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DIGITAL EDITION
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THIS WEEK'S TOPIC:
PROPANE PRICING
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Where is propane trading relative to crude?
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Last week, we wrapped up our four-part series on crude. This week, we are going to look at where propane is trading relative to crude and examine the prospects for pricing going forward.
Currently, global crude supplies are running an estimated 1.6 million barrels higher than global demand. The Organization of the Petroleum Exporting Countries (OPEC) has stated repeatedly it will not lower production and will continue to fight for market share against U.S. shale producers. Saudi Arabia’s oil minister went so far as to say it was not the job of OPEC to subsidize U.S. shale producers.
We believe that, as global demand for crude increases, OPEC is likely to increase its supply to meet that demand - up to full production capabilities - in many OPEC countries. The OPEC country with the most spare capacity is Saudi Arabia. We do not believe it will use all of its spare capacity to achieve its stated goal of increasing market share, but we do believe it is possible that it will maintain less spare capacity than it has in the past.
Other large non-OPEC producers, such as Russia, will continue to produce at full rates and have given no indication of cutting back. Russia estimates its production will increase this year. It has also been modernizing its refineries and is expected to use less crude internally, leaving more for export. Most believe sanctions will eventually eat into Russia’s production capability, but to date the impact seems to be minimal.
There is also the possibility that sanctions against Iran could be lifted and as much as 1 million barrels per day (bpd) of more crude could be pushed onto global markets. Further, Libya is producing about 1 million bpd below normal due to fighting between two factions trying to gain control of that country. If those issues are resolved, and the Islamic State in Iraq can be held in check, there could be another 2 million bpd of crude coming from the Middle East and North Africa. Both of those countries are desperate for revenue and will push their barrels into markets regardless of price, in our view.
For these reasons, we believe a rebound in crude prices could be slower in coming than most expect, and the recovery in prices will likely be very slow. At this point, it would appear that the tightening of the supply-demand balance will come from the demand side. It could take years for the global economy to recover enough to soak up excess supplies and begin to put pressure on prices. Then, as prices improve, U.S. production is likely to increase to keep supply and demand balanced.
With that expectation on crude, we can now look at propane’s value relationship to crude.
The chart above shows propane’s relative value to West Texas Intermediate (WTI) crude. The relationship is expressed in a simple percentage. Currently, if you bought a barrel of propane you would pay about 48 percent of what you would pay for a barrel of WTI crude.
Last year (as the blue line shows) during the winter, supplies of propane got tight and Mont Belvieu propane increased in relative value to more than 70 percent of WTI crude. Over the summer, inventory recovered rapidly and propane dropped well below its five-year average (as shown by the green line). However, through this year propane has recovered and is now trading very near its five-year, average relative price to WTI crude.
Propane inventory is at record highs for this time of year, so the recovery in value seems counterintuitive. It is a relative valuation, so things on the crude side can affect the valuation as well. In this case, through the winter U.S. crude inventory climbed to record highs, which has hurt crude’s value. Basically, since both propane and crude inventory are at record highs, there is no reason to value one over the other. Thus, the relative value is back to average.
At this point, we have to conclude that propane is valued about right against WTI crude, given the weak fundamental positions of both. If we also believe crude is unlikely to move significantly higher for the remainder of this year - and possibly even longer - then changes in the value of propane will most likely come with changes in its own fundamentals. That means we would expect propane prices to be highly reflective of the changes in its high inventory position.
Currently, inventory is at 54.284 million barrels after rising 500,000 barrels last week. From this point until the last week of September, propane inventory has averaged building 35.3 million barrels over the past five years. If anything close to that would happen, then propane inventory would easily be at a new record high by next winter. Inventory topped out at 81.612 million barrels last year, and an average build would put inventory just short of 90 million barrels. Again, if anything close to that happens, propane would likely fall in value to crude, and we would expect lower prices than we have now.
However, there are expectations for lower propane production, higher petrochemical demand and increased exports occurring this year. Based on some projections, propane inventory will actually be near where it is now at the end of September. In other words, we will see very little net increase in propane inventory over the summer months. Those projections would put inventory at or below the lowest beginning-of-winter inventory we have seen in the past 10 years. If that scenario develops, we can expect a sharp increase in the nominal value of propane, as well as its relative value to crude. It is hard to believe that crude inventory would decline anywhere near that rate over the summer months.
Obviously, there are two competing scenarios that make the potential range for propane prices very wide by the time next winter starts. The temptation is to buy into one or the other of the scenarios and go all-in on positioning for next winter. If you believe inventory builds will be normal, you would buy nothing for next winter. If you believe some of the current projections, you would buy everything you need for next winter. However, if you pick the wrong side, you could easily find yourself very uncompetitive.
If the goal is to have competitive supply for next winter, which we believe should always be our goal, it is advisable to not decide today which scenario to believe. Rather, get a base position for next winter when you think the current downtrend in propane prices has been completed. That base position might be 30 percent of next winter’s needs. After that, let the trend in inventory determine your action. If inventory is building at a well-below-normal rate early in the propane building season, begin to buy more of your next winter’s needs in stages as that trend continues. Continue to buy as long as that trend is intact. It might not be long until you have 100 percent of your next winter’s needs if inventory is building as slowly as some think.
If inventory is building closer to the five-year average rate, then hold tight at the 30 percent level until you see the trend changing. If inventory is building at near-normal rates through the summer, you may never have more than the 30 percent base position.
Lastly, our assumption is that it will be a flat year for crude prices. But if we are wrong and you see crude prices starting to move higher, that would be another reason to increase from the base position.
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WEEK IN REVIEW
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Crude rallied on the back of the dollar a couple of days last week, helping it to turn positive for the week. However, crude fundamentals remain very weak. Propane lost ground against crude after the Energy Information Administration (EIA) reported a build in U.S. propane inventory.
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LAST WEEK'S HIGHLIGHTS
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Less supportive temperature outlooks and high inventory positions had propane falling with crude to open the week. Crude closed at a new low for 2015. OPEC said it did not believe U.S. crude production would start falling until the second half of the year.
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It was another weak day for propane, with prices outpacing crude to the downside for the second day in a row. Crude set another year-low as traders focused on weak fundamentals.
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It was a volatile day in energy markets, with both crude and propane falling in early trade following the EIA Weekly Report on inventory. U.S. crude inventory increased by 9.6 million barrels to a new record. Propane inventory surprised with a 500,000-barrel build. However, commodities and equities markets exploded higher after the Federal Reserve released its monetary policy statement. The Fed was less optimistic on the U.S. economy, which caused the dollar to plunge. The falling dollar pushed commodities and equities higher.
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Markets essentially reversed themselves, giving back much of the gain following the Fed policy statement that was made on Wednesday. Comments from Kuwait that OPEC had no choice but to continue holding production steady or risk losing market share to U.S. producers had traders thinking about the weak state of fundamentals' support for crude and propane.
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Crude raced higher after a sharp fall in the dollar. The dollar fell against the euro after Germany’s chancellor made comments positive about Greece staying in the Eurozone. Propane was up, but lagged the gains in crude.
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CONNECT
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WHAT IS COST MANAGEMENT SOLUTIONS?
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The Propane Price Insider is an e-mail service that provides:
- Three daily price Flash Wires
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Evening report with executive summary, weather maps and complete review of energy prices that are based on propane's Btu equivalent
For a free 10-day trial subscription by e-mail, sign up online here or call 888-441-3338.
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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.
Contact us today to see if you can benefit from having the Energy Price Watchdog working for you.
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