It’s actually good when price protection doesn’t pay off

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, shares a lesson about price protection he learned from “Charlie and the Chocolate Factory.”

Catch up on last week’s Trader’s Corner here: Falling domestic propane demand

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Our routine is to write Trader’s Corners on Friday mornings. It gives the full week for the market to give us inspiration for a topic. But last week’s article was written on Thursday because we had to leave Friday morning open to attend our grandson’s play. The play was “Charlie and the Chocolate Factory,” and he had two parts: a boy in a candy story and an Oompa Loompa.

For the few who don’t know, “Charlie and the Chocolate Factory” is a story about an eccentric chocolate maker named Willy Wonka who schemes to bring five youngsters to his factory for a special tour. The way to win a tour is to find a golden ticket in a Wonka chocolate bar. What no one knew was that Willy Wonka planned to give the chocolate factory to the one of the five children he believed to be most deserving.

Of course, children used every penny they could scrape together to buy Wonka bars in hopes of securing a golden ticket during the allotted time of the contest because there was absolutely no one in the world that didn’t want a tour of the factory that designed and produced so many magical candies. People were buying millions of bars, so the odds were long on purchasing one of the coveted golden tickets.

Thus, our grandson’s first scene:

Three boys go into a candy store, and each buy a Wonka bar. Our grandson goes last and doesn’t get a ticket. He dejectedly says, “This is hopeless.” I was proud because my first thought was that he had channeled his grandpa when saying his line. It is one I use often when fishing for bass.

Before we go further, you are probably wondering what is wrong with this guy that he is thinking about a possible article on propane when watching his grandson’s play. First, if I had a counselor, that would be between me and her. Second, I don’t have a counselor because I don’t want to face the reality of what this must mean about my life. Let’s move on, shall we?

The boys being disappointed that they didn’t buy the candy bar with the golden ticket reminded me of propane retailers that take a swap or pre-buy position and are disappointed when it doesn’t pay off.

When a retailer takes a swap or pre-buy position, they are establishing a worst-case scenario for propane prices for a specific period. If a propane retailer bought an October 2025 swap position on March 6, the strike would be around 79 cents. If the swap bought had a volume of 40,000 gallons, then the retailer has just established the highest price, FOB Mont Belvieu (MB), Texas, that he will pay for propane on those 40,000 gallons during October 2025.

If the monthly average for propane in October 2025 at MB is higher than 79 cents, the retailer will get a check from the swap provider for the difference, bringing the net cost down to 79 cents. Let’s say the month’s average is 80 cents. That is what the retailer will pay to his physical supplier in MB (or along a pipeline terminal coming from MB plus the pipeline tariff). But they will receive a check for $400 from the swap writer that will bring the net cost back to 79 cents.

Conversely, if the monthly average turns out to 78 cents, the retailer will pay 1 cent lower than planned for the physical propane supply, but they will have a $400 loss on the swap. The extra money made because the supply cost was a penny less will be used to pay a loss on the swap. That is exactly the moment the propane retailer will say, “This is hopeless,” meaning buying price protection using swaps and prebuys is hopeless, stupid and dumb.

But unlike the boys in the candy store, where getting a golden ticket was the only acceptable outcome, not getting a payout on a swap position is probably the best possible outcome for a propane retailer. Making such a statement must mean we have eaten too many chocolate bars, which is true, but that’s beside the point. The boys were investing all their money in Wonka bars, but propane retailers would never do such a thing.

Propane retailers buy a relatively small amount of price protection to mitigate some of the impact on their customers should propane prices blow out to the upside as they did in January and February. To fully protect the customer from higher prices, the retailer would have to buy price protection on all their gallons, thereby assuming too much risk of falling prices. A risk they should never, ever, never take.

We would say in a year when the market provides a lot of good points to step in and buy price protection at good values. The most of their projected sales volume that a retailer should price protect is 40 percent. Many years, it would be less – sometimes far less.

In this case, anytime our swap and pre-buy positions do not pay out, it means the retailer is paying less for 60 percent or more of their supply. That means propane prices are low, which is good for the retailer and his customers. It means our propane customers are probably getting relatively low propane bills and are content.

When we take a swap or pre-buy position, we think we want the golden ticket, but it is actually better if we don’t get it. Yes, we will have to deal with a higher price on some of our supplies than if we had not taken any price protection, but that is a far better environment and situation to have to deal with than if prices are blowing out to the upside.

Spoiler alert: Four of the five kids who won the golden tickets turned out to be spoiled brats who met some nasty ends during the tour of the chocolate factory. One was swept away by a raging river of chocolate. One chewed gum she was told not to, then inflated and floated way. Another was shrunk. Oompa Loompas worked in Willy Wonka’s chocolate factory, and each time the spoiled kids got their just desserts, the Loompas would sing a little tune saying they should have listened.

Only one kid, Charlie Bucket, was not totally spoiled and tried to do the right things, and Willy Wonka wound up gifting him the chocolate factory. Unlike the other children, Charlie was a poor and humble kid. He had learned that things may not always work out the way you think they should, but in the end, they may work out the way that is best.

So, the next time that swap or pre-buy position doesn’t pay off, imagine a little Oompa Loompa singing you a song reminding you why you took the price protection in the first place. It’s about managing supply-side price risks, and our biggest reward is likely to include a much smaller and manageable disappointment as a part.

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