Eye-Popping Inventories, But How Many Barrels Are Handy?

(October 7, 2019) — Primary U.S. propane/propylene inventories were fast-marching to 100 MMbbl in August, an achievable level in the current environment and one that was surpassed as recently as 2016. The National Propane Gas Association (NPGA) notes in its Inventory Trends report that builds are accelerating within historical norms and are expected to stay robust and above 2018 levels for the U.S. as a whole. The association observes that continued growth in propane supply is being driven by upstream oil and gas drilling activity, especially in the Permian Basin and the Appalachia region. So, should everybody relax? Not necessarily.

“A few years back if you told propane industry professionals that we would have somewhere between 90 MMbbl and 100 MMbbl heading into winter, there would be little to no fear of supply shortages,” says Tony Botts, a supply and risk management specialist at Mission, Kan.-based Propane Resources. “However, with export capacity well over 1.3 MMbbld and roughly 50% of our total inventory earmarked for exports, it changes the narrative. Any combination of higher exports, high crop drying, or strong winter demand could still put a serious strain on propane infrastructure across the nation.”

That outlook was echoed by Botts’ supply and risk management colleague at Propane Resources, Jeff Thompson. Writing in his company’s propaneprice.com newsletter Aug. 22, Thompson focused on the magic 100 MMbbl number. “Yes, 100 MMbbl of propane is a real possibility. It is hard to see the market not get to 100 MMbbl. [But] of this 100 MMbbl over 50% resides in a storage system designed to make it go away on boats and not get pushed up lines to help the eastern United States.”

Thompson reviewed that from the beginning to the end of the heating season last year, Mont Belvieu propane inventories built by 224,000 bbl, according to the Energy Information Administration (EIA). “At the same time, Midwest inventories had a draw of almost 19 MMbbl. The total U.S. inventory draw during the heating season last year was 25 MMbbl. Almost 75% of the total U.S. draw was in the Midwest. This is the inventory to watch.”

He added that total U.S. propane stocks are no longer an indicator of whether prices will go up or down. “With all the West Texas pipeline capacity coming on in the next half year, the market should see propane inventories build, especially in PADD III—the Gulf Coast region. This doesn’t mean it is going to help propane retailers. Could this propane keep a cap on propane prices this winter? It could until it doesn’t. If Conway gets pulled hard and is not replenished as we go through winter—which will be a hard task since most infrastructure is pointed to the Gulf Coast—the propane market may see Conway pulling Belvieu higher even with all that Gulf Coast inventory.”

The veteran supply and risk management specialist pointed out that “100 MMbbl of inventory is impressive until we realize over 50 MMbbl of it is not for us to use. Winter looks a little different when we start thinking of 40 MMbbl of usable inventory. A number to watch will be PADD II inventories as we go through winter. If traders start to project that the Midwest is going to be less than 7 MMbbl to 8 MMbbl by the end of March, the market could see prices move higher. Remember, big moves in propane can happen in February.”

Additionally, Thompson underscored that an EIA tally of 100 MMbbl in storage may not separate out Y-grade volumes. “EIA likes to make assumptions. I can’t blame them. It is a hard task to determine what is out there. The propane industry really has no idea how much of this 100 MMbbl we are looking at is raw. One hundred million is big, but it may not be the number we think.”

John Powell, senior vice president and head of marketing, supply, and logistics at Crestwood Services (Kansas City, Mo.), also calls for scrutiny beyond the blanket U.S. inventory total published by EIA. “While the overall inventory levels are toward the upper end of historical highs, be careful to make sure the inventory is in your area, and not just in hubs like Mont Belvieu, Texas,” he advises. He draws attention to EIA’s sub-PADD stock reports, which show inventories standing at average levels in most locations. “Only Mont Belvieu has the majority of the excess inventory in the U.S. The sub-PADDs are much more important to the heating sector.”

Darryl Rogers, vice president of midstream oil and NGLs at IHS Markit, who will present his company’s supply outlook at the upcoming NPGA Board of Directors fall meeting, is more sanguine about stock levels. “We are reasonably supplied and I don’t see any unforeseen demand increases to tip the scales,” he says. “The wildcards are fall grain drying and LPG export terminal capacity additions on the U.S. Gulf Coast, but we don’t see those stressing the system through the upcoming winter.”

He further remarks that lower propane prices have driven higher incremental demand for propane as a petrochemical feedstock, but this too has been manageable against the pace of supply. In addition, incremental supply growth “is just overwhelming. Total inventory is expected to approach 100 MMbbl by the end of September, barring any significant and unforeseen events.” Eyeing petrochemical demand, Powell in turn calls attention to the industry’s preferred feedstock—ethane. “Most of the new chemical crackers will be using ethane as the primary feedstock,” he says, “so watch as the new crackers come online in the fourth quarter of 2019. Propane should not be the primary feedstock of these new plants.”

Nathan Keowen, a risk and fundamental analyst at Crestwood, has an affirmative inventory perspective thus far. “Propane-only inventories as of mid-August stood at 86.5 MMbbl, 20.7 MMbbl above last year and 9.5 MMbbl above the five-year average. It wouldn’t be surprising to see propane/propylene stocks climb to 100 MMbbl, which would indicate a 95-MMbbl propane cushion going into winter. Regionally, stocks are building normally and predictably, including PADD II. There’s no noise in the weekly data. More flexible pipeline infrastructure is now in place and there are fewer frac constraints.”

Keowen adds that he hasn’t seen “well-bedded” price estimates for fall crop drying, but typically that demand ranges from 2 MMbbl to 7 MMbbl spread across two months. “I don’t think grain drying will be the demand driver headed into the heating season, in part because Midwest flooding was so bad some farmers didn’t plant altogether. That cannibalized planting.”

“Grain drying will be very spotty as the flooding in many areas throughout the country will affect crop yields,” Crestwood’s Powell agrees. “In addition, while ME2 [Mariner East 2 pipeline] is transporting approximately 150,000-plus barrels per day of both propane and butane to the dock, the [arbitrages] to Northwest Europe are closed right now, so some of this product will remain local. However, exports are something to definitely watch over the winter period as well.”

Regarding exports, Rogers notes they “have been reacting to both supply availability and export capacity” via existing LPG terminals, along with “the price arbitrage between the U.S. and Europe and the U.S. and Asia, although the latter’s trade flows versus the norm have been impacted by the U.S.-China trade dispute.”

And with additional export terminal expansions scheduled to come online soon, he observes that production increases and market factors remain supportive of higher exports following the new facilities being commissioned. Again, those elevated exports will specifically follow the price arbitrage between the U.S. Gulf Coast and Europe and the Gulf-to-Asia arbitrage. “The utilization rate is therefore expected to be very high and is a function of demand and the commercial arrangements in place between the terminal owners and operators and the users and customers. We believe the incremental capacity coming on stream will quickly be filled up and additional capacity additions are needed to support available propane production for export.”

“New terminals are generally built with deals that underpin the economics of expansion,” Powell affirms. “So, I would look for the new space to be generally subscribed and moving barrels from the in-service dates. More importantly, these new terminals will allow for more efficient loading of ships and allow more surge capacity to export products, especially during the winter and other periods of high demand. But just remember that the world can only take so many exports, regardless of the price, as there is little excess shipping and storage capability globally.”

He elaborates that to the extent there is demand and shipping wherewithal, the extra U.S. export capacity will definitely keep the world much better balanced than it has been in the past. “I would expect much greater volatility in shipping volumes as the world balances out the supply and demand faster than it ever has in the past. This will lead to a little more volatility in pricing at the hubs as the markets will be able to react faster than ever before to solve the imbalances.”

U.S. propane production stood at 2.2 MMbld the week ended Aug. 23, according to EIA’s estimate, while the four-week output average was slightly more than 2.25 MMbbld, 297,000 bbld higher year on year. Industry experts expect production growth to continue, even in the lower-price environment. “We look for a continuation of growth, particularly from crude-producing areas in both the Bakken and West Texas regions, which has associated gas with that production,” says Powell. “Most of the growth in propane will be attributable to those areas and most of this propane will make its way to Mont Belvieu to support export growth going forward.”

He amplifies he doesn’t envision U.S. marketers and foreign buyers competing for Mont Belvieu supplies, Belvieu is for exports, but rather does see competition for Mariner East 2 volumes. “Most of the competition will be for ME2 barrels in the Marcellus/Utica area to supply winter demand, so look for changes in basis pricing as the heating sector competes to keep those barrels in the U.S. rather than moving across the dock. The excess barrels in Mont Belvieu should remain in Mont Belvieu, primarily for the export markets as the U.S. becomes the world storage for winter barrels via exports.”

IHS Markit also forecasts sustained propane production growth. However, “production growth rates are expected to grow at a slightly lower pace as compared to last year resulting from the relatively low gas price impacting upstream activity across all major plays and basins outside of the Permian,” Rogers says. “This will have an impact on overall propane production as well. Total NGL production growth for 2018 was approximately 13%, and we are estimating total NGL production growth for 2019 at 12%.”

U.S. propane marketers now spar in a global marketplace, but the new circumstances don’t negate convention and best practices. “There are many factors to consider in support of the upcoming season,” Rogers observes. “Price management is important and sound, pragmatic programs and strategies are required. The level of purchases can be tested from time to time, but each company must assess this against the associated volume and price risks.

“We are expecting prices relative to crude oil to be weak for the balance of 2019 and continue to be weak relative to crude for 2020 and 2021,” he adds. “Mont Belvieu propane has been hovering around 33% of crude oil for the month of August. IHS Markit expects Mont Belvieu propane, as a percent of WTI, to approach 50% of crude oil for 2020 and 2021, but price volatility is expected, likely to the downside given many factors including, but not limited to, the economy, global crude oil demand, and trade issues.”

Botts of Propane Resources clarifies that with the ability of the U.S. to export more than 1 MMbbld any time of year, the old “buy in the summer because it’s cheaper” plan has headed toward to door. “Our markets are being dictated by global propane demand and price, as opposed to domestic, winter usage. If given the opportunity, all customers should approach their propane providers about locking in the price of the propane for multiple years at these levels.”

“With the extremely low fixed price of product, make sure that all storages are full, both secondary and tertiary storages,” counsels Powell. “Also review winter contingency plans, especially in the areas with lower sub-PADD inventories, and review transportation plans with suppliers and carriers to make sure you have a solid plan going into winter.

“The main concern for supply will be related to production of crude and natural gas,” he cautions. “I would keep a close watch on crude and natural gas pricing as producers are quick to reduce production if pricing moves much lower. Producers have become a lot more responsive to lower pricing and quick to reduce production due to unfavorable economics. Lower production will mean lower propane production, and that is when pricing will move higher. All things remaining stable, I would expect a slow and steady increase of production across most of the producing regions.”

Expanding on that outlook, Powell holds that “the general view is that the world has plenty of spare capacity to produce more energy-related products if pricing moves higher. While there will be world factors like Iran sanctions, OPEC cuts, or other political tensions, the producers’ ability to respond to increased demand continues to grow rapidly. I am more concerned about price increases due to production cuts than price spikes as a result of other external factors.” — John Needham