Your behavior appears to be a little unusual. Please verify that you are not a bot.


Strategies for managing rapidly rising propane prices

September 21, 2021 By    

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, presents short-term price protection strategies as propane prices rise.


Chart 1 plots Mont Belvieu LST and Conway propane closing prices since January 2020.

Chart: Cost Management Solutions

Chart 1: Cost Management Solutions

Mont Belvieu (MB) LST closed Thursday, Sept. 16, at 132.75 cents and Conway at 133.5 cents. That is in stark contrast to the near 20-cent lows set in March 2020. Just one year ago, propane was at 52 cents MB LST and 45.25 cents Conway. MB LST has been as low as 73.75 cents and Conway 70 cents as recently as April of this year.

Propane is currently trading at highs for the year, even taking into consideration the “spike” in Conway prices in February during the winter storm. This kind of price appreciation makes it very difficult to pull the trigger on price protection for this winter. Even though propane’s fundamentals and outlooks for crude’s price suggest higher prices are possible, it’s hard to will oneself into buying propane at this price point.

Frankly, we can’t blame anyone for feeling that way. It seems every time propane retailers succumb to the pressure of the market in these situations, they get burned. All of the bullishness that is in the market will somehow disappear by the end of winter. Honestly, it’s hard to see how that is going to happen this year given the low-inventory conditions and continuing robust export rates. Still, it seems inevitable that if a retailer buys price protection at this point, they will regret it by the end of winter.

Perhaps that last statement is a clue to how a retailer that is feeling doomed about buying price protection here should be approaching the situation. Let’s stop trying to predict the winter and just let the current conditions dictate our action. Over the next couple of Trader’s Corners, we are going to look at short-term strategies for dealing with rapidly rising propane prices.

These short-term price protection strategies can be much more important than we realize. History shows that in a rapidly rising propane market, retailers tend to be slow in passing on the higher supply cost. As a consequence, retail margins tend to shrink during rising price environments. One might think it will be made up when prices fall, but history shows that is rarely the case. The bottom line is that retailers are slow to pass on rising prices and quicker to pass on falling prices to their customers.

Price protection tools

There are three financial tools that have traditionally been used to address this tendency and protect margins. The first is to buy a call option, and the second is to use “paper barrels” – better known as “physicals.” The third is buying a swap. We will look at call options first.

Frankly, the premium on call options at this time is going to make them unappealing to many retailers. However, they are simple, straightforward and require the least attention from the retailer. Those are not insignificant positives given retailers will have a lot on their plates in the coming months. Still, we think physicals and swaps will be preferred by most under current conditions.

Look at a call option as insurance against rising prices. A retailer pays a premium, thereby transferring the risk of higher prices to the option writer. The option is most often set or struck at the market price for the month that protection is desired. When this is done, it is called an at-the-money or ATM call option. When markets are fairly calm, and the ATM call option bought just before the month to be protected begins, the premium can be around 3 cents per gallon.

Retailers that use this strategy on a regular basis simply add the premium to their price structure and set prices for the month. Their margin is protected, and risk to rising prices is transferred to the option writer.

The settlement for the call option is very similar to the swap buy that we have covered often in Trader’s Corner (see our 10-part series on swap buys that ran from April 30 through June 25). The option holder buys the option at a certain strike – let’s say 133 cents – and pays a 3-cent premium. The option settles against the monthly average. If the monthly average is greater than 133 cents, the option holder receives the difference. If it settles below 133 cents, the option has no value, and the holder receives nothing. Look at the 3-cent premium for price protection as an expense, just like you would property and liability insurance protection.

An option struck at 133 cents with a 3-cent premium breaks even at 136 cents. What the insurance will do, even if not needed, will be to limit the holder’s exposure to higher prices to the premium cost of 3 cents. If the retailer adds the premium cost to his retail price structure, he knows he can set a retail price for the month and not worry about rapidly rising prices eating into his margin.

As we write, an October ATM call option at MB LST or Conway is striking at 133.5 cents, with a premium of 8 cents. The high premium at this point certainly reduces its appeal, as it would take propane averaging 141.5 cents during October for the holder to break even. Before you write this premium off as total insanity, consider that propane is up 17.25 cents so far in September.

The premium cost should come down as we get closer to October. Also consider that with an option, the holder is free to lower retail prices should prices fall. Remember with a swap or a pre-buy, we can’t really lower prices or we cut into our margin. Because of currently rising prices, we don’t expect the premium for October to get anywhere near 3 cents that might be typical in a calmer pricing environment, but if a little is shaved off the premium by the end of the month, it may become more appealing.

Next week, we will compare using the physical for short-term price protection. As a final note, anytime we are in a rising price environment, we believe propane retailers would benefit from purchasing swaps, physicals or call options at the end of any given month to establish a price and protect margins for the upcoming month. This counters the tendency to lag passing on price increases to our customers. When the market starts trending lower, the retailer can suspend this practice.


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.

Comments are currently closed.