What would you do if a third of your propane supply disappeared when you need it most?There is a good chance that supplies of propane in New England (PADD-1A), may be tighter this winter than in any year in the past. If we experience another warm winter, your business should be fine; but if we experience an average winter or a colder than average winter, the New England region could be faced with a supply shortage of more than 30%. This could affect your business dramatically and negatively by the potential price spikes, and a lack of propane gas to sell.
What would cause this extreme potential supply shortfall in New England?
New England (PADD-1A) has unique logistical challenges.Unlike the rest of the country, New England PADD-1A, is not close to a refinery or a natural gas upgrading plant, and has no pipelines supplying propane to the region. New England’s traditional supply points for propane are the Teppco pipeline terminating in Selkirk New York, a half dozen rail terminals, and two large refrigerated import terminals in Portsmouth, New Hampshire and Providence, Rhode Island. Any disruption in any of these supply points usually causes supply problems leading to a basis blowout.
The cheap new energy is in the wrong place.The propane gas supply sources are changing quickly. New sources of supply have emerged in the Upper Midwest of the Dakota’s and Appalachia but what does this mean for you? What’s changed in the dynamics of the propane supply system that New England marketers depend?
New sources of supply and where it is coming from?The recent boom in gas and oil production from the Bakken and Marcellus shale energy fields that is transforming the US energy market is not yet a viable and sufficient source of supply for New England. The current distribution systems of oil and gas pipelines are all in the wrong place. Since World War II, the supply system was structured on moving refined products from the Gulf Coast energy region, north and east. This lack of reliable and cost effective transportation for peak demand has forced suppliers from Bakken and Marcellus to deeply discount their product prices compared to both the traditional price setting point of Mount Belleview, Texas and to world propane prices. Producers seeking to profit on crude oil in the Bakken region are stuck with the Natural Gas Liquids (NGLs) as a byproduct. Recently, this oversupply of NGL’s by cause producers to leave the propane in an NGL mix for plastics. This dumping forced the Midwest Conway market to sell as low as 10 cents per gallon.
Wholesalers are trying to take advantage of this price differential, and passing on much of the reduced costs to marketers. Unfortunately, New England is at the end of a complex distribution system with many bottlenecks. The Teppco Texas Eastern Pipeline is from Texas to Selkirk, New York and not from Bismarck, North Dakota. The rail bottleneck is lack of cars, and allocation of transportation volume based prior years’ shipping. The trucking bottleneck is that there are not enough 10,000 LPG transport trucks and hazmat licensed drivers to move the product in volume from the Bakken shale oil/gas formation to New England. PADD-1A’s ocean terminals can only get product from another country due to US shipping laws, causing higher costs, and longer delivery times. These bottlenecks for accessing new American cheap sources of energy are significant.
So what about the old sources of supply?The old supply points are still there and are still priced on traditional market prices. The problem with the supply of off-shore product is that the Jones Act prevents supply tankers with a foreign flag from moving from one US port to another. Almost all LPG ocean vessels are foreign flagged. This means supply times from a common supply point like Algeria is two to three weeks. The average propane marketer has only two to five days of storage. You can’t get it in time!
Additionally, the pricing of product from the Middle East has increased dramatically since the beginning of 2012. In March of this year, Middle Eastern product sold FOB for $1150 per metric ton or $2.23 per gallon, while at the same time, Mont Belleview, Texas TET price sold for $1.25 per gallon. Because propane from ocean terminals are priced at a $1.00 per gallon or more over domestic sources, very few marketers have sourced supply from them this summer. This has led to little or no scheduled foreign supply to these terminals this winter. For all practical purposes, these terminals, which traditionally supplied 30% to 40% of peak load, will not supply New England this winter.
Nominated volumes and volume contracts build a stable price and supply. Lack of contracts creates volatility.You will constantly hear about nominated volume supply contracts in the propane industry. This is a contract that requires you to buy a minimum amount of product, from a particular supplier, at a particular location, and for a specific time interval (usually a monthly allotment). These contract requirements for unpriced product, although a throwback to another era, exist for several important functions.
Suppliers want to lock in retailers as customers. For retailers, this is not necessarily a negative thing. Suppliers who have contractual relationships with retailers will ensure that these retailers have product in their system when they need it and lock in supply contracts further upstream. Suppliers, though, are constrained by rail, pipeline and shipping. For example, railroads and pipeline operators would like to transport the same amount of product everyday regardless of demand. This is why in propane retailing it is import to maximize summer deliveries to customers. Even if they do not need the fuel, it will help to meet winter demand needs by building an allocation ratio for railroads and pipelines.
New England and PADD-1A has run out of propane before…The retailers in New England have had many examples of when of these supply systems have proven to be unreliable for supplying propane when you need it most. To compensate at these crisis points, the shaving of the peak load has been done via the two ocean terminals. The two terminals have traditionally supplied 100 million to 250 million gallons into the PADD-1A market. This year, these ocean terminals because of a price dislocation, will not have product at during peak demand as they have in the past.
According to the DOE’s EIA, the total propane sold in PADD-1A is 600 million gallons per year. Loosing even 100 million gallons at peak could be catastrophic. This possible shortage is a perfect storm that has been building unnoticed on the horizon.
Your action plan:You need to build a plan of attack on how to deal with the potential of an extreme shortage.
Diversify your supply.Unless you are will a reputable supplier who knows that you are using them as your sole source of supply, you need additional suppliers. You will also need to go further than you normally would to get your source of supply. Your suppliers may have supply outside of New England. Ask them where it is, and would they supply you from that point in a tight market. If you’ve had supply in the ocean terminals last year, you might want to see what you can afford to buy from them and blend it into your overall costs. High priced product is better than no product.
Build in a plan for delayed supply from places unimaginable.If you had to get product shipped from Kansas or Texas, who would you call? In the past, marketers have had product trucked in from that far away. These trucking costs exceeded $1.00 per gallon. Who would be willing to ship a hazardous material placarded 1075 for 2000 miles and ten states? The list is short. Think about that now, and reach out.
Build supply allocation now.You will need to supply as much product as you can this summer. Fill your customers’ tanks now, even if it presents a receivable problem. Do a second fill up before the winter allocation schedule begins. This will help when supply gets tight. The failure to do so, reduces you supply on rail and pipeline in the coldest of weather.
Plan on wholesaler outages and decide which customers will run out.Create a plan for your customers to run out when there is little supply. It sounds crazy, but it’s better for a cooking and hot water account to run out of product than a heating account whose house freezes. You can always have a service tech dump in a couple of 20 or 30 pounders in hot water or cooking than to get sued for failure to deliver to an automatic delivery home that needs $150,000 in repairs.
Increase your prices to your customers BEFORE you experience the higher product costs (you’re going to miss it anyway).Make sure to pass on increased costs to your customers early on. You will never keep up with the additional costs on items like extra shipping, surcharges, overtime, and the inevitable older receivables. In my decades in the business, every time I thought I was ahead of the increased cost structure, I looked at my monthly financial statements and found that I always missed it. My only advantage was that my competitors missed it by more.
Check your hedges and their trigger points.A basis blowout event is one of those rare items in risk mitigation, and consumer price programs, that is very difficult to hedge. Often in these events, the risk is laid off on you, the marketer. This is another expense that you must account for when deciding how much to increase prices for your consumers. Carefully consider how much this cost shift needs to be.
Forewarned is for armed.It is ironic that the new supplies of cheap new sources of American propane, will likely lead to the largest shortage and basis blowout in propane history for New England.
You are forewarned. You have the advantage of reading this newsletter and gaining from our years of experience. Your mistakes in what could be a record supply disruption event, could be very costly.
If you have concerns that we can help with, give us a call. Learn from us.