How the crude war could impact propane prices

Last week in Trader’s Corner, we discussed how a retailer can use swaps to manage supply-side price risk and perhaps take advantage of the current low-price environment. This week, we want to revisit our topic from the two prior Trader’s Corners. In those articles, we discussed how low crude prices could go and looked at a 12-year history of the ups and downs in crude prices, which led us to the recent price collapse.

We also focused on the damage low prices were doing to the U.S. energy industry, and how Saudi Arabia might be inclined to stay with its high production/gain market share strategy for a while, even though it was hurting itself in the short term. Its goal would be to do permanent damage to U.S. crude production.

Saudi Arabia has called an emergency meeting of OPEC+. The meeting was originally scheduled for today, but has been pushed out to Thursday, April 9. Saudi Arabia is seemingly making efforts to mend its differences with Russia. President Trump is being given a lot of credit for getting Saudi Arabia and Russia talking again after speaking with leaders of both countries this past week. Saudi Arabia might have been eager to end its “survival-of-the-fittest” strategy.

Saudi Arabia tried the strategy between 2014 and 2016, and it did more harm to its economy than it did to U.S. producers. Though we acknowledge that U.S. production firms operating primarily in shale formations are more vulnerable this time around, the strategy will still do damage to Saudi Arabia’s economy. Let’s look at the numbers.

In 2019, Saudi Arabia exported 8.339 million barrels per day (bpd) of crude. It has many grades of crude and different sales prices, so we will use the Brent benchmark to make our point. Brent averaged $64.07 last year. Using that as the sales price gave Saudi Arabia $534 million per day in revenue from crude sales last year.

Before the talk of once again implementing production controls, Saudi Arabia said it expected to export 10.6 million bpd in May. At the price of crude when it announced the export increase, its revenue on export sales would have been $240 million per day.

Further, it said it was going to increase production by a million bpd over the next year. Let’s say all of that is exported, and crude prices rise to $39 per barrel (just under U.S. shale company breakeven). Its revenue would be $452 million. That is still shy of what it was generating last year on much lower sales. Crude demand has been reduced so much by COVID-19 that there are reports saying Saudi Arabia is struggling to increase exports.

Saudi Arabia would need just over $46 per barrel for its crude at 11.6 million bpd of exports to generate the same revenue it did last year. That is a tough hill to climb given that price could bring back some U.S. production. Plus, other producers would be upping production to compete for market share against Saudi Arabia.

For this strategy to ultimately work for Saudi Arabia, U.S. producers would have to be so badly damaged that no matter what price crude got to, U.S. production would remain low enough that high global crude inventories would come down, pushing prices higher. If the impacts on U.S. producers were not permanent, the short-term pain for Saudi Arabia of the survival-of-the-fittest strategy would likely never be offset.

The conversation has now shifted to the possibility of the United States and other non-OPEC+ producer nations such as Norway, Canada and Brazil joining in controlling production. Given anti-trust issues, that might be hard for the United States to manage. However, there is little doubt – whether by choice or by force – that U.S. production growth is very likely to slow. There is the potential for sharply lower production from the United States.

From a retail propane perspective, what evolves here is critical for the future price of propane. Much of the gain in natural gas production has been associated gas with crude well production. If U.S. crude production falls, then it is likely that U.S. natural gas supply will fall, and that will lead to less propane supply. Lower propane supply likely leads to a fall in propane inventory and an upturn in propane prices.

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