Benchmarks and deciding when to ‘look before you leap’

August 3, 2020 By    

Over the last few Trader’s Corners, we have established some benchmarks for crude and propane. We have discussed at length why we feel $40 is the price for West Texas Intermediate (WTI) for the foreseeable future. WTI was at $39.93 on July 31. Last week, it ventured a little higher, but there is a lot of headwind for it to go much higher. Dips below $40 tend to be bought into, and forays above $40 turn into profit-taking opportunities. Both actions tend to drive the price back to $40 per barrel.

Over the last two weeks, we have focused on the 50/50 benchmarks for propane, pointing out that prices have been staying very close to 50 cents per gallon and 50 percent of crude at Mont Belvieu LST. In last week’s Trader’s Corner, we discussed that propane had ventured above those benchmarks but explained we thought a surge in demand for export barrels was a short-term event.

We ended last week’s article with the following:

At this point, we would conclude that this was a short-term situation. We suspect the arbitrage window is closing. We will see the impacts of this – perhaps in export and inventory data – for another couple of weeks, but the actual cause may already be behind us when we see the effect in the EIA data. Still, the effects could support prices a while longer, but for now we can’t conclude this is a longer-term trend changing situation. We can’t be sure that the conditions that caused the run in the Saudi CP prices will continue. Early indications show it is already correcting.

At this point, we still believe overall fundamental conditions will tend to draw propane back to 50 cents per gallon, 50 percent of crude benchmarks. These are short-term benchmarks and we know they are going to move, but for now we are still comfortable with them.

On July 31, Mont Belvieu LST was trading at 50.125 cents and at 52 percent of WTI crude. Mont Belvieu was at 52.5 cents when we wrote that statement above on July 17, but had dropped to 49 cents by July 29. Mont Belvieu prices jumped sharply again on July 30, which brings us to today’s topic – short squeeze.

Propane prices began showing weakness on July 30 with all price points lower. That was expected after Wednesday’s EIA data was on the bearish side and crude prices were falling.

Just before noon, however, Mont Belvieu propane prices jumped sharply higher. We noted that offers (made by sellers) were significantly higher than bids (made by buyers). When that happens, it generally indicates a “short squeeze.” A short squeeze occurs when an entity is short on the propane it needs to fulfill an obligation and is forced into the market to cover the position. For it to move the market as it did, the volume needed was likely large.

Another indication that the action could have been a short squeeze was that it occurred near the end of a month. Most propane contracts are called “anys,” which means they can be delivered anytime during a month. They are in contrast to the lesser-used “prompt” contracts, where the product is usually delivered within a day. The nature of any contracts can encourage someone who is not in a good position to wait as long as possible before fulfilling the obligation, hoping market conditions will change in their favor.

If they wait until the last day or two of the month to secure a large volume, there may not be enough motivated sellers. The market begins to feel the buying pressure, and offers from sellers can quickly jump. Sellers can feel the pressure in the market. They see prices going up with propane contracts being snapped up, so they throw out increasingly higher offers, and those get taken out quickly. Soon, the market senses that someone is in a bind, causing offers to climb exponentially.

You may recall a similar situation with crude in April, when the price went negative. In that case, speculative players were long crude and needed to sell to close. Their obligation to sell to close contracts literally drove crude’s price down to the point they were paying people to take it.

We do not have empirical evidence that Thursday’s action was the result of a short squeeze, but it had all the makings of it. At the least, it provided us with an opportunity to point out when observing unusual market activity, be sure to consider what time of month it is occurring. If it is occurring toward the end of a month, guard against feeling pressured to make a move, if what is going on feels illogical. Thursday’s action felt illogical based on what crude was doing and the recent fundamental data.

There was another event that may have been behind the quick jump in Mont Belvieu propane’s prices. There was an explosion and fire at the Mont Belvieu LST complex on Wednesday night. It turned out to be a minor incident, and speculation is it will not have any impact on propane supplies or deliverability. Since propane was down Thursday morning and prices did not spike until closer to noon, some speculate the explosion and fire had nothing to do with the bounce in Mont Belvieu pricing. Still, the incident and the jump in prices were too closely linked for us to discount the connection.

Regardless of whether the Thursday jump was a short squeeze or related to the LST accident, the takeaway is the same: Be sure to look before you leap. Remember crude was having a very bearish day that Thursday, and Wednesday’s data from the EIA had been bearish for propane.

It could have been entirely possible that the incident at Mont Belvieu LST caused long-term damage, and those leaping quickly into the price jump would have come out ahead. But from our experience, that is rarely the case. We believe it is generally better to have some idea of the cause of the price spike before reacting, even if that means leaving a little money on the table occasionally.

The $40 WTI, 50-cent propane price and 50 percent relationship between the two are still valid benchmarks. We will continue to look for longer-term fundamental changes in crude or propane that we believe make those benchmarks invalid, but for now we think they still apply.

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