|
Click here for a free, 10-day trial of The Propane Price Insider!
Call Cost Management Solutions today for more information about how Client Services can enhance your business at (888) 441-3338 or drop us an e-mail at info@propanecost.com.
Trader's Corner
This week’s Trader’s Corner looks at how propane prices are tied to crude prices.
Many readers wonder why we spend so much time analyzing crude markets and go on about the relative value between propane and crude. Some believe there is no correlation between crude and propane prices.
With propane so deeply discounted to crude, especially last year, it was not easy to see the correlation. In fact, there have been considerable periods of separation where propane and crude prices did not track each other well.
Nevertheless, there is a long-term price connection between the two energy sources. The price chart below (click to enlarge) converts crude to an equivalent-Btu value. Since propane is priced in cents per gallon and crude in dollars per barrel, it is sometimes difficult to do a price comparison. By looking at the Btu values, it is much easier to track the price correlation. The comparison is made even easier when crude is changed to a propane-Btu equivalent.
When you look at this chart, just imagine that you went to the local Btu store with three bags. You tell the clerk at the Btu store that you have $15 to spend and would like $5 worth of Conway Btu, $5 worth of Belvieu Btu and $5 worth of crude Btu.
It is easy see that the Conway Btu has generally been the cheapest, Belvieu the midrange and crude the premium Btu. So if we bought $5 worth of each, we would go home with more Conway Btu than the others.
So in general, we can say that propane has been a good-value Btu. We can see it was an exceptionally good value last summer. During that time, some argued that propane was not pricing relative to crude – to some degree that was correct.
However, if you look at the price trends of each of the Btu sources, you will see that by and large, even last summer, there was a correlation in the values. They are not always in lock step, but there is a general flow that represents a strong pattern of connectedness.
Frankly, your job as a propane buyer would be much easier if this connection didn’t exist. If we could simply look at propane supply-and-demand fundamentals, our job as propane buyers would not be so daunting.
But, no – it’s just our luck that our commodity is attached to a globally traded, volatile commodity such as crude that often trades in ways that belies its fundamentals. Crude has become an investment class all its own, with plenty of speculative buying to spice it up.
We have often used the analogy that crude is like a fighter jet and propane is like a rocket connected to the wing. Sometimes the rocket fires off from the jet and does its own thing, but ultimately it is carried to the theater of battle by the jet. Propane can do its own thing and can certainly be influenced by its own fundamentals, but the ultimate price level upon which propane will trade is greatly influenced by crude.
Given the reality, a propane retailer might decide to hedge his supply using crude futures as opposed to propane futures. But there is the worry that the rocket could fire off in its own direction for a while and cause the hedge not to perform well.
Another approach is to play the value spread between propane and crude. In this case, you don’t care which way prices go. You just care about the relative value between the two Btus.
The key is using history to determine which Btu seems discounted to the other. To make the spread play, you want to buy the discounted Btu and sell the premium Btu.
We have been discussing propane’s relative value to crude, which is currently around 40 percent. Last summer, it was much lower, around 30 percent. If you believe that propane is destined to trade at higher relative values to crude in the future, due to more export capacity, high petrochemical consumption and the current inventory trend, a spread play would be something to consider.
To make the play, you would buy propane futures and sell crude futures. The nice thing about spread plays is that you really don’t care which way prices move. You don’t have to predict price direction. What you are betting on is that the price relationship will get closer to normal. What makes that a little easier is that fundamentals tend to play a more important role in the relationship, which can make it a little easier for us to evaluate.
It is hard to know what geopolitical or economic events will do to crude. It is much easier for us to keep a close eye on propane’s fundamentals and predict if propane is likely to trade at a higher or lower relative value to crude at some point in the future.
That brings us to the greatest challenge of the spread play. If you believe the value relationship is out of whack and that it will eventually correct to a more normal condition, the key is deciding when that correction will be complete. And, of course, with so many moving parts in the propane supply/demand chain, it is important to decide what is the “new normal.”
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 had another volatile week, with little net price movement. A lack of a fundamental basis for the current rally is undermining confidence.
Propane got support from the inventory numbers, but still could not find enough buyers to push prices higher in Belvieu. Conway managed a gain for the week, but remains priced below Belvieu despite the Midwest inventory position being well below normal.
We go into the week neutral. The market is struggling to find direction.
LAST WEEK'S DAILY HIGHLIGHTS
Monday: Conway propane prices increased sharply on heavy trading volume. Israel conducted two airstrikes in Syria, increasing Middle East tensions. Germany’s business activity contracted during April, limiting the upside for crude.
Tuesday: Demand for propane – some of it potentially from international buyers – eased, interrupting the uptrend. Less than supportive fundamentals began to take away the aggressive buying of crude.
Wednesday: A light build in propane inventory sent propane prices up sharply. Both hubs easily outpaced crude to the upside, even though the Energy Information Administration reported a light build in crude inventory. The U.S. and Russia announced they were setting aside differences to try to broker peace talks between Syrian President Bashar Assad and his rivals.
Thursday: Propane gave back some of Wednesday’s big gains as the market struggled to find a sustainable price direction. Despite jobless claims falling to a five-and-a-half-year low, crude prices retreated as traders struggled to ignore a weak fundamental basis to the recent rally.
Friday: Crude fell hard in early trade, but managed to erase the bulk of the losses by the close. To a large degree, propane followed the movement in crude. Conway struggled to find enough buyers to rebound from its lows, but prices there actually finished up for the week.
|
