In the Know: Propane Costs

In the Know is a monthly partnership between LP Gas magazine and Propane Resources. Our focus this month is on the state of the propane industry, addressed by supply and risk management expert Pat Thornton.

Q. According to the U.S. Energy Information Administration, the average wholesale price of propane dipped to less than 60 cents a gallon to begin the new year. This was $1.10 lower than year-ago levels. What does this mean for propane retailers and are these prices sustainable?

A. As the saying goes, “What goes up must come down,” and in the energy industry the opposite usually always applies, as well. We have seen three other instances in the past 25 years where a steep decline has occurred and, in all cases, the market always moved at least halfway back up by the end of the next year.

For the propane retailer, prices at these lows present an opportunity. Low prices typically present many opportunities for buyers, which ultimately pull prices back up. There is limited downside potential and what downside potential there is represents limited risk. The dramatic decline of all energy commodity prices will affect the market in many ways that can have a bullish effect for the next year. Saudi Arabia and the majority of OPEC members are willing to take a financial hit in hopes that enough oil producers in the United States will see less opportunity and product will be shut in.

Saudi Arabia can afford to have prices low, while a minority of OPEC members cannot. The end of December marked the seventh straight month that OPEC exceeded its 30-million-barrels-per-day production quota. Meanwhile, the U.S. has been setting new daily records at more than 9 million barrels per day. Already, though, during the first week of 2015, we did see 35 horizontal rigs idled in places such as North Dakota’s Bakken Shale and Texas’ Permian Basin. That was the single biggest drop since the drilling boom started six years ago. We expect 2015 will bring about a lot of shut-in products.

While natural gas liquids producers take a hit on propane and ethane, they have still been seeing high-enough prices for butane and natural gas. Butane prices will likely decline after the winter gasoline blending season, which will cause more production of all products to be shut in. A drop in exports will also cause more propane to be shut in. Exporters have been taking a loss of up to 7 cents a gallon versus paying 10 to 14 cents a gallon on their take-or-pay agreements. As energy traders have been trying to find the floor for crude, it appears that $43 a barrel is an area that could trigger a push back up to the $80-per-barrel range by late 2015 or early 2016.

As we have seen the U.S. become a net exporter of propane, it has traded much lower as a percentage to crude oil. Prior to 2012, propane traded closer to 70 percent of crude oil. For the past several years, propane below 50 percent has been commonplace. Last winter was the exception when a true shortage of product in much of the U.S. drove prices significantly higher. On six occasions, prices have touched 35 percent of crude, and each time the propane price jumped higher versus crude oil. We saw propane hit 35 percent again in December 2014 and then rebound some.

Looking back 25 years, four major events played a role in a sharp price decline. In 1990, prices declined after an exceptionally cold December moved prices higher. In 2001, the tragic events of Sept. 11 dragged prices down. The global meltdown of 2008 pulled propane down with everything else. Then in 2014, we saw the extreme high due to weather and a shortage at the beginning of the year, and then we faded to more-than-adequate supply and lackluster world demand by the end of the year. In the first three cases, prices stabilized to balance at a higher level as demand was created. Prices moved down about 61 percent in all of those cases. We have now seen the market move down at an even higher percentage and, once again, all signs point to a likely rebound to a higher level by winter 2015-16.

Pat Thornton is a supply and risk management expert for Propane Resources. He can be reached at pat@propaneresources.com or 913-262-0628.