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Trader's Corner
This week’s Trader’s Corner looks at how propane inventory and the relative value of propane to West Texas Intermediate (WTI) crude is trending. Do we change our supply strategy?
In one of our recent Trader’s Corners, we discussed the inventory trend and looked at the global prices of propane. Based on the rate at which the U.S. inventory surpluses were declining, the value of crude, the history of propane’s relative value to crude and the global price for propane, we suggested that propane valued at 55 percent to 65 percent of WTI crude by this winter was not out of the question.
All was going according to plan, with propane inventory surpluses going down. But, when winter demand weakened, the relative value of propane started to decline. Not surprising, but inventories were still coming down, so the 55 to 65 percent propane-to-crude theory remained intact. That was until last week, when propane inventory built more than normal for week 17 of the year.
If you recall last week, we discussed supply strategy. We suggested that a propane retailer might buy future supply needs based on the current inventory trend. We discussed that we can only base our supply decisions on what the market is giving us at any given moment.
Further, we discussed that we must adjust our strategy as conditions in the market change. Each day, when we come into the office, we must ask if the assumptions we made when taking supply positions remain.
It is important to understand that we are talking about supply that we have bought but have not yet sold. If we have bought supply to fill specific needs, such as a fixed-price offering to a commercial account, our margin is locked, making no adjustment necessary.
So let’s assume we have been doing a little buying for next winter, to make sure we have competitive supply, because of how the inventory trend has been going. We now have fresh data and should ask ourselves if we should continue with that strategy, put it on hold or even reverse some of what we have done.
In this evaluation, we will look at the relative value of propane to WTI crude and the propane inventory trend. The first chart is Belvieu’s relative value to crude and is followed by Conway’s. Click to enlarge.
The relative value charts show that propane has been improving in relative value to WTI crude this year. The overall trend is distinctly upward. However, since about the middle of March, the trend has been lower. Now let’s look at the current U.S. propane inventory position. Click to enlarge.
The inventory trend changed directions last week. It looked as if U.S. inventory would easily be back to the five-year average sometime in May after a long string of above-average draws and below-average builds in inventory. But last week, inventory actually built at an above-average pace for week 17 of the year, with a gain of 1.512 million barrels. The five-year average gain for week 17 has been 1.489 million barrels. It wasn’t much above normal, but it still broke the trend that was driving a lot of propane-buying decisions.
Last week, due primarily to strong imports, U.S. propane supply increased by 5,000 barrels per day (bpd). The big reason for the build in inventory was a 220,000-bpd drop in demand.
So, in recent weeks, we have seen propane’s relative values slip instead of move toward our theorized 55 to 65 percent range. Now the trend to pull down inventory surpluses has been interrupted. These are the kinds of events that should prompt us to ask if the assumptions we made when buying our supply remain true.
Depending on our answer, we could continue to buy for next winter, suspend buying or reverse some of the positions we have taken. At this point, the right play for many will be to suspend buying until it can be determined if the inventory above-average build was a one-week anomaly or the start of a new trend.
The slip in relative value could be more about timing and the price movement in crude rather than traders really seeing propane overvalued. Crude has a nice rally going right when propane is losing a lot of winter demand. The slip there is not surprising. On lower demand, it is hard for propane to find enough buyers to follow a sharp rally in crude. The key is to watch for a slowdown in the crude rally and see if propane improves in relative value. Especially look for propane’s resistance in following crude lower. If that occurs, we would not yet throw out propane’s 55 to 65 percent relative value of crude by beginning of next winter.
If these changes have shaken you to the core and you want to reverse positions or protect them, you have two primary options. If you have bought a swap or a pre-buy and are really convinced propane is headed lower, you should sell a swap against the barrels you have bought.
If you still feel like there is upside but are moderately nervous about more downside, you could buy a put option against your position. That could be a costly choice now because option premiums are higher the farther it is to the month of settle. So if you were buying put options to protect pre-buys or swaps you hold for the upcoming winter months, the premium might be a tough pill. Still, you could price the option and consider the positives of the flexibility it offers against the costs.
The absolute biggest mistake that propane retailers make is to speculate (take a supply position with no sale against the supply) on next winter’s supply and then never look at the position again, no matter what changes occur in the market. We absolutely must manage the risk using all of the latest information and tools available. If we do not, we have better odds at the nearest casino.
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
Crude was volatile but shook off fundamental weakness to move higher.
Propane had a strong finish to the week, but the fading of winter is having an impact.
We go into this week neutral. Propane has momentum, but we have a feeling fundamentals could catch up with this crude rally.
LAST WEEK'S DAILY HIGHLIGHTS
Monday: Crude went higher and Belvieu propane followed. Data on pending home sales and incomes helped support crude. Conway did not participate in the rally.
Tuesday: Propane prices were lower on low demand, outpacing a fall in crude. Worries about the euro zone hampered crude, as did a fall in Midwest business activity.
Wednesday: Above-average builds in propane and crude inventory sent both sharply lower. Crude inventory was up 6.7 million barrels and total U.S. propane inventory was up 1.5 million barrels. Weak data on global manufacturing activity weighed on investors as well.
Thursday: Crude reversed course, posting a near $3 gain after the European Central Bank lowered interest rates and on generally positive U.S. economic news. Weekly jobless claims were lower than expected, small businesses added workers and U.S. companies reported plans for fewer layoffs.
Friday: A better-than-expected unemployment report from the Labor Department sent commodities and equities sharply higher. Propane outpaced the strong rally in crude, extending its rebound attempt into a second day.
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