on an inventory build that was slightly below expectations, although the build was higher than average. The most significant impact was a 1.4-million-barrel build in Midwest inventory, which was 450,000 barrels higher than normal. Crude prices moved up after the EIA reported another large draw of nearly 4 million barrels in U.S. crude inventory.
Thursday: Propane prices moved lower, influenced by falling crude prices, the good build in Midwest propane inventory reported on Wednesday and issues being caused by high storage positions in Mont Belvieu.
Friday: Propane prices started the day out a little on the weak side but recovered by the close. Falling crude was a drag on propane early, but recovered later in the day.
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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:
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Three Daily Price Flash Wires
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Periodic Option Quotes
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Wednesday Inventory Data Updates around 11 a.m. ET
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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:
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Detailed market recommendations on hedge and pre-buy entry points
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Prompt market execution of hedging strategies
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Supply cost analysis and recommendation as to effective hedging strategies
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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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