US Propane—MIDYEAR 2009: Global recession, OPEC discipline combine to boost propane prices

Nov. 2, 2009
Two factors mainly influenced propane markets and pricing during second and third quarters 2009.

Two factors mainly influenced propane markets and pricing during second and third quarters 2009.

First, the economic recession continued to limit ethylene production and total feedstock demand during second and third quarters 2009. Second, key Organization of Petroleum Exporting Countries' producers maintained reasonably strict adherence to their production quotas in accord with agreements reached in September and December 2008.

Propane's use as a space-heating fuel in the residential and commercial markets reaches its seasonal peak each year during fourth and first quarters. Residential-commercial propane demand begins to increase during September-October and usually peaks in December-January.

Specifically, crude oil production in the Middle East averaged 21.6 million b/d, or 2.2 million b/d less than in third-quarter 2008. OPEC's overall reductions in crude oil production had significant bullish impact on crude oil prices and prices for crude oil-derived ethylene feedstocks during second and third quarters.

Equally important for propane markets, LPG production in Saudi Arabia from gas processing plants declined as a result of crude oil production curtailments on associated gas production. Propane exports from Saudi Arabia averaged 168,000 b/d February-August, or 76,000 b/d (31%) less than the same time period in 2008, according to data complied by Waterborne Energy, Houston. The reduction in propane exports from Saudi Arabia resulted in a tightening international supply-demand balance, while at the same time propane supply in the US remained plentiful.

Feedstock demand

During second-quarter 2009, feedstock demand for propane increased by 55,800 b/d vs. consumption during first-quarter 2009 and averaged 286,000 b/d. This increase was consistent with seasonal patterns, but demand in second-quarter 2009 was 47,000 b/d (14%) less than prerecession demand. We note that feedstock demand for propane averaged 330,000-360,000 b/d during first-half 2008 and reached a peak of 410,000-430,000 b/d in June-July 2008.

Propane demand averaged 335,000-345,000 b/d in July and 320,000-330,000 b/d in August. We estimate demand for third-quarter 2009 averaged 325,000-335,000 b/d for third-quarter 2009.

Table 1 summarizes trends in ethylene feedstock demand for propane.

Ethylene producers operated at 72% of capacity in first-quarter 2009. Our analysis of ethylene production trends indicated ethylene producers continued to limit output in response to heavy liquidation of polyethylene inventory and sharply reduced demand for ethylene.

Inventory liquidation ran its course and ethylene demand began to recover in second-quarter 2009. Specifically, the industry's operating rate improved to 83% in second-quarter 2009 and reached an estimated 85% in third-quarter 2009. Unless global economic growth is much stronger in fourth-quarter 2009, the industry will continue to operate at 85% in fourth-quarter 2009 and first-quarter 2010.

On this basis, total demand for fresh feed will average 1.50-1.55 million b/d during fourth-quarter 2009 and first-quarter 2010. Feedstock demand for propane will reach 275,000-315,000 b/d during winter 2009-10, and propane's share of fresh feed will average 18.0-20.5%. Fig. 1 illustrates historic trends in ethylene feedstock demand for propane.

Retail demand

Consistent with the seasonal heating degree-days, retail demand fell to its seasonal low during second and third quarters 2009. We estimate that total retail propane sales averaged 380,000-390,000 b/d in second-quarter 2009 and 190,000-210,000 b/d in third-quarter 2009.

Heating degree-days for the winter 2008-09 in key regional markets of the upper Midwest, New England, and Middle Atlantic were generally 5-10% higher than in winter 2007-08. Our forecasts for retail sales during winter 2009-10 are based on average heating degree-days for the winter heating seasons of 2003-08. We note, however, that some early weather forecasts call for a colder-than-average winter.

Consistent with the seasonal decline in retail propane sales, propane imports from Canada typically decline to minimum seasonal volumes of 50,000-75,000 b/d during second and third quarters. Additionally, propane imports from international sources (outside North America) usually increase during second and third quarters.

Exports are seldom a significant component of propane supply-demand trends, but prices in the Gulf Coast were at levels that provided economic incentives to international LPG traders to ship record volumes into Europe and Asia during second and third quarters 2009.

Retail propane sales typically begin their seasonal increase in September-October and reach their peak in December-January. During a severe winter, retail propane sales will be 10-20% higher than during recent winters. The record high for retail propane sales occurred during winter 2000-01 and totaled an estimated 210 million bbl. Propane supply-demand balances for winter 2009-10, however, are based on total retail sales of 170-180 million bbl. In comparison, retail sales totaled 176 million bbl during winter of 2007-08 and 178 million bbl during 2008-09.

Propane supply

Crude oil prices rebounded strongly during second-quarter 2009 and remained higher than $65/bbl in third quarter, and propane prices increased as well. Natural gas prices, however, continued to decline during second and third quarters 2009. Consequently, profit margins for propane recovery from gas processing plants were sharply higher in second and third quarters 2009.

Profit margins for ethane recovery also improved in second and third quarters 2009. As a result, gas plants had strong economic incentives to operate at maximum NGL recovery—subject only to capacity constraints on raw-mix pipelines and at raw-mix fractionation plants at Mont Belvieu.

For refineries, economic incentives to move propane into the merchant market also remained strong. Propane prices averaged $8/MMbtu during second-quarter 2009 and increased to $9.50-9.75/MMbtu during third-quarter 2009. Propane prices were $5-7/MMbtu higher than natural gas prices. Refineries had strong economic incentives to sell propane and purchase natural gas.

Based on data published by the US Energy Information Administration, we note that total domestic production from gas plants and net propane production from refineries increased to 881,000 b/d in second-quarter 2009, or 24,000 b/d (2.2 million bbl) higher than year-earlier production volumes.

We estimate that domestic production averaged 865,000-875,000 b/d during third-quarter 2009 vs. 798,000 b/d in third-quarter of 2008. We forecast domestic production to average 830,000-860,000 b/d during the winter heating season 2009-10 vs. 800,000-820,000 b/d during the winter heating season 2008-09. We note that Hurricane Ike curtailed propane production in fourth-quarter 2008 and first-quarter 2009.

For the winter 2009-10, domestic propane production will total 152 million bbl, or 6 million bbl less than during the winter heating season 2008-09.

Gas plants

EIA statistics indicate that gas plants' propane production averaged 515,000 b/d for first-quarter 2009 and was 3,000 b/d lower than year-earlier volumes. Gas plants' production increased to 539,000 b/d in second-quarter 2009 and was 8,700 b/d higher than year-earlier volumes. Gas plants' production in second-quarter 2009 was the highest volume since second-quarter 2002. We note that gas plants' production in Louisiana during second-quarter 2009 averaged only 73,000 b/d and was 40,000 b/d lower than in second-quarter 2002. After accounting for this variance, aggregate gas plant production from other areas was at record high volumes in second-quarter 2009.

Typically, gas plants' propane production reaches its seasonal peak in the second quarter and generally declines modestly in the third and fourth quarters. Accounting for typical seasonal patterns, we expect gas plants to produce an average 515,000-525,000 b/d in third and fourth quarters 2009.

Fig. 2 illustrates trends in propane production from gas plants.

Refineries

Refinery propane production increased to 342,000 b/d in second-quarter 2009, and we estimate that production averaged 345,000-350,000 b/d in third-quarter 2009. Based on typical seasonal patterns, we forecast production to decline in fourth-quarter 2009 and to average 310,000-330,000 b/d during the 2009-10 winter heating season.

Fig. 3 shows trends in total propane production (gas plants and refineries).

Imports, exports

Based on data from the US Census Bureau's Foreign Trade Division, propane imports from Canada declined in second-quarter 2009 and averaged 70,000 b/d, or 8,000 b/d lower than year-earlier volumes and 31,000 b/d less than the average for 2000-05. We estimate that propane imports from Canada increased to 85,000-95,000 b/d in third-quarter 2009, equal to volumes in recent years.

Demand in the northern hemisphere declines to minimum levels during second and third quarters, and international producers usually have surplus cargoes to sell. As a result, waterborne imports into the US usually increase during the off season.

This year, however, due to the decline in supply in the Middle East, international markets had few surplus cargoes. During second-quarter 2009, waterborne imports into the US averaged only 21,000 b/d, or 11,000 b/d less than in 2008 and 57,000 b/d less than in 2007, according to Foreign Trade Division statistics. During third-quarter 2009, waterborne imports were an estimated 25,000-30,000 b/d, or 63,000 b/d (5.8 million bbl) less than in 2008.

Exports from the US are rarely a major factor in the supply-demand balance. Propane prices in Mont Belvieu during second and third quarters 2009, however, were much lower than in international markets. According to EIA statistics, US propane exports averaged 54,000 b/d in second-quarter 2009 and were 6,000 b/d higher than in 2008 but 27,000 b/d higher than in 2007.

Based on loading schedules for third-quarter 2009, we estimate that exports surged to 80,000-90,000 b/d and were 60,000-70,000 b/d (5.5-6.5 million bbl) higher than in 2008. The surge in exports during third-quarter 2009 helped offset the continued impact of subpar ethylene feedstock demand.

Overall inventory trends

Propane inventories typically fall to seasonally minimum levels in mid to late March. Apr. 1 normally marks the beginning of inventory accumulation season for the US. Occasionally, however, propane inventories begin to accumulate as early as mid-March.

In fourth-quarter 2008, propane inventory in primary storage reached its seasonal peak of 57 million bbl (excluding nonfuel propylene) during the second week of November.

Based on EIA statistics for the US and National Energy Board statistics for Canada, propane inventories in North America fell to a seasonal minimum of 42.4 million bbl at the end of February 2009 from a seasonal peak of 70.6 million bbl at the end of October 2008. The seasonal decline of 28.2 million bbl was well below the typical withdrawal of 40-44 million bbl, and total inventories in North America were 9.2 million bbl higher than year earlier levels.

Inventory accumulation rates were higher than average in second-quarter 2009, and inventories for the US and Canada totaled 72.5 million bbl at the end of June 2009 and were 21.9 million bbl higher than year-earlier levels. As a result of the surge in waterborne exports in third-quarter 2009, inventory accumulation rates were below average and total stocks in storage in Canada and the US reached 83.5-84.5 million bbl at the end of September 2009.

At the beginning of the winter heating season, inventories were 12.5-13.5 million bbl higher than in 2008. US inventories reached a peak of 70-72 million bbl. The US inventory peak was 3-5 million bbl lower than was generally expected early in the second quarter.

From a seasonal minimum of 1.3 million bbl on Mar. 1, 2009, purity propane in primary inventory in Canada increased to 9.1 million bbl on Sept. 1, 2009, and was 1.3 million bbl more than year-earlier volumes but 0.6 million bbl less than the 5-year average. Based on historic patterns, purity propane inventories in Canada began to decline in September.

Fig. 4 shows trends in US propane inventory.

Regional inventory trends

Propane inventory in primary storage in Petroleum Administration for Defense District II (accompanying box) reached its seasonal minimum at the end of February 2009 and totaled 13.0 million bbl, or 4.3 million bbl more than year-earlier volumes and 2.7 million bbl more than the 5-year average (Table 2).

According to EIA's Petroleum Supply Monthly statistics, propane inventory in PADD II storage increased to 24.2 million bbl at the end of June and was 6.3 million bbl higher than in 2008. Based on EIA weekly reports, inventories in PADD II increased to about 31 million bbl at the end of September.

Propane inventory in primary storage in PADD III (excluding nonfuel propylene) reached its seasonal minimum of 17.9 million bbl in mid-March and totaled 19.5 million bbl at the end of March, according to EIA's Petroleum Supply Monthly statistics. During second-quarter 2009, inventories increased by 13.4 million bbl and totaled 33.5 million bbl at the end of June. At this level, inventories were 16.1 million bbl higher than year-earlier levels and 12.1 million bbl higher than the 5-year average.

According to EIA weekly inventory reports, propane stocks in PADD III were unchanged during early July through late September and totaled about 32.0 million bbl. Typically, inventories in PADD III increase by about 9 million bbl. The surge in waterborne exports and the slump in waterborne imports effectively absorbed the typical increase in inventories during third-quarter 2009.

Pricing, economics

Key OPEC producers maintained strict compliance with their production quotas during second and third quarters 2009 and forward-looking crude oil buyers and traders began to see reasons for optimism for an end to the economic recession. As a result, the crude oil price rally during February-March 2009 was the beginning of a strong rebound rather than an overdue correction, as we had anticipated (OGJ, May 4, 2009, p. 72). As a result, WTI prices averaged $60-70/bbl during second and third quarters 2009.

As expected, however, ethane supplies were plentiful and spot ethane prices remained relatively weak. Competition from ethane for incremental feedstock demand continued to undermine propane's feedstock value.

At the end of the heating season, propane prices in Mont Belvieu averaged 65.2¢/gal in March 2009. The price average for March was 7.4¢/gal lower than the average of 72.6¢/gal for January 2009 despite the increase in West Texas Intermediate crude oil prices of $6.25/bbl. Propane's ratio vs. WTI declined to 57.0% in March 2009 from 73.0% in January 2009. Propane prices fell to a low of 63.4¢/gal in April and the ratio vs. WTI fell to 53.5%.

Prices strengthened in May and June and averaged 72.7¢/gal for second-quarter 2009, or 5¢/gal higher than the average for first-quarter 2009. Despite the price rally in May and June, however, the price ratio vs. WTI averaged only 51.4% in second-quarter 2009 vs. 66.7% in first-quarter 2009. Prices continued to increase in the third quarter and averaged 87¢/gal. Propane's ratio vs. WTI also improved in third-quarter 2009 and averaged 53.6%.

For second-quarter 2009, propane prices averaged 72.7¢/gal, but feedstock parity values vs. light naphthas averaged 87.9¢/gal. The discount of 15.2¢/gal revealed the full impact of plentiful ethane supply and weak ethane prices on propane's market value.

In third-quarter 2009, propane prices averaged 87¢/gal and feedstock parity values vs. light naphthas averaged 97¢/gal. The discount of 10¢/gal showed that propane remained deeply discounted in the Gulf Coast ethylene feedstock market.

These comparisons indicate that the impact of the economic recession on ethylene feedstock demand reinforced the generally bearish impact of the propane inventory surplus. Feedstock parity values vs. ethane, however, averaged 68.4¢/gal in the second quarter (4.3¢/gal lower than spot propane prices) and 85.8¢/gal in third-quarter 2009 (1.3¢/gal lower than propane prices). The narrowing differential between spot prices and propane's feedstock parity values vs. ethane indicate that the surge in waterborne exports from the Gulf Coast during third-quarter 2009 began to counter some of the bearish impact of the inventory surplus.

Winter 2009-10

We expect key OPEC producers to continue to maintain strict compliance with their production quotas during fourth-quarter 2009 and first-quarter 2010. Furthermore, we expect gradual improvement in global economic activity to encourage forward looking crude oil buyers and traders to remain optimistic regarding the global crude oil supply-demand balance in 2010. WTI prices will average $68-72/bbl during fourth-quarter 2009 but will weaken somewhat during first-quarter 2010 and will average $62-67/bbl.

In the Gulf Coast ethylene feedstock market, feedstock demand for ethane exceeded production during first and second quarters 2009 and ethane inventories in the Gulf Coast declined by almost 5 million bbl during January through June 2009. This trend continued during third-quarter 2009.

Most likely, as the ethane supply-demand balance continues to tighten during the winter heating season, spot ethane prices will strengthen. As a result, spot propane prices in Mont Belvieu will average 95-100¢/gal, or 8-18¢/gal higher than during third-quarter 2009.

The author

Daniel L. Lippe ([email protected]) is president of Petral-Worldwide Inc., Houston. He founded Petral Consulting Co. in 1988 and cofounded Petral Worldwide in 1993. He has expertise in economic analysis of a broad spectrum of petroleum products including crude oil and refined products, natural gas, natural gas liquids, other ethylene feedstocks, and primary petrochemicals. Lippe began his professional career in 1974 with Diamond Shamrock Chemical Co., moved into professional consulting in 1979, and has served petroleum, midstream, and petrochemical industry clients since that time. He holds a BS (1974) in chemical engineering from Texas A&M University and an MBA (1981) from Houston Baptist University. He is an active member of the Gas Processors Association, serving on the NGL Market Information Committee.

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