Greatest Risk Now for Propane Retailers: Supply Complacency

By JD Buss…

An “outlier” can be defined as a value that “lies outside” most of the other values in a set of data. In 2008, Malcolm Gladwell published the book “Outliers” in an attempt to identify why some individuals have been extremely successful. In a separate question and answer section, he wrote that “we vastly underestimate the extent to which success happens because of things that the individual has nothing to do with.”

Expanding Gladwell’s thought process, success also has a great deal to do with how individuals respond to circumstances they have nothing to do with. Looking at this coming winter, there are several risks propane retailers can’t control, but they can certainly be successful based on how they prepare and respond when those risks show themselves.

The end of May through June saw some of the largest historical price discounts in the propane market. Rumors of product in western Canada moving for below-zero values (producers having to pay buyers to move propane) to large discounts in other regions clearly marked the period as a buyer’s market. Those discounts began to fade in mid-July, but the sweet taste of discount values still lingered in the mouths of most buyers.

For roughly two and a half months, the spot market tightened as speculation built that more producer volume was entering storage. Beginning in October, however, we saw the spot market start to loosen up. Railcars appeared plentiful and primary U.S. storage levels reached the 100-MMbbl mark. Spot prices were coming in well below winter index levels. Even though they didn’t drop to match the low prices of the early summer, it was clear that the market has propane to spare.

Through the ebb and flow of the past few months a great risk lurks for the propane retailer: supply complacency. The buyer’s market has seen record-low prices in early summer along with experiencing at least two periods of decent spot market selling. Both of these can lead to the perception that these conditions will last forever. As we all know, nothing lasts forever, and nothing cures low prices like low prices.

And the end of forever could start in December of this year. For well over a year, there has been great anticipation for the coming export expansions. The current year has seen one minor expansion (de-bottlenecking) at the Enterprise Products facility. Sunoco’s Nederland, Texas export terminal has now been actively moving product since February, with summer volumes peaking at above 4 MMbbl a month. Trafigura’s Corpus Christi facility should be gaining momentum this fall, as well as Occidental’s Ingleside terminal. Even the Ferndale terminal in Washington saw propane exports over the summer months.

At the time of this article, the Energy Information Administration provided export data through the end of July 2015. Total exports for the first seven months of the year stood at 121 MMbbl. That level stands 48% above the seven months for 2014. Utilizing third-party waterborne data, we see the first nine months of the year showing propane exports of 160 MMbbl, 6 MMbbl above the total level for all of 2014. By merely keeping a steady pace through the fourth quarter, annual exports for 2015 will be 43% above all of last year and end above the 200-MMbbl mark.

All of this export growth comes while propane inventory levels are setting record highs, and still leaves open the question of why December could change the export status. One of the most anticipated items this year has been the coming Enterprise export terminal expansion. The buildout includes a new refrigeration train that will pump 11,000 bbl an hour and expand the overall facility capacity up to 16 MMbbl a month. From an incremental standpoint, this would provide anywhere from another 6 to 8 MMbbl a month of export capacity.

For much of the second half of 2015, the expansion’s completion has been scheduled for the fourth quarter, with the rumor mill widely calling for December as the start-up time. The trend in the last three years (2012-2014) shows the fourth quarter with the highest level of exports. The current steady export rate, along with the Enterprise expansion, should continue the trend in 2015.

The market risks with this expansion are twofold, and center on different price trends as well as timeframes. First, the coming growth rate of roughly 7 MMbbl a month would generate another 84 MMbbl of export volume during 2016 and represent another potential 40%-plus growth rate for that year. If production levels of propane merely maintain status quo, the export growth would easily eat up the U.S. storage surplus. The last piece of this scenario involves the expansion of the Panama Canal, which should shorten the travel time to the Far East and further support U.S. export growth. This overall scenario definitely generates a strong, bullish view that could start to quickly drive prices during the heaviest demand period of the U.S. retail market.

The second risk with the export growth is short-term. Between now and mid-December, there remains limited to no overall demand increases that can significantly lower the current storage levels. Crop drying, one of the larger fall propane demand sectors, appears very weak. This second overall scenario implies that prices could be range-bound or even lower as inventory levels balloon further in the coming weeks, giving support to the supply complacency risk mentioned earlier.

Cold temps will be coming! That has been the hope, battle cry, and mantra of retailers for decades. El Niño has been all the rage in weather discussions this year, prompting multiple weather forecasts for warmer winter weather from the Pacific Northwest to parts of the western Great Lakes region. The weather trading market has a similar viewpoint as heating degree day (HDD) swap bids (prices at which traders are willing to buy) have dipped well below historical HDD averages. For much of the summer, the weather market has trended downward, with expectations of lower HDD counts from the Pacific Ocean to the Great Lakes.

Pull up the Farmer’s Almanac for the upcoming winter. The publication is calling for a repeat of last winter. Specifically, the Farmer’s Almanac is forecasting “unseasonably cold conditions over the Atlantic Seaboard, the eastern portion of the Great Lakes, the lower peninsula of Michigan, Ohio, Kentucky, most of the Tennessee-Mississippi Valley, as well as much of the Gulf Coast.” Getting more detailed on the timing side of winter weather, the almanac has highlighted the second week of January and February as “possible heavy winter weather.”

Weather 2020, a firm with technology said to provide 75% forecast accuracy from 1 to 200 days out, has another view on winter weather. According to founder and meteorologist Gary Lezak, “This is likely going to be the strongest El Niño ever recorded. Every year’s pattern is unique. We will have our winter outlook after the pattern sets up in the next few weeks. These other forecasts are based entirely on El Niño or just a pure guess. Every El Niño is different.”

Which weather view is correct? Will El Niño bring warmer temps to a larger region, will the Farmer’s Almanac prediction come true, or will this be a completely different weather cycle than previous El Niño events? Either way, the weather presents two distinct timing risks. Neither a strong El Niño nor a repeat of last winter signals strong weather-related demand for the fourth quarter of this year. Couple that view with rising storage levels, strong available spot volume, and export expansion not slated until December, and overall propane demand could be minimal and result in lower prices through the end of this year.

The second timing risk could prove much more bullish. A repeat of last winter in the January and February periods will coincide with a rapid increase in propane exports, which will generate bullish price actions. In addition, regional supply challenges could exist as propane storage — while plentiful in the Gulf region — still has to be transported to areas of need.

The feeling of security, induced by a summer of burgeoning inventory and low prices, could fade quickly as exports ramp up and winter weather finally makes its mark at the end of 2015 and beginning of 2016. In order to protect a retailer’s physical supply of propane, we’ve been strong advocates of both using storage assets and ensuring contract compliance with your supplier, strategies that the National Propane Gas Association white paper from May 2014 recommended. To mitigate price fluctuations, we recommend being open to purchasing more upside protection for both this winter and future winters during the middle of the 2015 fourth quarter. Our recommendation for managing weather focuses on retailers considering utilization of specific HDD tools (weather hedges) that provide cash flow protection should cold temperatures fail to appear.

Writing this in mid-October, we don’t know all the outlier risks that will pop up this coming winter. Heeding the advice of plan, plan, and re-plan will help propane retailers prepare for multiple risks and fend off succumbing to complacency in the market.