P. 6 ~ Continued - US PROPANE — MIDYEAR 2011: US propane trade undergoes historic changes; more likely

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Propane prices: winter 2011-12

Financial traders accounted for 60-70% of total open interest in the New York Mercantile Exchange (NYMEX) crude oil futures contract during second and third quarters 2011, according to the Commodities Futures Trading Commission. Based on CFTC statistics, large traders (excluding commercial accounts engaged in hedging physical positions in crude oil) boosted net long positions (holding of long contracts minus short contracts) to 250,000-270,000 contracts during March and April.

Despite the further declines in crude oil production during second-quarter 2011, large traders began to reduce net long positions during May and net long holdings were 150,000 contracts in late June. Net long positions for this group had not been this low since late November 2010.

We highlight this trend to illustrate the shift in concern among this group of traders from a strong "supply risk" orientation in March-April to their growing concern about weakening demand for refined products. Various factors indicate that economic growth in the US is likely to be weaker during the winter heating season 2011-12 than in the previous year.

Total crude oil production is likely to increase during this coming 6 months as production in Libya recovers and Arab members of OPEC slowly reduce production to offset. The outlook for increasing production and traders' concerns about sluggish economic growth support a forecast for further weakening in crude oil prices. We base our forecasts for propane on OPEC basket prices of $95-105 /bbl during winter heating season 2011-12.

The market has an imperative to offset the likely pull on supply as exports continue to flow into the international market at 100,000 b/d or more during winter 2011-12. During fourth-quarter 2011, we forecast spot propane prices in Mont Belvieu will average 155-165¢/gal. In this range, ethylene producers will have incentives of 20-25¢/gal to use less propane and more ethane. They will also, however, have incentives of 10-15¢/gal to use more propane and less natural gasoline and light naphtha.

If ethylene feedstock demand does not decline in response to this level of disincentive during fourth-quarter 2011, propane prices in Mont Belvieu will increase to higher levels.

We expect these feedstock economic relationships will result in reduced feedstock demand especially during fourth-quarter 2011, and a large reduction in feedstock demand will be necessary to offset tight availability. International LPG traders, however, will have price incentives of 10-30¢/gal to load cargoes for export from the Gulf Coast during fourth-quarter 2011.

Prices in Mont Belvieu will increase to a peak of 165-175¢/gal during first-quarter 2012, but discounts compared with spot prices in the Middle East and Mediterranean will be only 3-5¢/gal. Unless prices in Mont Belvieu rise to premiums, when compared with primary international supply sources, waterborne exports will continue to flow and propane availability will remain tight.

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