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Slightly higher propane prices could mute demand and erode distributors’ margins

2013.03.27 - Propane PricesEnlarge Graph

  • Propane prices rose 2.9% last week from $0.90/gallon to $0.93/gallon, which was a negative short-term driver for propane distributors.
  • Higher prices are a negative for distributors of propane as price increases are passed on to customers who consume less when costs are higher. However, in this case the price increase was likely caused by higher consumer demand due to colder weather, in which case distributors should not see volume loss.
  • From a longer-term perspective, propane prices have remained relatively low as a record amount of propane is being produced as a result of high levels of natural gas drilling, from which natural gas liquids (such as propane) are often produced.

Propane distributors, such as AmeriGas Partners (APU), Ferrellgas Partners (FGP), and Suburban Propane Partners (SPH), can see reduced demand from their customers when propane prices rise. This is because propane distributors generally pass on increases in the cost of propane to customers; at the same time, when prices rise, customers try to conserve their use of propane. Therefore, propane prices are a key indicator to track for propane distributors as prices can ultimately affect earnings.

For the week ended March 22, propane prices at Mont Belvieu (a major hub for natural gas liquids such as propane) rose from $0.90/gallon to $0.93/gallon (or 2.9%). This is a short-term negative for propane distributors as prices rose which will cause distributors to pass on the cost increase to customers who normally consume less at higher prices. However, the recent price increase in propane was likely caused by the recent colder than normal weather (see “Icy temps last week helped propane names” for more) spurring increased propane demand from home heating customers, in which case the price increase would not have result in decreased volumes from customers, but rather the result of increased volumes from customers.

Last week propane prices rose, which in itself could be viewed as a negative short-term catalyst. However, investors should note that propane prices are also at relatively low levels given a medium-to-long term context. Propane had spiked to prices of above $1.50/gallon at points in 2011.

Propane had traditionally tracked crude oil directionally, which was one of the drivers for the run up in prices from early 2009 to late 2011. Last winter was particularly hard for propane distributors as a combination of high prices and warm weather squeezed margins. Since last winter, propane prices have fallen off significantly as a flurry of domestic oil and natural gas drilling has produced a surfeit of natural gas liquids (NGLs), such as propane. The increase in supply of some of these NGLs, such as ethane and propane, could not readily be absorbed by the market, which contributed to the price drop in propane. Additionally, as a consequence, the correlation between propane and crude oil has weakened somewhat.

The largest publicly traded propane distributor, AmeriGas (APU), noted on its fiscal 1Q13 earnings call on January 31, “There are several reasons for our fine performance this quarter. Among them are… the low-cost propane prices in the US which helped margins as well as the overall competitiveness of propane as a fuel.” Comments by APU’s management confirms that this winter season’s lower propane prices are a positive for propane distributors.

Additionally, on Suburban Propane’s (SPH) fiscal 1Q13 earnings call on February 7, management stated, “…we are very pleased with our overall results despite the unseasonably warm temperatures experienced throughout much of our service territories, particularly during the month of December. However a lower commodity price environment… helped to mitigate the negative effects of the warm weather on overall profitability.”

Again, last week’s rise in propane prices was a negative short-term catalyst in itself. However, prices have remained relatively low through the winter heating season which is positive in the medium-to-long term for propane distributors such as SPH, FGP, and APU. Additionally, the price rise was likely caused by increased demand from propane customers, nullifying the negative effect. Despite this, investors should be aware that upward price movements could negatively affect earnings, especially a sudden and significant movement upward. Therefore, investors with propane stocks may want to monitor propane prices as they can be a significant indicator of earnings results. Propane companies also comprise a portion of the Yorkville High Income MLP ETF (YMLP).

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