Propane Scarcity Drives Trading Shifts

Many commodity traders are closely monitoring propane markets in 2024 as tightening supplies point toward potential price spikes.

Propane, commonly used for home heating, cooking, and industrial purposes, has recently experienced production declines and inventory drawdowns.

In this article, we’ll explore the reasons causing propane scarcity and how traders can capitalize on volatile propane prices.

What is Causing the Propane Supply Crunch?

The propane supply is primarily impacted by two factors: a decline in domestic production and inventory draws.

Declining Domestic Production

Propane is extracted from natural gas streams and oil refineries as a byproduct of processing these fossil fuels. However, as shale drillers have scaled back natural gas and crude oil operations in recent years, less associated propane has been produced as well.

The number of active oil and gas rigs with low energy prices dropped considerably in 2020-2021. While drilling activity has recovered, it remains below previous highs.

This is especially true for dry gas wells, which yield higher fractions of NGLs like propane than oil wells. Less drilling directly equates to reduced propane output.

Furthermore, some major propane-producing infrastructure has recently shifted towards more profitable exports. This includes the Mariner East pipeline, which now transports significant NGL volumes to Canada and overseas markets. Thus, the domestic propane supply pool has shrunk.

Unexpected Inventory Draws

Adding to production declines, back-to-back cold winters severely drained propane storage inventories. Winter 2022/2023 saw multiple polar vortexes and above-average heating demand nationwide.

The Energy Information Administration reported that US propane stocks dropped to 55 million barrels in January—the lowest level for that month since the agency began recording storage data.

Usually, inventories rebuild to comfortable levels in the summer injection season. But the huge winter draw pushed inventories so low that stocks have struggled to recover to historic averages.

This raises the risk of further inventory draws if winter 2023/2024 also proves colder than normal. With storage remaining tight, another extreme cold could force prices to spike, as seen following last year’s inventory.

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How Propane Prices React to Scarcity

Spiking Spot Prices

As supplies have tightened from production declines and inventory draws, propane spot prices have already posted significant gains.

Propane traded for less than 30 cents per gallon in early 2020 at the Mont Belvieu benchmark hub in Texas. But prices spiked over $1 per gallon in early 2023 as winter stock draws intensified scarcity.

While spot prices have since eased as inventories partially recovered this past summer, they remain well above historical averages.

This year, Mont Belvieu propane has traded between 60 and 80 cents per gallon, roughly two to three times higher than typical price levels just a few years ago.

Backwardated Futures Markets

In future markets, propane contracts will display a market structure known as backwardation. This means futures prices decrease for each month further out along the curve.

For example, early 2024 propane futures recently traded around 85 cents per gallon, while 2025 futures traded under 60 cents. This backwardation indicates traders expect tighter inventories and higher spot prices in the next 12-18 months before loosening in future years.

The premium for front-month futures signifies traders anticipate further scarcity this coming winter.

Any supply/demand surprise that drives spot prices higher could create profitable trading opportunities in these backwardated contracts.

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Regional Price Spikes

While benchmark hubs give a general indication of market conditions, propane prices can also spike much higher regionally during periods of scarcity.

When inventories draw down significantly, logistical constraints may prevent swift supply transfers from other hubs. If a specific area faces an intense cold blast, local prices can skyrocket due to the inelastic nature of heating demand.

These temporary dislocations have caused propane to trade as high as $4- $5 per gallon in some Midwestern and Northeastern states over the past two winters.

Watching for extreme regional price moves can also present savvy traders with short-term profit windows on which to capitalize. The key is closely monitoring demand trends and inventory data at storage hubs nationwide.

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Trading Strategies to Capitalize on Propane Price Swings

Commodity traders have already begun positioning for this impending supply crunch. Propane futures at Mont Belvieu for early 2024 delivery trade at a steep premium to spot prices, indicating expectations for a stock draw later this year.

Beyond futures, traders can gain exposure through companies sensitive to propane prices. Many US propane retailers, like Suburban Propane (SPH) and AmeriGas (APU), have seen share prices surge over 300% from 2020 lows with heating fuel margins.

Midstream providers, including Enterprise Products (EPD) and ONEOK (OKE), also benefit from the high-price environment.

For short-term trades, watch weather forecasts this coming fall/winter. Sustained cold snaps, like those seen in 2022/2023, could send cash prices spiking and provide opportunities to capitalize.

Longer-term capital investment in processing and storage will be needed to rebalance propane fundamentals.

Until then, be prepared for more large swings as this essential commodity sees scarcer supplies against recovering demand.

You might also like to read: How to Trade Commodities as a Beginner Trader

In Summary

The propane market is experiencing significant supply constraints due to declining domestic production and unexpected inventory draws. This scarcity has led to spiking spot prices, backwardated futures markets, and regional price dislocations.

Traders should closely monitor these developments, as the tight supply situation could lead to profitable trading opportunities.

While short-term trades based on weather forecasts and regional price moves may offer quick profits, longer-term positions in propane-sensitive companies could also benefit from the high-price environment.

Traders should remain cautious and manage their risk carefully, as the market’s volatility can be unpredictable.

Given the current market conditions and potential for further supply crunches, it appears to be an opportune time for experienced traders to explore propane trading strategies while keeping a close eye on fundamental factors driving price movements.

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