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Trader's Corner

This week’s Trader’s Corner discusses how financial tools and physical activity are separate, yet work together to provide retailers and their customers control over unpredictable propane prices.

Last week, we completed our second hedging workshop of the year, which was held in Columbus, Ohio. As always, it was very enjoyable to spend time with propane retailers to discuss how to meet the challenges that face our industry.

We have been doing these workshops for about nine years. How we approach teaching the concepts and what concepts we are teaching has evolved over the years. But it has not been just our teaching concepts that have evolved over this period. Propane retailers’ understanding of the hedging process and how it is used effectively in their businesses has evolved as well.

We now have folks in attendance who have been applying these hedging tools for a while. Their ability to apply these tools to resolve supply price management problems and deliver more predictable pricing to their customers is quite remarkable.

But there are also propane retailers in attendance who are taking their very first steps in understanding these concepts and how to apply them. At the end of the first day of the workshop, one of those retailers came to us and said he was lost.

He had spent the day hung up on one very common problem that had made it difficult to understand how the hedging process fit with what he was already doing on the supply side of his business.

A good teacher has to meet his students where they are in their level of understanding. Frankly, we got ahead of this retailer’s level of understanding early on, making a common teaching error of not confirming that each attendee was clear on some basic concepts that must be in place to avoid confusion as we moved deeper into the hedging process.

As we met with this retailer after the workshop and better understood his level of understanding, we were able to meet him where he was and bring him forward. As the one-on-one discussion progressed, we could see the lights coming on for this retailer. The confused, strained face that was there at the beginning was replaced by smiles and a sense of excitement.

There were two key points that had to be addressed and once they were, this retailer was off to the races. The first was how the value of propane is established in the first place. For this retailer, the value of propane was established by his supplier at the supply point near his business. The factors that went into establishing that price were not transparent to him, however.

We needed to take this retailer all the way back to the hub and build the price of propane from there to his location. That is a key concept in understanding how the hedging process works, because the financial hedges will trade and settle on the value of propane at the hubs. But the value of propane at the hub is not the value of propane where you buy your supply.

So we went back to Mont Belvieu (or it may be Conway in your case) and discussed what makes Mont Belvieu unique and why it is a hub in the first place. We then talked about the trading activity that goes on there that establishes the value of propane.

The trading activity establishes not only the value of propane on any given day, but also the value of propane in the future. So each day, buyers and sellers agree (using their composite knowledge of all things that affect propane’s value) on the value of not only propane currently (in this case, in June) but also on the value of propane for months into the future.

Once we clarified how that works, we discussed the reasons that the value of propane in his market was higher than the value at the hub. We talked about pipeline tariffs, loading fees, wholesaler margins and other factors that establish propane prices at a pipeline terminal near his business. We also explained that propane made at natural gas processing plants and refineries in his area would be priced relative to the pipeline that connected back to Mont Belvieu. Moving his focus on supply away from where he picks it up, all the way back to the hub where the value is really established, was a major step and paved the path to understanding how hedging works.

The second key point to clarify was that the process of getting propane into his tank is not altered or affected by the financial hedging process. The two processes are completely separate and one does not affect how the other is done. The physical process of getting propane in your bulk tank does not change, whether you use financial tools or not.

However, when you combine the physical activity and the financial activity, you are able to establish known pricing outcomes. Very simply, the job of the financial tool is to counteract changes in the price of the physical propane.

For example, as we write this, the value of propane for December is established at Conway at 105.75 cents and Mont Belvieu at 104.5 cents. If the retailer likes that price, he can own that price in December by using a financial tool that will offset changes in the price of propane between now and then.

The value above (say 104.5 cents for Mont Belvieu) is where buyers and sellers are striking deals for December Mont Belvieu propane. If a retailer likes that price, he can own it. He can then use that strike price and what he knows about the difference in value in propane between Mont Belvieu and his location, plus his margin, to fix a price to his customers for next December.

Let’s say the retailer buys a December swap with the strike price of 104.5 cents. If prices in December are higher than this strike price, his counterparty will pay him the difference. If prices are lower than 104.5 cents, he will pay the counterparty the difference. Regardless whether prices actually rise or fall, the value of propane between the two parties in this swap transaction will be 104.5 cents in December at Mont Belvieu.

As we know, none of us has any idea what he will actually pay a supplier to get physical propane into our bulk tank next December if we are buying at market prices. What we do know is that the price he will pay will reflect the value of propane at Mont Belvieu. Since he has fixed his sales price to his customer, if what he pays his supplier is higher, he will make less of a margin on the physical sale to his customer.

However, the payment from his counterparty on the swap deal will offset or counteract this. When the financial and physical results are combined, the retailer will make the same margin he set when he made the sale.

If prices go down, the retailer will pay less for his physical propane than he expected. Because the price to the customer is fixed, he will make more of a margin than anticipated. However, he will use the extra margin made to pay the obligation on the swap. Since prices are lower, the price of December propane at Mont Belvieu will be lower than the 104.5 strike price and the retailer will pay the difference.

Although they operated completely separate, once the outcomes of the physical and financial activities are combined, the retailer will make the same margin he set when he made the sale to the customer well in advance of December, no matter which way prices move.

It is very important to understand in our discussion that we establish a connection between what we pay for physical supply in our market with the hub (Mont Belvieu or Conway) that sets the price for our location. That is why it is important that you buy from your supplier at an index or fixed differential with the hub.

For example, with the retailer we were talking to, the pipe tariff between Mont Belvieu and the terminal on the pipeline in his area is 17 cents. If we add loading fees and wholesaler margins, we would expect to pay Mont Belvieu plus around 20 cents FOB the pipeline terminal. In his case, we would add around 8 cents transportation costs to our location. Total cost to get it to his tank, if buying on index, would be 28 cents. By knowing this, he can add that number to any financial deal made at Mont Belvieu, plus his margin, and know what price to sell to his customers. We really can’t do that if we are buying at posting or in a way that does not have a fixed relationship to the hub.

You can manage the cost of the propane you sell to your customers; it isn’t as hard as you think. There are ways to manage the cost where you are not taking a risk to provide the known price to your customer.

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
Crude prices have been falling because there is greater hope that the situation in the Ukraine is going to be resolved without Russia taking more territory in that country. Propane inventories continued to build at a very high rate. That will have us bearish going into this week.

Monday: Propane prices fell in early morning trading and continued to fall throughout the day. West Texas Intermediate (WTI) crude fell on economic news and production increases.

Tuesday: Both hubs posted a small gain following crude’s lead. WTI posted a 0.19 percent gain while propane outpaced crude, with Mont Belvieu being at 0.48 percent and Conway at 0.32 percent.

Wednesday: Propane prices fell at both hubs after the Energy Information Administration reported the sixth above-average inventory build in a row. Crude inventory fell 3.4 million barrels against expectations of a decline of just 300,000 barrels.

Thursday: Both hubs started out weaker early, but Conway ended up closing slightly higher and Mont Belvieu held onto its losses. WTI posted a loss on the day while Brent crude actually turned positive.

Friday: Propane and crude prices held fairly steady to close out the week. Crude prices were buoyed by a good jobs report. Propane was lightly traded and followed crude.

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Cost Management Solutions LLC (CMS) is a firm dedicated to the analysis of the energy markets for the propane marketplace. Since we are not a supplier of propane, you can be assured our focus is to provide an unbiased analysis.

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Mark Rachal 888-441-3338,

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