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Trader's Corner
What makes buying propane supply so difficult?
If you are a regular reader of Trader’s Corner, you know that many of our discussions recently have centered on the changing dynamics in propane production. The increase in production has caused dramatic changes in how propane is priced, how it moves and where it goes. Considering those changes alone makes anticipating the future price of propane a tremendous challenge.
Figuring out fundamental changes on the propane supply front and anticipating what they could do to propane pricing is actually the easiest part of supply evaluations. As propane retailers, if we have the information, we can get our arms around the impact of new propane production, or new infrastructure to process, transport or store that new production.
We may not be able to calculate the exact impact of a new petrochemical facility or a new export facility on propane supply and prices, but we can develop a feel or a sense of its impact. With enough information about supply, demand and infrastructure, we can probably make reasonable decisions on where we need to position ourselves supply wise. Plus, there is enough regular information for us to monitor how our assumptions are doing. If only that were the end of the evaluation process, we could dramatically cut down on our cost of sleep aids.
As you may recall, we equated the propane fundamentals discussed above as a rocket attached to the wing of a fighter jet. The fighter jet in our analogy is crude. The analogy is to illustrate that propane fundamentals (the rocket) are sometimes fired and go off in their own direction for a while, but the rocket is soon spent. It is the fighter (the price of crude) that often determines the altitude (price level) from which the rocket is deployed.
In the past, in discussing the influence of crude pricing on propane, our analogy was limited to a rocket and a fighter. For this discussion, we are going to take the analogy one step further.
The jet, a naval fighter, travels around the world on an aircraft carrier. The aircraft carrier in our expanded analogy is the equivalent of the global economy. The aircraft carrier can take the fighter anywhere in the world, where it can take off to a wide range of altitudes from which the rocket can fire in almost any direction.
The economy can take the price of crude all over the place. In addition, the price of crude can go higher or lower based on its own fundamentals and geopolitical events, while propane prices can go higher or lower in relative value to crude based on its own fundamental situation.
So now, as propane retailers, we are going to make a handful of supply purchases between now and next winter that are supposed to predict where the rocket will be at some point in the future.
As we write this article, crude prices are dropping sharply. Prices have fallen about 5 percent in less than three days, primarily on speculation over what the U.S. Federal Reserve will do concerning monetary policy.
The Federal Reserve made it clear that it is not changing its policy of buying $45 billion in Treasury bonds and $40 billion in mortgage-backed securities each month to help stimulate the U.S. economy. Nor is it going to change the interest rates it charges banks. In other words, there was no change in monetary policy at the last meeting. The movement down in crude oil is due to minutes of the last meeting, which showed more detailed discussions of when policy changes might occur, what would drive the changes and how the changes might be rolled out. Those discussions alone caused the altitude of the jet to adjust down 5 percent.
The recent runup in commodities and equities values has been dubbed the “central bank bubble.” The world bubble causes us to have involuntary twitches. References to the tech bubble, the housing bubble and other bubbles tend to put investors in a defensive posture. In general, bubbles are formed based on artificial influences or unrealistic expectations. Investors generally support the expansion of a bubble because they see everyone else getting rich while they sit on the sidelines. Invariably all but a few get burned with the bubble bursts.
The low interest rate and bond buying of the Federal Reserve have driven down the returns of safe-haven investments and essentially forced investors into higher-risk investments, such as commodities and equities to get a return. Many need good returns to recover from huge losses caused by the housing bubble.
Equities indexes are at record highs. Yet we get data that the economic recovery is on a long, slow slog – at best. A disconnect seems to exist between reality and valuations. That feels kind of bubbly, doesn’t it?
That makes one wonder in what direction the aircraft carrier is traveling. What hemisphere will it be in this winter?
So, if you are a retail marketer and you know in what hemisphere the aircraft carrier will be traveling, in what altitude the jet will be flying and in what direction the rocket will be going this winter, you should take all of your supply positions now and then forget about them.
The rest of us will have to do this: First we make an assumption on where the economy is headed. We make an assumption on what the value of crude will be. We make an assumption on where propane fundamentals, such as inventory, exports and production, will be by this winter.
As bad as we hate it, we have to make assumptions – hopefully with a little knowledge and education behind those assumptions. We then hope our assumptions are correct, because if they are then our initial supply moves will be correct and we should make more profit. But the wise trader also assumes all of his assumptions will not be correct and that adjustments will undoubtedly have to be made as more information on the route of the aircraft carrier, the disposition of the fighter and the direction of the rocket are known.
Unfortunately very few of us will have the luxury of making just three or four supply decisions between now and the end of next winter. Most of us will have to make many decisions, as we adjust to the information that comes our way.
As daunting as the task may seem, if we make educated assumptions to guide our initial actions and then be diligent in adjusting our supply positions as things develop over the next few months, we should meet our goals. Remember what we said is a realistic goal? Is it to buy at the cheapest price of the year, every year? If that is the goal, we will never make a decision. The realistic goal is to have competitive supply.
If we are willing to accept that we can’t know the future and will therefore have to adjust as the future is known, if we understand the tools available that allow us to make adjustments along the way, we can confidently make the decisions that allow us to meet our goals.
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 moved lower on weak fundamentals and the possibility that the U.S. Federal Reserve could end or reduce its economic stimulus later this year.
Propane fell with crude and on a bearish Energy Information Administration (EIA) report.
We went into the week bearish, with neither crude nor the latest inventory data supportive of propane.
LAST WEEK'S DAILY HIGHLIGHTS
Monday: Propane started the week by ending its three-day uptrend that developed the previous week following a supportive EIA report. Crude managed to post a gain largely on the growing complexities of the civil war in Syria that is threatening to overflow into a broader Middle East war fought along sectarian lines between Sunnis and Shiites.
Tuesday: Belvieu continued to give up value, though Conway recaptured some of the steeper losses it had suffered on Monday. A strong dollar and investor conservatism ahead of Federal Reserve Chairman Ben Bernanke’s testimony to Congress had crude giving back most of its previous day’s gain.
Wednesday: The downward pace of propane picked up following a 2.177-million-barrel build in propane inventory reported by the EIA. The build was higher than the five-year average for week 20 of the year. Crude also retreated following a large build reported in gasoline inventory. Also, minutes of the last Federal Reserve meeting pointed to increased consideration of when and how the Fed would begin to wind down its economic stimulus.
Thursday: The week’s trend of falling propane prices continued. A carryover from the release of the Fed minutes on Wednesday that revealed more consideration of ending economic stimulus, along with weaker Chinese manufacturing data, held crude to near Wednesday’s close.
Friday: Investors continued to shed riskier assets on fear a commodities and equities rally that has largely been fueled by accommodative monetary policies by central banks may be nearing its end. Propane largely tracked the ups and downs of crude.
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