Sunday, February 15, 2009

WTI is Disconnected - and that Should Matter to Propane Retailers

Here is an excellent piece from the Financial Times on the NYMEX benchmark crude value - West Texas Intermediate. West Texas Intermediate is a grade specification that is found in Texas and Oklahoma, and has major inventory storage in Cushing, Oklahoma. (Here is a recent article from the Guardian UK about Cushing.)

The problem is, when Cushing fills up with supply, the front month of the crude price curve gets exceptionally cheap. This is the same phenomena as when corn price drops 30-50% as the harvest comes in - to much supply for the physical capacity to store the product.

Well, Cushing is full. Way full. And likely the logistical bottlenecks associated with this over-supply are likely to get worse instead of better as we run through the month of March - a time when domestic inventories typically build significantly. This over-supply is a result of several factors - lack of demand for products such as unleaded gasoline in the 4th quarter of 2008 ius a big one. But additionally, the crude market is actually making it advantageous for companies to store product right now, allowing them to forward sell the commodity and lock in guaranteed profits.

The article from the Financial Times mentions how WTI is not an effective benchmark because its logistical storage constraints are creating a disconnect between WTI crude and Brent crude (the European benchmark).

The spread between WTI and Brent, the European benchmark, which is increasingly seen as more representative of global market conditions, was trading at more than $7 a barrel on Wednesday, after reaching a peak of $10.06 on January 15.

Historically, WTI trades at a premium of between $1.50 and $2.50 a barrel to Brent.

The front-month WTI contract has come under pressure because of weak US demand, increasing supplies from Canada and rising crude stocks at Cushing, Oklahoma, a hub in the US distribution network.

Why does this matter? Because it is ALMOST IMPOSSIBLE for new waterborne propane supply to get bid into the country. Not only does one have to pay the freight, but one has to overcome the difference in the front month spread between the European market and the domestic market. This means that propane would need to increase in value by +$.10 to adjust for this inconsistency between the markets.

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