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Call Cost Management Solutions today for more information about how Client Services can enhance your business at (888) 441-3338 or drop us an e-mail at info@propanecost.com.


Trader's Corner

This week’s Trader’s Corner looks at using swaps to manage our supply costs.

Each week in Trader’s Corner, we provide market analysis. During each day the markets are open, we keep our daily readers’ inbox full of the latest market moving news and information. From the beginning of our company, we believed that propane retailers needed more information. Too many were trying to make important business decisions on information that was too old to be useful or being provided by a source that had a bias about the market. We are not producers and we do not market propane. We do our best to be unbiased and just tell the story of the market.

The information we provide allows propane retailers to enhance the performance of their business, making it more secure and profitable. The information helps identify threats and opportunities, but knowing them does little good if it does not prompt some sort of action.

In this week’s Trader’s Corner, we will look at one of the simple tools that you can use to easily take action when you have identified a threat to your supply position or see an opportunity to enhance it. We want to emphasize that we have mentioned threats and opportunities.

When we take a pre-buy position, it is based on the assumption that the purchase is an opportunity to avoid higher prices in the future. Unfortunately we often act upon this “opportunity” when we feel threatened because prices are going up. So when you get right down to it, the buy is often less driven because it was a good opportunity and more because we felt threatened at the time.

We track a lot of buy-and-sell indicators in our office, and it is not rare that when many of them are showing buy opportunities that our phones are dormant. But, when prices have been running higher for a while, the calls from folks wanting to take supply positions pick up. Often many of the buy indicators have long switched to neutral or sell indicators by the time the phone calls start coming in. They are coming in because the retailer is feeling threatened by rising prices, not because the opportunity is so good.

We know if we are getting calls that propane retailers are also calling their suppliers and locking in pre-buys for the future. That means they are using a supply tool that is designed to take advantage of market opportunities to lock in lower prices, but they are often using the tool when the “real” opportunity has long passed. Ironically the result is locking in what we fear most – high-priced propane. It’s a price we now have to live with no matter what direction the market is moving.

But that is exactly the reason retailers often follow this pattern, because once a pre-buy is made we must live with it for a long time. We all know how miserable we feel when the market starts going against these positions. So we often enter the positions begrudgingly, out of what we feel is necessity, not what we see as opportunity.

Pre-buys are useful, especially because of the ability to pull the volume as needed over a period of months. That is a valuable option. However, they are ridged when it comes to reacting to the big picture of price movement.

Swaps are tools that are much more flexible in terms of being able to react to threats and opportunities. They, however, are not good for managing fluctuations in monthly volumes. It is here their rigidity is revealed. But, if you are looking to take a position because you feel there is “real” opportunity, they can be the way to go. The reason is that position can be closed to capture gains or, because the assumptions we made about price movement were wrong, to minimize losses.

Swaps are simple financial instruments. Imagine your best friend is the operator of the local gas processing plant and sells propane into the local market. His price risk is opposite of yours; he is worried most about falling prices and you are worried most about rising prices.

Over a cup of coffee, you are both commiserating about the uncertainty of propane prices. Finally you say that you would like to buy propane for 90 cents next November. He says he would like to sell his propane for 90 cents next November. Eureka! An opportunity is born. You agree to buy his propane for 90 cents next November. No matter where the overall market price is, you both agree that having the known of 90 cents is a good thing.

Now, one of you will probably wish you wouldn’t have made the deal come November. The market for propane probably won’t be 90 cents. If the market is 80 cents, you will probably wish you wouldn’t have done the deal and he will be happy he did. If the market is a dollar, you’re happy and he is not … maybe.

If both of you have used this known number to lock in agreements with customers, then both of you fixed your margin well in advance. Where the actual market is in November becomes irrelevant. However, if that were not the case, there is a perceived winner and loser in the transaction.

Now in the real world, two friends do not set the price over coffee. It is set by the composite knowledge of the entire market over the fair value of propane in the future. When you do swaps, you are doing them with traders, not the actual producer. The trader has relationships with producers and buyers, and that is how he makes his living. He takes positions on both sides of the equations and builds a “trading book” that he keeps balanced. If the market moves, he pays money on the one side, but receives money on the other.

Basically he strikes a position with someone wanting protection from higher prices at a slightly higher number than he strikes a position with someone selling a position. So he buys for slightly less than he sells, making a small margin. If he keeps his book balanced, he makes a nice living because he has the relationships and gives both parties close to what the general market says the price should be. When he is selling, he is offering the position. When he buys, he bids. The difference is known as the bid/offer spread.

It is important for the propane retailer to know where the market is trading. In addition to providing market information, providing that transparency to the retailer, so he knows he is getting a fair price, is a big part of what we do. Below is a table we send to our daily readers several times per day so they know the propane futures market and where a deal is likely to get done. We will use this to further explain how a swap works. Click to enlarge.

For the sake of space and time, let’s focus on one month, November 2013. As of this writing, we estimated the market had November Belvieu priced at 92.125 cents and November Conway at 90.25 cents. From this point, let’s just use the Belvieu number, but the discussion would apply to Conway equally as well.

So you get this table, like the November number, call us up and say you want to lock in a price for November propane. We talk to traders, make sure what they offer you is somewhere near where the trading screens are showing the market and tell you the price. The number probably won’t be exactly the number above, but hopefully it will be close. Let’s just say our estimate was right on the money, and you agree to buy a November Belvieu swap with a strike of 92.125 cents. You put a volume of 1,000 barrels or 42,000 gallons on the swap.

At that point, you will get a confirmation that you have a financial position at that price and volume. Your price or strike will be compared to the actual monthly average for November when it becomes known on Dec. 1. If the monthly average is higher than the strike, you get the difference; if lower, you pay the difference.

Ideally you took this known cost of supply and sold against it to your customers to lock in a margin. Thus, you would have a fixed cost of supply and a fixed sales price. This is known as a hedge and is what we really want to see you do.

Let’s say you sold November to your customers at $1.50. If prices are lower come November, you will be paying less to your actual physical supplier for propane he delivers to you and therefore will make more margin on the $1.50 sale to the customer. However, you will have to use that extra margin to pay on your swap.

Conversely, if propane is higher in November, you will pay more to your supplier, make less margin on the sale to the customer, but the swap will pay you. Either way the market goes, you get back to your budgeted margin.

So far this doesn’t sound any different than a pre-buy, does it? So where is the advantage of the swap?

Let’s say you didn’t make sales against the swap position, just like you often don’t with a pre-buy. In this case, you are speculating. As long as you have a locked in supply cost and no sale against it, you are speculating.

So you bought the swap in March, made no sales against it and it is now June. Propane inventories are building more than expected, as the new export facilities have not kept up with all of the new propane production. Crop drying is expected to be a bust again because of another drought. In addition, forecasts for winter aren’t looking very good.

Suddenly that November position is looking more like a liability than an asset. You decide it is best to close the position. To close the position, you must make a countering transaction. You bought a November position originally, so to close it you must sell a November position for the same volume.

Remember it is June; three months have passed since the original purchase. You call us up and find out you can sell a November swap for 90 cents. If you sell the swap, the two swap positions will counter each other from that point forward. So if you sell the swap in June, you lock in a 2.125-cent loss. That doesn’t feel too good right now. But it may feel really good when November comes and propane is at 80 cents. You realize if you had a pre-buy you would be seeing a loss of 12.125 cents.

Keep in mind the market could have gone higher and you could have used the same process to capture your gains if you thought the market was going lower moving forward. Also, if you did buy a pre-buy instead of a swap, you can use a swap sale to counter its effects.

We would prefer that you use swaps and pre-buys to lock in supply costs and then make sales against them to your customers to lock in margin. But that isn’t always easy to do.

We believe a combination of swaps and pre-buys gives us outstanding flexibility in managing volatile winter volumes and uncertainty of prices when we have not made sales against the position. The ability of a propane retailer to sell swaps greatly enhances his ability to avoid major hits to margin.

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
It was a bullish week in the energy complex. Crude is shaking off weak fundamentals to pull out of a downtrend it had been in since Feb. 13.

Propane is getting support from weather. Also, expectations that new export capacity could reduce the inventory surplus are lending support.

We begin the week neutral, but could be bullish fairly weekly if last week’s trend carries over to Monday.

 

 

LAST WEEK'S DAILY HIGHLIGHTS
Monday: The disappointment of the Italian elections and the implementation of mandatory spending cuts by the federal government carried over to start the new week. Crude got its primary support from issues with a pipeline that carries North Sea crude.

Tuesday: Stronger crude and defensive buying ahead of Wednesday’s Energy Information Administration (EIA) report helped push propane prices higher at both hubs. The Dow hit a record as improvements in the U.S. services sector encouraged investors.

Wednesday: Crude and propane traded along the fundamental data provided by the EIA. Conway propane gained after a 1.651-million-barrel drop in Midwest propane inventory was reported. Belvieu slipped on a Gulf Coast inventory draw that was about half the average draw for week nine of the year. Crude fell after the EIA reported a 3.833-million-barrel build in U.S. crude inventory.

Thursday: Constructive budget talks in Washington and fewer jobless claims helped crude regain value it had dropped earlier in the week. Belvieu propane rebounded from the disappointment of the light Gulf Coast inventory draw. Conway gave up a portion of the gains it posted on Wednesday.

Friday: Propane at both hubs gained on pre-weekend buying aided by continued winter heating demand as harsh cold held on in some areas. WTI crude rallied off of technical support to keep its recovery hopes alive. Brent crude was lower on the restart of the North Sea crude pipeline.

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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:

  • Three Daily Price Flash Wires
  • Periodic Option Quotes
  • Wednesday Inventory Data Updates around 11 a.m. ET
  • 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:

  • Detailed market recommendations on hedge and pre-buy entry points
  • Prompt market execution of hedging strategies
  • Supply cost analysis and recommendation as to effective hedging strategies
  • 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  318-865-9928, mrachal@propanecost.com

 

 

 

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