On October 13th, the Energy Information Administration, a division of the U.D. Department of Energy, published its latest Short-Term Energy and Winter Fuels Outlook.
The upshot is this: While electricity prices are expected to fall over the winter months, by 2% on average, all fuel prices are heading north. The EIA estimates a 4% rise in natural gas (a 6% increase in prices offset by a 2% decline in consumption over last year), along with a hefty average aggregate increase of 12% in heating oil.
The average rise in heating oil, however, hardly tells the whole story. About 80% of heating oil usage is centered in the Northeastern U.S., and there, the increase will be greater – coming in at about 22 cents a gallon.
Yet the real issue will surround yet another oil product: propane. It is already developing into a major concern, especially if this winter is a particularly cold one and, specifically, if it hits hardest in the Midwest. But as you’ll see, these EIA projections provide a great play for the investor.
Propane Prices Are on Thin Ice
The spike in propane results from some of the lowest stockpiles in memory. While propane is a major source of energy and heating in rural areas during the winter months, it is also required for drying out crops in the fall. And that has already created some spot problems.
In overview, about 6% of total U.S. households heat primarily with propane. The EIA expects these households to spend an average of $136 (or 8%) more this winter, but that increase will vary by region. Households in the Midwest will see an average increase in winter propane expenditures of 14%, as projected residential propane prices increase by more than 15% from last winter and consumption falls by about 1%.
Forecast household propane expenditures in the South are 6% lower this winter, because a 13% decline in consumption more than offsets a projected 7% increase in prices. However, the EIA has also identified another problem that intensifies things.
The agency regards propane supply in parts of the Northeast as the most significant concern in the entire winter fuel outlook. A leak was found in the TEPPCO Partners (TPP) propane pipeline east of Watkins Glen, New York, in late August. The pipeline closed its Oneonta, Harford Mills, and Selkirk terminals and is not expected to re-open any of them until later in the year.
While much of New England’s propane supply comes from imports, the relatively low level of inventory in the region means that any water-borne delays or an early cold snap will likely drive prices higher, since suppliers would have to travel extended distances for incremental barrels until supplies normalize.
And the problem may be worse than the EIA thinks. Last week, the Propane Gas Association of New England issued an update indicating that the TEPPCO pipeline may be down longer than anticipated – at least into December. That will introduce reliance on even more expensive, imported volume and put some hard choices on premium supply availability to local markets.
And the actual rise in propane cost in those regions where supply remains a concern – certainly the Northeast and agricultural areas of the Midwest – will have an impact on food costs at least through next spring. The problems with the fuel now will extend into rising costs during the sowing season and into the early periods of harvesting.
How to Profit
And here’s what will generate the greatest return to the investor: The ability to correctly determine where in the production cuts the rises will come first.
In the U.S., that usually means directing emphasis (and analyst interest) from March until August to the light distillate end of the curve, since that production division provides high-octane gasoline. We have, of course, seen shortfalls elsewhere, for example, in diesel (a middle distillate), and even experienced a limited supply of asphalt (a heavy distillate) in certain parts of the country.
The 137 refineries remaining in operation in the U.S. have little ability to address this propane shortfall short term. The overall refining capacity in the country remains at about 17.5 million barrels a day. In a normal year (which this is not), gasoline prices decline after Labor Day – with refineries already having moved to an emphasis on heating oil by that point. That is, they’ve moved from what is called the light distillate end of the production cycle (primarily high-octane gasoline) to middle distillates (kerosene, jet fuel, and low sulfur-content heating oil).
An August 4th EIA report recorded the fourth consecutive week of aggregate refinery usage in excess of 90%. That figure is also rising against 2009 figures, with the spread now greater than 2%. Put another way: Weekly combined facility usage is now more than 350,000 barrels higher than it was at this time last year.
However, this year, gasoline prices are continuing to advance. Projections for the fourth quarter look similar to the pattern experienced in the same quarter of 2007. And that was a run-up to the last major spike in crude prices…
Given limited refinery capacity, we have limited ability to play both the light and middle distillate emphases. That means gasoline pricing will continue to rise on limited volume, while heating oil continues to rise on increasing demand. What is squeezed out in the process is the ability to provide any more of another light distillate – propane.
Propane is a gas that results from both crude oil and natural gas distillation. The total supply of propane cannot easily be raised to meet increasing demand. About 90% of the volume used in the U.S. comes from domestic refineries. Most of the remainder pipes in from Canada. It is a by-product of primary refinery runs, with significant increase in volume coming only by cutting other supplies of light distillates.
The market is sitting with less supply or propane supply last year – in some areas, barely 80% of last year’s stockpiles at this point in the season. The most manageable play, for average investors, would be to straddle the propane-heating oil price differential. Normally, that would be in one or more exchange-traded funds (ETFs). Unfortunately, there exist no sufficiently liquid ETFs for propane plays only.
So instead, the move I would suggest is to buy AmeriGas Partners (NYSE:APU). APU is one of several propane master limited partnerships (MLPs) available. It has been leading the field in returns over the last three months and is better positioned than the others to supply areas of primary propane needs moving into the winter.
However, this is a short-term play, and the upside potential will continue into the spring, if demand is not easily met due to continuing pipeline problems or inadequate refinery product runs. Plan on moving out of this position by early March, unless the dynamics are such that a further spike is expected.
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