|
Click here for a free, 10-day trial of The Propane Price Insider!
Call Cost Management Solutions today at 888-441-3338 for more information about how Client Services can enhance your business or drop us an email at info@propanecost.com.
Trader's Corner
Propane is finding a new price field to play on.
Most of the calls from our clients and subscribers recently have centered on the reasons for the rise in propane prices. Of course, everyone wants to know: Will prices continue to climb or will they fall? That is such an easy question to answer – yes.
Markets cycle between periods of gaining in value to periods of losing value. Since propane has been on a strong run recently, the risk to the downside is increasing each day. At some point, the rally will exhaust itself and there will be a downward correction. It is not a matter of if; it is a matter of when, and that is where the question gets much more complicated. Then, of course, there is the problem of trying to determine how much the correction will be and how long it will last.
We don’t want to hear that, though, do we? We want someone to tell us that in 14 days, two hours and 17 minutes, propane will be priced at 95.375 cents and that will be the lowest price for the remainder of the year. At that exact moment and price, you should lock in all of your supply needs for this winter. We want our clients to succeed and we live each gut-wrenching supply decision with them. There is nothing we would like to do more than bring that kind of confidence and certainty to their life. If we could, we would, but we can’t. At best, we can try to bring insight into what is going on and help develop sound strategies to manage risks associated with the unknowable.
Strategies
There are many trading strategies to try and manage all of these unknowns and the risks they present. A strategy could be to buy short term to simply address the current momentum in the market. There could be strategies to buy long term, under the assumption the current trend will continue. Doing nothing is a strategy and, in the end, could be the best of all. One thing is certain: If you are waiting on all of the answers before making a decision, you will do nothing.
Let’s discuss what appears to be happening in the world of propane pricing. Hopefully you can use the information in your supply-buying decisions. Before we do, let’s try and establish some expectations that might make this discussion more valuable. If your goal is to buy at the lowest price of the year, the discussion is unlikely to help. Actually, we think that occurred about seven months and 25 to 30 cents ago. The more realistic goal is simply to try and assure we are competitive no matter what direction prices move.
We want to focus on where the market is now, what is driving it and then ask these questions: Am I more likely to be uncompetitive if I buy propane at its current price, assume my competitors do nothing, and prices fall? Or am I more likely to be uncompetitive if I don’t buy propane here, my competitors do and prices rise? You are better positioned to answer those questions than we ever will be because you can see how your competitors are moving their prices right now.
Just about every retailer tends to lag rapid price increases like we are currently seeing. But if street prices in your area are moving up fairly regularly, we would suspect your competitors have bought little propane. If fixed-price and cap programs seem to be a little late hitting the street, then your competitors are likely still on hold waiting for a pullback. If the opposites are true, then they are likely being more aggressive in covering future supply needs.
The big picture
Before shale gas production contributed to today’s supply glut, propane was valued at 70 to 75 percent of West Texas Intermediate (WTI) crude. When supply overwhelmed demand and infrastructure, propane fell in relative value, eventually trading between 30 and 35 percent of WTI crude. Changes in fundamentals had altered the “price playing field” where our game was being conducted. Now that infrastructure and the demand side, namely more propane consumption by petrochemicals and more exports, are catching up to the supply, propane is moving toward a new price playing field.
As we move to the new field, the normal oscillation in prices is all but gone. The movement is almost all upward, and technically propane is extremely overbought. Once propane is on the new field, we will see prices begin to oscillate again.
At the beginning of the year, we said there was potential for propane to revalue at between 45 and 55 percent of crude. That range was based on the fact that the primary changes in supply/demand fundamentals were coming from new export capacity, which makes the global price of propane more influential on the U.S. market.
We had hoped the new exports from the U.S. would bring down the global price, but so far it hasn’t. Propane has already reached the 45 percent level against WTI. Since the global price is not coming down, the risk remains that the price will gravitate up – toward the 55 percent of WTI valuation.
The thing that concerns us most in making that statement is that we are not completely sure how much the recent reopening of the Dixie pipeline after a long summer maintenance period is influencing propane inventory builds over the last couple of weeks. However, we know more export capacity is coming on line and current information is pointing to a good crop-drying year. So even setting the Dixie unknowns aside, there are some known upside price risks.
The charts below show the current movement in relative value for propane. Click to enlarge.
The move to the 45 to 55 percent valuation was much slower getting started this summer than we expected. Frankly we had about decided supply was going to keep up with the new export capacity. It did from March through June, making us think our 45 to 55 percent prediction was going to be well off the mark. But as the charts show, the shift is now underway.
There are short-term factors, such as the Dixie, that could explain the inventory pressures. This may not be a sustainable shift in propane’s relative valuation against crude. But there are plenty of factors supporting the possibility of a new “normal” relative value.
In greater demand
We looked at propane demand this week for our daily readers and it has nearly doubled since mid-June. Canadian inventory is 25 percent below normal, petrochemicals are hot on propane and recent data shows U.S. manufacturing activity increasing. Targa will bring on more export capacity in September and crop drying should be at least average. Those are all mid- to longer-term issues that will require propane supplies to catch up with the demand side.
Because there are enough mid to long-term factors at play, we still believe we are shifting to a new price playing field. We think that decreases the risk supply bought here will be a major mistake. Buying after a strong run is never good, and it certainly increases the risk that supply bought in this range could go under water for a while. If we do take positions here, we may want to shut them down by selling swaps if our view of the market changes. We can also buy puts if we think downside risk has increased after we take supply positions.
The bottom line is that we can’t ignore the current inventory trend, but because of the strong run to this point we have to exercise caution and diligence with whatever position we take. If you go long, then look at your reasons for doing so each day and ask if the assumptions you made have changed. If they have, you should consider reversing your position.
Call Cost Management Solutions today at 888-441-3338 for more information about how Client Services can enhance your business, or drop us an email at info@propanecost.com.
WEEK IN REVIEW
Another week of essentially no build in propane inventory sent both hubs up sharply. Crude rebounded on Friday, but could not overcome early-week losses that were primarily driven by traders taking profits before the U.S. Federal Reserve releases the minutes of its most recent monetary policy meeting. It looks like upside price risk could remain for propane until traders see a more normal build in propane inventory.
LAST WEEK'S DAILY HIGHLIGHTS
Monday: The previous week’s light inventory build continued to create buying interest in propane. There was separation from crude as crude went lower as traders worried more about the Fed announcing a tapering of its bond buying than all of the supply issues in the market.
Tuesday: It was an extremely volatile day for crude. Traders were trying to balance supply issues against the potential for a cutback in economic stimulus by the U.S. Federal Reserve. Crude eventually settled lower by 2 cents, which pulled propane lower.
Wednesday: The U.S. Energy Information Administration (EIA) reported essentially no build in U.S. propane inventory and another draw in Gulf Coast propane inventory, sending propane prices up sharply. Crude went lower despite a supportive EIA report. Investors remained mostly sellers of crude and equities ahead of the Fed meeting minutes release.
Thursday: The upward momentum in propane slowed, with prices at both hubs closing near Wednesday’s close. Positive news on Chinese, U.S. and euro zone manufacturing sent crude higher.
Friday: The upward pressure on propane prices resumed. Trade was volatile. A late run in crude, partially driven by a refinery outage in Canada that pushed gasoline prices higher, helped support late buying in propane. |
