How natural gas impacts propane supply and pricing

Trader’s Corner, a weekly partnership with Cost Management Solutions, analyzes propane supply and pricing trends. This week, Mark Rachal, director of research and publications, examines how natural gas impacts propane supply and pricing.

We last wrote a Trader’s Corner that specifically focused on the potential impact of natural gas pricing on propane pricing in April. We need to revisit the subject since conditions have changed – winter is likely to change them even more – and because it ties nicely with our crude outlook article from last week. We are going to cover this over a couple of weeks because we feel the need to set the foundation of why looking at natural gas should be important to our readers, who are by and large propane buyers/consumers.

As we discussed last week, propane’s price is heavily influenced by the price of crude. Once natural gas liquids (NGLs) – such as ethane, propane, butanes and natural gasoline – are separated from methane, they become priced against the value of crude. However, from a propane supply perspective, natural gas is king and our focus.

The process of producing natural gas – processing it to separate the methane from the NGLs and then fractionating the NGLs – provides around 87 percent of our propane supply. Crude refining yields about 13 percent of propane supply.

To complicate matters, much of natural gas supply is associated with crude production. Some hydrocarbon wells produce just methane and NGLs and are referred to as natural gas wells. Wells that produce heavier hydrocarbons are classified as crude wells. However, crude wells almost always produce the lighter hydrocarbons as well. The methane and NGLs that are produced, along with heavier hydrocarbons (crude), are classified as associated natural gas production. The more we drill for crude the more associated natural gas production there is and the less we need to drill purely natural gas wells.

As of Aug. 19, there were 601 rigs in the U.S. drilling crude wells and 137 drilling purely natural gas wells. Much of our increase in natural gas and NGL supply will come as associated production. All this hydrocarbon stuff is intertwined so we must sort through it to figure where we are weak and where we are strong. The job is made more difficult by the fact that propane is just a part of a much larger hydrocarbon stream.

Drilling and production are primarily based on the need for refined fuels such as gasoline and distillates (crude) and methane (natural gas). The value of propane certainly comes into play when determining the economic viability of drilling and producing a particular well. But no one is looking specifically at propane and deciding to drill a well.

So, no one is looking unilaterally at propane and saying let’s go drill a well to get propane because demand for propane is high and we need more of it. One could say that the activity in gasoline, distillate and methane markets is demand driven. But because propane is more of a byproduct of those markets, its activity is more supply driven.

Propane markets are driven by whatever supply is put into them. To put it another way, gasoline, distillate and methane markets adjust primarily to demand. Propane markets adjust primarily to supply. This can create increased pricing volatility in propane markets.

When propane supply is tight, those of us who use it and especially those whose livelihood depend on it can become very frustrated. When supplies get low and prices go high, we wonder how we got into this situation. “Why isn’t there more supply?” we ask. The discussion above was to try and provide more insight as to why that is the case.

It may be frustrating, but to be smart, prepared propane buyers we must understand and monitor crude and natural gas markets to anticipate propane supply because the propane demand side will need to adjust to the available supply. If propane supply gets tight, no one is going to drill propane wells to help us. We on the demand side must adjust.

If you get frustrated by this, it is certainly understandable. If you get fooled sometimes because there are so many moving parts to figure out, then welcome to a long and distinguished club. As a propane buyer, we can’t just be a propane expert; we must be a crude and natural gas expert as well.

Next week, we are going to delve into something in natural gas markets that could significantly affect our propane supply and pricing, especially in the second half of winter. And more broadly, it could significantly affect geopolitical events that will impact all of us economically, financially and maybe even morally. So, there will be two facets, specific and general, in next week’s discussion, but as usual they are intertwined.

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