Inventory Peaks, Price Declines Present Buying Opportunity for Propane Industry

By Pat Thornton, Marty Lerum, and Jeff Thompson…

As we move toward September, often the month when propane inventory levels peak before winter demand draws the volumes down, many are confident this could be a year where propane gets to 90 MMbbl. Such peaks in propane volume are also usually accompanied by dips in the price of the product as the laws of supply and demand play out.

Looking back to 1971, we see six super inventory level peaks over the past 43 years, in addition to the September peak we are currently about to experience. Usually there is always a significant event that causes these super inventory level peaks.

From 1976 to 1978, the Energy Information Administration (EIA) shows propane/propylene inventory levels reaching the 90-MMbbl to 95-MMbbl level. However, at that time there wasn’t an EIA. The government relied on the American Petroleum Institute for information, so we are a little suspect of some of those numbers. In the 1976-1978 peak inventory timeframe, the U.S. was the largest crude oil producer in the world. Crude oil, West Texas Intermediate, was at $8.36/bbl and propane at Mont Belvieu/Conway was 15 cents/gal. Crude oil production in the U.S. peaked in the 1970s at 9.5 MMbbld. So, propane production was strong at a time when the propane industry was looking for new demand such as the expansion of the petrochemical industry. Now, as of 2014, after years of crude oil production decline U.S. crude production is back to the record levels of the 1970s!

By the 1981 propane inventory peak, crude oil was at $31/bbl and propane at Mont Belvieu/Conway was in the area of 50 cents/gal. Ronald Reagan was president, and a year earlier he freed crude oil and propane from government controls, spurring domestic production. Meanwhile, Saudi Arabia decided to flood the market with its production.

By the 1986 propane inventory peak, crude oil had dropped to $13/bbl and Mont Belvieu/Conway propane was at 19 cents/gal. With worldwide overproduction, crude prices fell 50% and propane inventory surged.

By the 1998 propane inventory peak, crude oil was at $11/bbl and Mont Belvieu/Conway propane was 25 cents/gal. Propane imports surged by 100 million barrels from 1996 through 2000, coupled with newly discovered Gulf of Mexico natural gas liquids that saw production soar 100%. The propane industry thought it would be swimming in propane for years. But within two years, the petrochemical industry had absorbed the increase.

By the 2009 propane inventory peak, crude oil fell to $65/bbl from the $145/bbl peak in 2008, and Mont Belvieu/Conway propane dropped to 94 cents/gal. This was the first year of the propane export increases, but production rose as well as the propane retail market purged its higher-cost plant and customer inventory purchased in 2008.

By the 2012 propane inventory peak, crude oil had increased to $96/bbl and Mont Belvieu/Conway propane was 90 cents/gal. Crude oil prices had jumped by $31/bbl since September 2009 and propane had dropped in price by 4 cents/gal. We saw the influence of propane production outstripping rising propane exports, on top of 2012 being the warmest year on record, which cut deeply into retail propane demand.

We are now in the middle of the 2014-2015 propane inventory peak. Crude oil prices have dropped to $58/bbl and propane at Mont Belvieu/Conway is in the 35-cents to 40-cents/gal. range. Propane inventory is set to move into the 90-MMbbl area on the back of record propane production of 1.6 MMbbld. Propane exports and petchem demand are flat. Producers, who previously lost money on ethane, are now losing money on propane. Look for production to curb as more money is lost producing propane.

The Shale Revolution has contributed significantly to the overhang of propane, as well as for crude oil and natural gas supplies. During the past year, OPEC has allowed its production levels to remain at 30 MMbbld as member nations compete for market share and hope to cause prices to drop to the point where U.S. producers will lose sufficient money to abandon their drilling efforts. While we have seen some signs of lower production of crude oil, there is very little sign that propane production is slowing down. After meeting again in June, OPEC held its output quotas at 30 MMbbld, a level that many traders believe adds 2 MMbbld of excess supply to the world market.

Propane spot prices have plummeted to 13-year lows as supply in the U.S. continues to grow at a time of slower demand. While production from the Marcellus and Utica shale regions has begun to serve retail markets in their respective areas, imports from Canada are also finding their way into the U.S. Since the Cochin pipeline no longer moves propane south into the northern U.S., railcars and other pipelines have helped propane to find homes in northern U.S. demand points. The price of product at Edmonton has been near zero for several weeks. In some cases, shippers are being paid to take the propane away. For the suppliers able to take advantage of this opportunity and move propane to the U.S. for as little as 5 cents/gal., there is still plenty of margin to be earned despite the record-low wholesale prices.

Adding to the pressure on propane prices in late May and early June were heavy rains in Texas that caused challenges for salt caverns. With brine ponds diluted, a significant amount of propane had to be sold into the market at a reduced price, rather than being stored. At the same time, the slowdown in petrochemical propane demand during the past winter, and continued strong production levels, helped build inventory levels to the current high. While exports have also been strong, reaching an all-time record of 661,000 bbld in February, they fell closer to 470,000 bbld in June. Prices overseas have also fallen to a level where many offshore sources are more competitive with waterborne propane exported from the Gulf.

The key factors in the price of U.S. propane will continue to be expanding exports and petrochemical demand, and the timing of production curtailment. Our supply infrastructure has shifted dramatically with local production serving many areas of the U.S. and propane able to rapidly move south to the Gulf from Conway and other regional production areas. Unlike crude oil and natural gas, there is no legal limit to the amount of propane that can be exported. We will soon be at a point where we have the capacity to export every drop of propane produced in the U.S., and the only thing stopping us will be the economics. When, and if, overseas demand picks up significantly, U.S. prices will be forced higher as more product heads for the Gulf and leaves the U.S.

Although the market can’t see any current factors that suggest propane prices could take off and rise dramatically, there is a strong undercurrent that is working to balance the NGL system in North America. It will be balanced, we just don’t know when. And propane supply and demand always balances faster than the market expects with so much money at stake!

While front-month and rack prices have been amazingly low, out-month prices have not dipped as fast. The January 2016 Mont Belvieu contract did trade about 10 cents/gal. higher than the May 2015 contract, and now it is 18 to 20 cents/gal. higher.

Considering the downside potential is currently so limited, it does make sense to be positioning gallons for this coming winter season at current price levels. It also makes sense to position some gallons for the winter of 2016-2017 as well.

Pat Thornton joined Propane Resources in 1996. He provides the Supply Division’s risk management and supply planning services in the East-Central U.S. area. Marty Lerum has led the Propane Resources Supply Division since 1995, working with retail propane marketers on supply planning and risk management. He previously directed distribution, supply, and risk management for Ferrellgas and was marketing director for Enron’s Central U.S. and Canada territories. Jeff Thompson joined Propane Resources in 1997 and provides the Supply Division’s risk management and supply planning services in the Northeast and East-Central U.S. areas.