Timing and opportunity

January 21, 2020 By    

In last week’s Trader’s Corner, we looked at the relationship between Mont Belvieu propane prices and Gulf Coast inventory levels. We noted that price and inventory are generally inverse. As propane inventory rises, prices tend to fall, and as inventory falls, prices tend to rise. But we also noted some exceptions.

One exception came in early 2016 when propane prices were increasing even while propane inventories were building significantly. During that time, propane traders were generally ignoring the inventory build because they believed that new export capacity would eventually start bringing down inventory. They were correct as inventory declined in the second half of the year, ushering in a general uptrend in propane prices that lasted until October 2018.

It is important to note, though, that the price uptrend that began in January 2016 and ended in October 2018 began before inventories started declining in the second half of 2016. This shows us that the price trend for a commodity can change well ahead of when the fundamental data actually reflects the reason for the change.

We had propane clients start buying three-year strips of propane in January 2016 because they saw the price trend changing. Had they waited on the actual decline in inventory that the new export capacity created, they would have missed much of the opportunity that the low-price environment of 2015 had created. Mont Belvieu propane had dropped to 30.125 cents that month and the overall uptrend that followed would not end until the price reached 110.25 cents in October 2018.

Obviously, the current fundamental conditions for propane are not supportive. Prices are once again trending toward those lows of January 2016. It would probably be best to wait for an indication the price trend is changing, especially if a longer-term position in propane is being considered, before buying. Nevertheless, if a propane retailer is going to take advantage of a similar opportunity that presented itself in January 2016, they must be prepared to act when they observe a trend change and conclude it is likely sustainable.

The primary reason propane prices are falling is too much production, little growth in domestic demand and inadequate exports to deal with the excess supply. Thus, propane inventory is climbing, and prices are falling. An obvious change in the fundamental conditions may be hard to detect anytime soon, but as we have shown, that may not mean that propane prices can’t start increasing well before the changes to fundamentals are obvious.

Let’s explore some reasons that propane fundamentals may be more price supportive by 2021. And remember, the change in price trend could happen in 2020:

First, U.S. propane exports are not running at full capacity. It’s hard to know what sustainable export capacity is since it is going to be below nameplate capacity. We believe the sustainable capacity should be around 1.3 million barrels per day (bpd). Exports averaged 1.164 million bpd in the final quarter of last year, after new capacity was added. That was up 129,000 bpd from the previous quarter. There was one week when exports were 1.538 million bpd, but we don’t think sustainable exports are anywhere near that number.

The United States and China signed Phase 1 of a trade deal last week. In that deal, China pledged to buy $52.4 billion in U.S. energy products. It is possible that U.S. propane exports will increase because of this deal. There is also more export capacity being added, which could make a difference if the demand is strong.

Second, in its Short-Term Energy Outlook, the Energy Information Administration reported that U.S. natural gas production was a record 92 billion cu. ft. per day (Bcf/d) last year. Production is expected to increase this year to 94.7 Bcf/d. Increased natural gas exports via pipeline to Mexico and waterborne LNG exports will drive the increase. However, falling prices and decreased drilling are expected to cause natural gas production to decline to 94.1 Bcf/d in 2021.

While there will be more natural gas production and thus more propane production in 2020, the growth should be interrupted in 2021. If at the same time propane exports are improving, there could be a reduction in the propane inventory overhang, which would likely lead to a rise in propane prices.

Third, natural gas processing provides 80 percent of U.S. propane supply, with crude refining providing the balance. The United States is expected to increase its crude production to an average of 13.3 million bpd this year. Production averaged 12.2 million bpd in 2019, up 1.3 million bpd from 2018. This year’s growth will only be 1.1 million bpd, and the rate of growth is expected to drop to just 400,000 bpd in 2021.

What is more important for propane supply than crude production is how much of it is being refined in the United States. The United States is exporting most of its new crude production. Refinery throughput is not increasing. Refinery throughput was 16.622 million bpd in 2019, which was down 356,000 bpd from 2018. Again, since propane is a byproduct of the refining process, it is refinery throughput that is important to propane supply, not crude production.

What is more, refiners are tweaking their systems to yield more higher-valued propylene than fuel-use propane if possible. While the strong economy could yield more refining throughput this year and next, the growth in propane supply from crude refining should be limited.

Finally, Canada is adding additional waterborne propane export capacity. It is also adding propane dehydrogenation (PDH) units that turn propane into propylene. While propane imports from Canada did not drop this year after new waterborne export capacity during the first half of the year, we know Canadian producers would like to avoid exporting to the United States if possible. Their netbacks when shipping to Asia are certainly better than what they get exporting to the United States, and they can get a lot more for propylene than propane with their new PDH units. The key will be how much their propane production grows as to whether there will be net change in propane exports to the United States.

These are the things we will be watching in 2020 to see if we see the possibility that propane supply could start tightening. We believe that propane retailers should make sure they are set up to take advantage of a potential uptrend in prices should fundamental conditions change.

In next week’s Trader’s Corner, we are going to discuss how propane retailers locked down their supply costs back in 2016 for three years to take advantage of the uptrend in propane price we discussed above. A similar opportunity could happen this year or next, and retailers need to be prepared to execute their plans quickly should that happen.

ANNOUNCING HEDGING SEMINAR: Please note that Cost Management Solutions will be conducting a two-day hedging seminar on March 19-20 at the Houston Airport Marriott. This seminar will provide tools and strategies for helping propane retailers navigate the changes in propane pricing in the coming months. Please contact Dale Delay at 888-441-3338 for more details.

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.

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