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THIS WEEK'S TOPIC:
CRUDE
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We wrap up our series on crude this week
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This week we are wrapping up our short series in Trader’s Corner on crude. As we stated in the other Trader’s Corners during this series, crude is like a fighter jet and propane is a missile fixed under its wing. For the most part, propane follows along with crude, but sometimes fires off in its own direction due to its own fundamentals.
It is important that propane retailers follow the factors that affect crude prices if they are to increase the odds of managing the risks associated with buying propane supply properly.
During this series, we have discussed the paradigm shift in crude markets that has taken place over the past few months. The Organization of the Petroleum Exporting Countries (OPEC) had been the self-appointed swing producer for crude.
But now it looks as if they are going to take market share and become the world’s baseline producer, leaving higher cost producers in the U.S. to be the swing production for global oil markets. That is a great move for OPEC, but as we discussed in our first article in this series, it likely increases the chances of crude price spikes in the future.
We then focused on U.S. crude production and showed how the rapid rise was the catalyst in forcing OPEC to shift its strategy. That was followed last week by a look at U.S. crude inventory and what the over-supplied market has done to crude futures prices.
When we started this series, crude prices were rising primarily due to speculation that recent cuts in capital spending, primarily affecting drilling programs, would cut U.S. crude production. Throughout the series we repeatedly warned about the recovery in crude prices.
At the conclusion of the first article in the series written on Feb. 20 with West Texas Intermediate (WTI) closing at $50.34, we said:
So as a propane retailer, we should probably expect a period of relatively low and stable crude prices that will keep our propane prices at relatively low levels. Many think crude prices are going to recover starting in the second half of this year. Frankly, we think that might be a little soon. Therefore, we should probably consider the possibility of flat crude pricing even into next winter.
At the conclusion of the second article in the series written on Feb. 23, with WTI at $49.76, we wrote:
The assumption has been that crude prices would recover in the second half of this year. But those assumptions did not include OPEC increasing production, which will offset the decreases in production by U.S. and other high-cost producers. It would seem that OPEC is going to employ a strategy of maximizing market share and that strategy may take longer to employ than many think. The real, sustainable recovery in oil prices is unlikely to take place until the economies of Europe and Asia improve and increase energy demand. At this point, it is anyone’s guess as to when that will occur.
At the conclusion of the third article in the series written on March 9 with WTI crude at $49.61, we said:
Some think prices will begin to recover in the second half of this year. The assumption is based on less U.S. production at that time.
But even when U.S. production begins to decline, supply and demand will not be immediately balanced. Plus there is the matter of cleaning up all the crude that is being stored now. Further, those assumptions do not include more production from OPEC. For all we know at this point, the sanctions on Iran that have cut a million barrels per day (bpd) of crude supply out of global markets could be lifted. You can bet Iran forces those barrels into the market as soon as it can - it needs the money.
Of course it can go the other way too, with more disruptions to supply in the Middle East, perhaps caused by the Islamic State. But for now, we predict the fighter to which our propane missile is attached will be flying low for a while. That means price escalation in propane will likely be from changes in its own fundamentals, rather than a strong rally in crude this year - or even next.
There is plenty of reason to believe that propane prices could go higher on their own - without the support of crude - later this year. But for now, our belief is that one must be cautious in assuming any type of major rally in crude prices this year.
As we wrap up this series on crude on March 17, WTI closed on March 16 at $43.88 - a new low for the year. Prices are trending lower this morning, with WTI at $43.15 at presstime. Goldman Sachs is predicting WTI at $40 per barrel and Citibank is even saying that WTI could fall to $20 before recovering.
The key here is that ultimately, the fundamental conditions for crude could not be ignored or denied. Speculation can only carry a market so far without eventually seeing fundamental support for the move. In the case of crude recently, not only did the fundamentals not come along to support the speculative buying, they were actually getting weaker during the rally. Therefore, we are seeing the price correction that is currently underway.
Currently, global crude production is estimated to be 1.6 million bpd more than demand. OPEC’s current strategy is not to cut production, rather to gain market share. The focus is on forcing high-cost U.S. producers out of the market.
That will eventually happen, but it still looks like that is going to be a slower process than originally believed. Meanwhile, there is the possibility that sanctions will be lifted on Iran and increased exports from that country will simply offset decreases in U.S. production for a while.
Of course, plenty of things could happen that could change the landscape. The U.S. government could wake up and put a tariff on crude imports so we do not fall back into high dependency on foreign supplies. There could be arguments made that would be a smart move, but any government action that raises energy costs has never been popular in this country.
As propane retailers, we can learn a lot from these recent moves in crude. We must be careful in making decisions based on speculation that is not supported by the fundamentals. There is a lot of talk of propane inventories building at far below normal rates this year. There are a lot of good reasons to believe that is going to be the case. However, it is never a bad idea to wait and see if the trends in the fundamentals are supporting those theories before leaping too far, too fast.
For now, we are highly likely to exit this winter with record-high inventory. It makes good sense to wait and see if builds on inventory are below normal this summer before getting in too deep. Our advice is to not ignore the mountain of propane inventory that is a known. Then, let trends in crude and propane fundamentals determine how aggressive you are in buying for future supply needs.
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WEEK IN REVIEW
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Crude prices fell as fundamentals remained bearish, pulling propane lower. We are currently bearish with potentially more downside risk for crude and waning weather support for propane.
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LAST WEEK'S HIGHLIGHTS
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Propane prices fell 2 cents per gallon at both major U.S. trading hubs, even as crude gained. Forecasts for milder weather for March was the key reason for the fall.
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Propane remained in a sharp decline with 2 1/4-cent losses at Conway and Mont Belvieu. Traders were discounting last week’s 4.2-million-barrel propane inventory draw and focusing on the fact that the end of winter is near and U.S. inventory is at a high level. Crude tumbled, as the strong dollar undermined commodities.
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A lighter-than-expected draw on propane inventory did not keep prices from moving higher. A turn in the weather outlook that shows a higher probability of below-normal temperatures in the higher-consuming eastern third of the nation seemed to be the key driver. Another crude build to record levels in the U.S. had WTI crude falling.
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After Wednesday’s somewhat surprising bounce in propane prices, there was little upside to be had. Prices at both hubs were little changed. Falling crude was certainly a headwind for propane. Weak fundamentals continued to dominate crude trade.
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Propane ended the week on a weak note as WTI crude fell. Propane prices began the week in a steep decline, but pulled out of it on Wednesday. However, the recovery may be short-lived.
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CONNECT
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WHAT IS COST MANAGEMENT SOLUTIONS?
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The Propane Price Insider is an e-mail service that provides:
- Three daily price Flash Wires
- Periodic option quotes
- Wednesday inventory data updates around 11 a.m. ET
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Evening report with executive summary, weather maps and complete review of energy prices that are based on propane's Btu equivalent
For a free 10-day trial subscription by e-mail, sign up online here or call 888-441-3338.
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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.
Contact us today to see if you can benefit from having the Energy Price Watchdog working for you.
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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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