If you are going to be wrong, it’s better to have company.
That sounds a bit defeatist, but it’s an accurate portrayal of how a lot of folks are feeling in the propane markets right about now, me included.
I’ve had a few conversations with propane traders in recent days, seeking a variety of opinions. The summation of those conversations do not engender comfort and stability, rather, bewilderment and uncertainty.
When markets behave somewhat predictably for decades on end, and all of the sudden they behave 180 degrees differently, it’s stressful. When down becomes up and up becomes down, that creates disorientation….but here we are.
Here are a few facts:
Conway has traded at $.8275 this morning, while Mt Belvieu has traded at $.9650. The daily averages on April 4th were $.5950 at Conway and $.7387 at Mt. Belvieu.
I’d love to be able to point to the cold April as being the culprit for such a jump in spot pricing, or that the trading community was fearful of an inventory shortage in propane, as those would be logical answers for the jump in prices. However, that’s not the case or at least, that is not something the trading community believes is the cause for these incredible price spikes.
What’s most troubling is that no one I’ve spoken with feels confident in any particular explanation for market behavior as of late.
Conway is up a dime over the past two days, but where is the demand? As you can see from the numbers above, there is an enormous Mt Belvieu to Conway spread, something we have seen for the past several months. There are not many plausible explanations right now for the rise, other than there possibly being some late month export cargo demand, or folks who hedged themselves on paper needing to come in and cover with physical product, or that this is a short-squeeze, which is most likely and could be a combination of the first two points.
Folks just aren’t sure and these are folks whose job requires them to be sure…or as near to sure as is possible in a commodities environment.
Mt Belvieu is a dime or more backwards out into the 4th quarter, which is what is called backwardation, which typically indicates underlying bullish sentiments in the markets. John Kemp of Reuters is an acquaintance of mine, and he offers a simple to grasp explanation of backwardation:
“If consumption is expected to exceed production, and inventories are already low and falling, spot prices tend to trade at a premium to forward prices. The premium for spot prices over forward prices, known as backwardation, acts as a signal to conserve remaining stocks as much as possible. The premium for spot prices is intended to boost supply in the short term while encouraging consumers to defer purchases. Backwardation is the most important and reliable signal of a tight and tightening oil market.”
However, there remains widespread belief among traders that very strong propane production remains on the near term horizon, and I have heard that there could be a handful of export cargo cancellations for May already. These aspects would typically lead to the front to back spread being flat or tilted towards Contango, which is when the front months are most expensive than the outmonths, as the belief is that values will not be better out the curve than they are right now for whatever bearish fundamentals are present or believed.
So trading sentiment is at 6 o’clock while market behavior is at midnight….180 degrees opposite and disconnected from logical and historical trends.
While few things are certain, there is a unanimous opinion on one matter; the trading community is collectively scratching their heads right now trying to figure things out. Is this sort of erratic, ‘disconnected from fundamentals’ market behavior a part of a new normal (adding in what we experienced at the trading hubs in January) or is it just going to be one of those weird periods where can’t sift through the chaff to find the answers, but things return to a more predictive behavior pattern later this summer?
I tend to side with that thought…that the near term chaotic behavior will pass, and fundamentals will kick in as everyone actually sees the production come to bear.
IF ONLY THOSE THE ONLY THINGS TO TAKE INTO ACCOUNT: If it weren’t already hard enough to make sense of what’s going on with propane prices, or try to figure out what WILL go on, we must add the crude oil into the equation.
Here is an article from the aforementioned John Kemp of Reuters. It’s titled, ‘Oil’s big backwardation spells trouble ahead‘. I strongly suggest you read it.
Here are some highlights, in Kemp’s words:
- The oil market is becoming extremely tight as consumption outstrips production, and traders expect it to tighten even further over the next six months.
- Front-month Brent futures have recently been trading in a backwardation of more than $3.40 per barrel over the seventh-month contract.
- The current backwardation in Brent is among the most extreme in the last quarter of a century and in the 91st percentile of all trading days since 1992.
- If the backwardation was confined mostly to one or two months, it could be dismissed as an aberration or a sign of market manipulation.
- But big backwardations are evident for all months through 2018 and 2019.
- The increasing backwardation is consistent with statistics from the physical market showing oil inventories are becoming increasingly tight.
That’s just a small portion of this column from Kemp, that might be one of the most valuable, educational and important items I have read in years. Here is another snippet, in Kemp’s words:
Logically, there are five ways in which the oil market can be moved off its currently unsustainable course and brought back towards balance:
- Slower consumption growth (in response to higher prices, an economic slowdown, or a combination of both)
- OPEC and its allies lift their output
- Supply disruptions (existing and threatened) ease
- U.S. shale output increases even faster than expected
- Non-OPEC non-shale output increases faster than predicted.
The most likely path to rebalancing of the oil market is likely to involve a combination of some or all of these factors.
I agree with Kemp, as we will likely see a crock pot of factors coalescing in their own broth…higher prices lead to slower consumption growth. OPEC members will be tempted to pump more at higher values, but they have been united in their production cuts over the past year and a half at a level heretofore unseen…supply disruptions are geopolitical risk….US Shale output increases, which is definitely going to happen and is in the process of happening, which is a part of the increased propane production I have written about quite a bit. To this last point, Kemp adds, “U.S. shale output is likely to accelerate further in the second half of 2018 and into 2019: the number of rigs drilling for oil is rising again in response to the increase in prices.”
Kemp’s conclusion: “The oil market is already tight and on track to get tighter. The backwardation is high and could rise even further. But experience suggests such large imbalances between production, consumption and inventories are not stable for long. Something will have to give soon. Supply. Demand. Or both.”
Let’s put a bow on all of this….to quote the great prophet Kenny Rogers, you’ve got to know when to hold ’em, know when to fold ’em…know when to walk away, know when to run.
Propane fundamentals don’t look strong enough to me to support these price levels over the long run. They have me fearful of a scenario where things are strong in the summer and fall out of bed in 4Q, and we have all lived through such times.
But crude fundamentals are bullish, and crude markets are behaving in ways you would expected based on those fundamentals…and I am fearful that crude prices are nowhere near their eventual peak.
When one can present both upside and downside risk factors with sincerity, financial protections would be worth looking into for a year like this…but even that is not a cheap endeavor. The volatility percentage is high for financials right now, in the range of a dime for an at the money call, which would be similar for an at the money put.
That number provides confirmation to that sinking feeling some of you have been feeling in the pit of your stomach; the market sees both upside and downside risks at these levels.
Such days are not for the faint of heart