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Summary Propane distributors like Suburban Propane and AmeriGas Partners count on the next few months for substantially all their income. With propane supply near all-time highs, wholesale prices have fallen through the floor. Consumers look to benefit this year, but pricing spreads indicate a repeat of 2014 results. The early indicative data for propane distributors such as Suburban Propane (NYSE: SPH ) and AmeriGas Partners (NYSE: APU ) is a mixed bag heading into the incredibly important winter season. This period running from November-March of each year is an incredibly stressful time for these propane distributors, who derive substantially all of their operating income during the winter heating season. The first hurdle for these companies is the weather. The chance of a deep winter chill currently looks decent for some areas of the United States and mediocre for the rest . Most meteorologists forecast above average temperatures for the Northeast, with below average temperatures for much of the Southeast and East Coast. As the South and Midwest form the largest markets for propane, these forecasts end up being a mixed bag and are hard to call as solidly favorable in one direction or another. (click to enlarge) * Source: EIA.gov From a market perspective, available supply of propane continues to peak well above long-term historical averages, due to the significant bounce in production of the commodity from ever-increasing domestic production. Shortages that were widespread in many markets in 2014 seem unlikely to repeat themselves this time around. This excessive supply has brought wholesale and residential propane prices down, yielding what should be solidly lower prices going into this year’s heating season for consumers. This is a bright spot for those that count on propane to heat their homes, but what does it mean for propane distributors? Fixed Margin Pressures Usually, low propane prices provide a boost for propane distributors like Suburban Propane and AmeriGas Partners. All else equal, low propane costs increase the demand for their products and protects against customers switching to alternatives, such as heating oil or electricity. With propane and other alternative heating fuels more commonly used among rural homes with lower annual incomes, these consumers are much more cost sensitive to price changes than the heating markets served by traditional utilities. Propane distributors, while keeping that fact in mind, still try to maintain a fixed spread between the wholesale and residential cost of propane. This is where they can derive their profit, and we can see the results of that in a comparison from 2014 to 2015 below. (click to enlarge) Trying to protect this fixed margin per gallon is why we see the current market situation in propane today with resiliently high residential propane prices. While wholesale propane prices are down 46% from a year ago according to EIA data, skirting along at $0.50/gallon in 2015 from $0.93 gallon in 2014. Residential prices have remained stubbornly high in the meantime, and are only down 19% year/year. In my opinion, wholesale prices in the U.S. cannot fall much further, so this year will be as good as it can get for propane consumers. At these prices, it is barely worth it for producers to ship, store, and market it for sale. Look for propane exports to increase, as unlike natural gas, propane is more easily shipped abroad for sale, and these price declines make exporting increasingly attractive. (click to enlarge) Heating oil, a chief competitor of propane, looks more profitable going into the winter of 2015/2016. The profit spread is up, but heating oil is primarily used in the Northeast , where it heats nearly 30% of all households. If we remember our 2015 weather forecast data, this area is at this point expected to be a little warmer than usual. The demand may not simply be there for the product compared to 2014. Conclusion With margin spreads down and supply up, propane producers are counting on a chilly winter to drive some additional demand to make up the difference. Without old man winter swirling up some unexpected cold, investors should expect operating income flat to slightly down from 2014 levels. Suburban Propane has the most opportunity for surprise earnings upside over 2014 due to its heating oil exposure, but only if the Northeast comes in much colder than expected. Heating oil is set up to be better currently year/year, and with supply running at long-term averages, a cold shock in the Northeast could drive significant demand for the company. Scalper1 News
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