A must-know overview of AmeriGas Partners and its 1Q14 earnings (Part 2 of 7)
Propane is typically extracted from natural gas or separated during crude oil refining. Residential and commercial customers use propane primarily for heating and cooking purposes. Industrial customers use propane to fire furnaces or as a cutting gas. Industrial customers also include large-scale heating accounts and local gas utility customers who use propane as a supplemental fuel to meet peak load deliverability requirements. As a motor fuel, propane is burned in internal combustion engines that power over-the-road vehicles, forklifts, commercial lawn mowers, and stationary engines. Agricultural uses include tobacco curing, chicken brooding, and crop drying.
For fiscal 2013, APU’s four distinct end users—namely residential, commercial, motor fuel, and agriculture and transport—accounted for 42%, 33%, 12%, and 13 % of consumption, respectively. APU is part of the Yorkville High Income MLP ETF (YMLP), an ETF that tracks select MLPs.
Competitors for propane distributers include suppliers of electricity, fuel oil, and natural gas. These alternates compete on various parameters. Electricity, even though it’s more expensive than propane, competes with propane because of the convenience it offers to its customers. Natural gas, on the other hand, competes because of its competitive price. Propane serves as an easy alternative in areas where natural gas is unavailable or portability is difficult. Fuel oil is also a major competitor of propane and is generally more expensive than propane.They both do, however, require different types of installation, and residential furnaces and appliances that burn propane won’t operate on fuel oil unless fuel oil becomes significantly cheaper than propane. Other competitors for propane include gasoline, diesel fuel, electric batteries, fuel cells, liquefied natural gas, and compressed natural gas.
The determinants of propane prices
The propane distribution industry depends on several external factors. These include supply and demand dynamics, propane prices, markets served, cost of alternative energy sources, et cetera.
Supply and demand dynamics
While propane production isn’t seasonal, residential demand is highly seasonal. This imbalance causes inventories to build up during the summer, when consumption is low, to be drawn down during the winter, when consumption is much higher. When inventories for propane at the start of the winter heating season are low, the increased demand due to cold weather pressures propane prices, driving them up. Also, due to transportation costs, the customers farthest from the major supply sources (the Gulf Coast and the Midwest) will generally pay higher prices for propane.
APU has approximately 250 domestic and international sources of supply, including the spot market. Enterprise Products Partners, L.P (EPD), Plains Marketing—a subsidiary of Plains All American Pipeline (PAA)—and Targa Liquids Marketing & Trade—a subsidiary of Targa Resources Partners (NGLS)—supplied approximately 51% of APU’s fiscal 2013 propane. Note that EPD, PAA, and NGLS are all major master limited partnerships (MLPs) and components of the Alerian MLP ETF (AMLP).
During periods of sharp demand due to colder-than-normal weather, the locally available stocks of propane can be depleted, which can cause price spikes as suppliers such as APU try to locate other sources of propane and transport them to end customers. APU noted in its recent earnings report that weather for the quarter ended December 31, 2013, was 3.8% colder than normal and 14.0% colder than the prior year.
Propane demand comes from several different markets that exhibit distinct patterns in response to the seasons and other influences. Residential demand, for instance, depends on the weather, so prices tend to rise in the winter. The petrochemical sector is more flexible in its need for propane and tends to buy it during the spring and summer, when prices decline. Agricultural uses of propane include crop drying, weed control, et cetera. The amount of propane used for crop drying, the largest component of farm use, is not only seasonal (highest in the fall) but also dependent on crop size and moisture content. Agricultural propane use is primarily concentrated in the Midwest.
Propane price volatility
Propane prices occasionally spike beyond normal supply and demand fluctuations. The main cause for this volatility appears to be the logistical difficulty of resupplying during the peak heating season (November through March). Logistical challenges include weather and transportation costs. Because propane is produced at a relatively steady rate year-round, there’s no ready source of incremental production when supplies run low. Propane wholesalers and retailers are forced to pay higher prices due to dwindling supply. Consequently, higher propane prices pass on to consumers.
Costs of alternative sources of energy
The gradual expansion of the nation’s natural gas distribution systems has resulted in the availability of natural gas in some areas that previously depended on propane. As per company reports, APU loses an average of 2,500 customers annually to natural gas. Natural gas is cheaper than propane. However, natural gas pipelines aren’t present in many areas of the country where propane is available.
To read about the two major factors affecting propane demand, continue to the following parts of this series.
Browse this series on Market Realist: