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Click here for a free, 10-day trial of The Propane Price Insider!
Dear Propane Price Insider readers:
On Oct. 6, your PPI newsletter is getting a makeover. In addition to a fresh redesign, the newsletter is undergoing a name change. It will be called Trader's Corner. The new name will reflect the strategic role that propane marketers play – deciding when to buy and sell their supply in order to protect customers in a volatile energy market and maximize business profits. Please be on the lookout for this name change in your inbox so you won't miss this valuable weekly propane market report.
Trader's Corner
This week’s Trader’s Corner discusses basis risk and the importance of index pricing for retailers.
In the four most recent Trader’s Corner newsletters, we filled a toolbox with the hedging tools a propane retailer can use to manage just about every supply-cost management issue. In this Trader’s Corner, we are going to discuss an important element that ensures those tools can function properly.
At the end of last winter, U.S. propane inventory was very low. Fortunately, inventories have recovered nicely this summer. U.S. propane inventory reached 101 percent of its five-year starting-winter-inventory position this past week, with the opportunity for inventory to build another eight weeks before demand is high enough to start drawing on those inventories.
Gulf Coast inventory is 115 percent of its average position for the beginning of winter. Inventories have even been high enough to create issues related to high storage positions.
Midwest inventory is lagging at just 83 percent of its pre-winter target of 27.5 million barrels. Inventory needs to build 4.61 million barrels to be at its five-year average for Oct. 1. That certainly is still possible. Midwest inventory is 2 million barrels above where it was at this point last year, so at least it should begin the winter in better shape than last year.
All of this propane inventory can give a sense of security concerning supply and optimism that propane prices will stay under control this winter. However, as last year demonstrated, adequate inventory at the hubs does not necessarily mean supply will be where it needs to be and prices will be tame. Last season, inventory was plentiful in Mont Belvieu, but prices at distribution points fed from Mont Belvieu were much higher than their traditional spread, or differential, to Mont Belvieu.
Financial activity
Mont Belvieu, Texas, and Conway, Kan., are the trading centers for U.S. propane. All of the hedging tools we discussed over the past four weeks will price and settle based on the prices at one of these two trading centers. If the price of the propane retailers buy locally is based off of Mont Belvieu, they would enter into financial agreements at Mont Belvieu. If their local supply is based off of Conway, they would enter into financial agreements that will price and settle against Conway.
Buyers or sellers of these financial instruments have to be in the energy business to trade propane at these hubs. If they are not in the energy business, they likely are using these tools to speculate. Large banks and other institutions can enter into financial positions that will settle based on prices at these hubs.
Physical activity
Because propane retailers physically distribute propane to consumers, they do not have to use the financial tools strictly for speculation; they can use them to hedge.
Hedging means retailers use the financial instruments to counter, or offset, the price changes to the physical supply they buy. The physical activity of buying propane supply from a pipeline terminal, storage location, refinery or gas plant and moving it to end-use customers is a completely separate activity from the financial activity conducted at the trading hubs.
The physical and financial activities are completely separate activities, yet they work together to produce predictable results concerning supply cost. Understanding how these two activities are separate yet work together, generally gives retailers the most trouble when trying to understand the hedging process.
Over the years, Trader’s Corner has given many examples of how physical and financial activities work together, and it will include many more in the future. We will not give another here, however, because we don’t want to distract from the key point of this edition of Trader’s Corner.
Although the financial and physical activities are totally separate, they do need to share a common trait that allows them to function together at their best. The price retailers pay for propane at their physical supply point needs to be directly related to the price at the trading hub.
The financial instruments used to manage supply-side risk and yield predictable results to retailers will price and settle against the price at the specific trading hub: Mont Belvieu or Conway. Therefore, it is extremely important that the price retailers pay their supplier is based on a known, or fixed, relationship to the hub where the financial instruments will settle.
This type of pricing relationship is commonly known as index pricing. Retailers will have an agreement with their supplier to buy at the hub price, plus a set differential. That differential is negotiated between the retailers and their suppliers. It is based on many factors, but has its foundation in the historical price relationship between the particular market where the retailers operate and the price at the hub.
By buying supply at a price that is a function of prices at the hub, a known price relationship between the hub and the local market is established. Therefore, a known, or common, relationship between the price of the financial instrument and the price of the physical propane in the local market can be established.
As last year demonstrated, without this link in prices between the hub and the supply contract, retailers can experience a total disconnect between the pricing of their financial instruments and what they actually are paying for their physical supply. This disconnect can completely destroy the benefits of hedging.
Without index pricing, retailers who try to hedge are assuming what is commonly known as basis risk. Basis risk is simply the risk that the price relationship between a commodity (in this case, propane at Main Street USA) and the tool used to hedge will become disconnected. The historical relationship that was used to establish pricing will be lost.
Last year, the price difference between the hubs and local markets was at the highest levels ever. For example, the historical relationship between Mont Belvieu, Texas, and Hattiesburg, Miss., had historically run around 7 to 10 cents in the winter. However, last year the difference was more than 100 cents at times.
If retailers bought financial instruments in Mont Belvieu and then added the historic 7- to 10-cent spread when building a fixed-price offering to their customers yet were buying at posted prices, they assumed basis risk. This would have cost them dearly last year.
Buying at an index price that establishes a fixed, or known, price relationship between the hub and a retail market is essential for eliminating basis risk. Therefore, this is an essential part of being a true hedger.
There are many ongoing issues when working out all the kinks with propane by rail supply. The loss of the Cochin Pipeline and TEPPCO’s 16-inch line to propane services still will be a reality this winter, making propane supply by rail critical for many markets.
Above-average potential remains for high price spreads between the hubs and local markets if crop drying and winter demand are once again strong and taxes limit propane infrastructure. Do not get complacent because of good inventory builds and take on basis risk. Do not commit to customer programs that are based on fixed prices beyond what your index-type supply contracts can cover.
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
Propane prices rallied over the past three days of the week following a lighter-than-expected inventory build the week before. Crude was down for the week, but showed signs of ending on a downtrend Friday.
We are bullish starting this week, with the upward momentum in propane solid on Friday.
LAST WEEK'S DAILY HIGHLIGHTS
Monday: Propane continued its downtrend whereas crude found buyers on increased fighting in Libya and Iraq. Islamic State fighters in Iraq turned their attention north, taking an oil field from the Kurds.
Tuesday: Trading in Mont Belvieu continued to be marked by heavy volume, but prices drifted lower. Conway was even harder hit as traders anticipated another large build in Midwest propane inventory. Crude was unable to hold gains from Monday. A 72-hour ceasefire in Gaza helped take some of the support away from crude.
Wednesday: The Energy Information Administration (EIA) reported a lighter-than-expected build in U.S. propane inventory, sending prices at both major U.S. hubs higher. Crude fell despite warnings by NATO that Russia appeared to be preparing for an invasion into Ukraine.
Thursday: Propane prices continued to rally around a lighter-than-expected build of propane inventory reported by the EIA Wednesday. Crude gained as the Islamic State continued to take towns and assets in Iraq.
Friday: Propane buyers stepped into the market motivated by last week’s light inventory build. West Texas Intermediate (WTI) had a volatile trading session, but managed to break through technical resistance to increase the possibility of ending its downtrend that began on July 22. The announcement the U.S. had attacked Islamic State fighters in support of Kurdish forces helped push WTI higher.
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COST MANAGEMENT SOLUTIONS
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.
Market Information Services
The Propane Price Insider, an e-mail service that provides:
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Three Daily Price Flash Wires
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Periodic Option Quotes
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Wednesday Inventory Data Updates around 11 a.m. ET
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Evening Report with Executive Summary, Trader's/Hedger's Corner, Weather maps and complete review of energy prices that are based on Propane's Btu Equivalent
Free trial!
For a free 10-day trial subscription by e-mail, sign up online here or call toll-free at 888-441-3338.
Client Services
Many retailers simply don't have time to analyze the large amounts of data to make an informed purchasing decision.
We offer:
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Detailed market recommendations on hedge and pre-buy entry points
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Prompt market execution of hedging strategies
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Supply cost analysis and recommendation as to effective hedging strategies
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Because of the volume of transactions we place annually, we receive large volume consideration when we place your hedges
Visit us online at www.propanecost.com. Or e-mail info@propanecost.com.
Contact us today to see if you can benefit from having the Energy Price Watchdog working for you.
Dale G. Delay 888-441-3338, ddelay@propanecost.com
Mark Rachal 888-441-3338, mrachal@propanecost.com |
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