<

8 trends that could affect propane names this winter

Part 2
8 trends that could affect propane names this winter (Part 2 of 9)

Why higher propane costs could cause lower sales volumes

Propane prices have been increasing noticeably, driven largely by higher exports

Propane prices in early September (as priced at the hub of Mont Belvieu) have been trading in the $1.15-to-$1.20-per-gallon range. This is significantly above prices as recent as mid-June, when propane was trading at $0.80 to $0.85 per gallon. This represents an over 30% increase in the price of the commodity in under three months.

2013.09.06 - Propane PricesEnlarge Graph

Higher propane exports are one of the major drivers behind the rise in propane prices, as more export capacity has come online. This is because greater export volumes result in higher propane demand and can drive prices higher. For more on this trend, please see Propane exports on the rise, provides support to prices and MLP frac spreads.

However, more expensive propane costs could cause customers to buy less

All else equal, more expensive propane will likely result in lower propane sales volumes for distributors such as APU, FGP, and SPH. This is because propane distributors generally take a fixed margin from propane sales and pass on price increases to customers. So more expensive propane means a higher sales price for customers, which incentivizes customers to conserve the fuel and buy less.

Propane distributors generally take a fixed margin on volumes, so lower volumes result in lower earnings

However, because the margins on propane volumes are more or less fixed (on a per-unit basis), lower volumes mean lower earnings. Take a simplified theoretical example where the cost of propane to a distributor is $1.00 per gallon. If the distributor sells to end at cost plus a margin of $1.00 per gallon, the sales price to the customer is $2.00 per gallon. Let’s say the company’s customer demand at $2.00 per gallon is 1,000 gallons, so sales are $2,000 ($2.00 per gallon * 1,000 gallons) and gross profit is $1,000 ( [$2.00 – $1.00] per gallon * 1,000 gallons). If the price of propane rises to $1.50 per gallon, and the company sells propane at $2.50 per gallon, demand will likely drop below 1,000 gallons (let’s assume 900 gallons). At 900 gallons of sales, revenues are 900 * $2.50 per gallon or $2,250. However, gross profit falls to ($2.50 – $1.50) per gallon * 900 = $900.

Last year’s propane prices versus this year’s propane prices

Last heating season, propane was largely trading between $0.75 and $0.95 per gallon. Currently, propane trades at $1.15 to $1.20 per gallon, which all else equal should spell lower propane demand. Plus,  Targa Resources (NGLS) is expected to bring online propane export capacity in October that could further drive upward propane price action.

The Realist Discussions

  • nawar alsaadi

    Best way to play this trend is through investing in NGL producers (with heavy propane weighting) such as Equal Energy (EQU), New Source Energy (NSLP) among others.