Propane market surprised by inventory draw

August 25, 2020 By    

We ended last week’s Trader’s Corner with the following statement: “The developments within crude production are a threat to the continued recovery in propane supply. If that threat is realized, it could develop into more fundamental support for propane prices. With the rapid recovery in propane production and some weakness and threats to propane exports, it’s justifiable to be bearish about propane. That is especially true given the low outlooks for crop drying and winter heating demand.

But be careful you do not write off the potential for a higher price scenario for propane prices too quickly. Watch the developments in crude production and pricing carefully and see how that translates to propane production and pricing leading up to winter. There may yet be a need to add more price protection ahead of this winter.”

Chart: Cost Management Solutions. Click to expand.

Chart: Cost Management Solutions. Click to expand.

As fate would have it, this week’s Weekly Petroleum Status Report from the Energy Information Administration (EIA) provided some justification for the warning. The EIA reported a surprising and unusual draw of 41,000 barrels in U.S. propane inventory. The draw came with industry analysts expecting a 2.31 million-barrel build during a week that has averaged a 2.6 million-barrel build over the past five years.

As the chart shows, propane inventory is usually building this time of year, with draws starting in September or, more typically, October.

A key reason for the draw was a sharp drop in domestic propane production – just what we were concerned about when making our statement last week. The drop took propane production from just 141,000 barrels per day (bpd) below the record high, set during the first week of January, to 260,000 bpd below. There was also a rise in propane exports and a drop in propane imports that contributed to the draw.

Chart: Cost Management Solutions. Click to expand.

Chart: Cost Management Solutions. Click to expand.

Propane markets did not panic when the draw was revealed. We think the skeptical view of the draw was warranted. It also tells us just how little buying pressure is in propane markets right now. Buyers are simply not motivated. It is going to take a lot more than one week’s worth of supportive data to change market bias.

Crude production had dropped 400,000 barrels over a two-week stretch and stayed flat for the week ending Aug. 14, the latest data available. Our concern right now is that this drop could be an indication of systemic weakness in U.S. crude production that could result in less propane supply. We are seeing more and more bankruptcies and mergers in the U.S. oil sector. We are also seeing crude drilling decline despite some improvement in crude’s price.

The drop in crude production at this point may not be producers shutting in more producing wells. It could be there is less production because the lack of drilling is not replacing depleting wells. Wells drilled in shale formations deplete rather quickly compared to conventional wells. Much has been done to improve the efficiency and productivity of wells drilled in shale formations, but their depletion rate remains relatively fast.

Chart: Cost Management Solutions. Click to expand.

Chart: Cost Management Solutions. Click to expand.

Nonetheless, we can see just how quickly market dynamics can change and why, as potential propane buyers needing to protect ourselves and our customers from higher prices, we must be diligent in staying on top of fundamental data.

What prompted us to share our concerns last week was the drop in crude production we witnessed in the two prior weeks. Much of our propane supply comes from the natural gas liquids that are associated with the production of crude wells. Of course, natural gas liquids come from the production of purely natural gas wells that do not produce crude. But sometimes we forget about the associated natural gas that comes from crude production. Indeed, most of the increase in natural gas production and natural gas liquids production in recent years has come from the surge in U.S. crude production.

In our view, the propane market got it right by not overreacting to the unusual draw on inventory. As we have said before, it is generally best not to respond to an anomaly. It is prudent to make sure it is not a one-off event, even if that means we leave a little opportunity on the table as we wait for a more definitive trend to develop.

Still, our concerns for the health of the U.S. oil industry and the potential impacts to U.S. propane supply are very real. In June, propane inventory was even compared to the same time last year. Then, inventory built to about 6 million barrels more than last year during July and August. With this surprise inventory draw, inventory is suddenly just 2.8 million barrels more than last year. If nothing else, last week’s data shows just how fast market dynamics can change, so please guard against becoming overly complacent in monitoring propane and crude fundamentals. It is very easy to get lulled to sleep by propane staying very close to the 50-cents-per-gallon benchmark established for weeks on end. The benchmark will change. It is simply a matter of when.

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