The U.S. is the world’s leading supplier of liquid petroleum gas (LPG), exporting nearly half of the country’s two million barrels per day (bpd) of propane production to Asia, Latin America and Europe.1 Propane fundamentals have shifted dramatically in the U.S. in less than a decade. Recent growth in oil and natural gas processing from U.S. shale contributed to a wave of export capacity investment in the U.S. Gulf Coast region from 2013-2017, which allowed the U.S. to become a net propane exporter and a leading supplier to the global marketplace.
The recently expanded shipping channel through the Panama Canal is also supporting U.S. propane exports by providing shorter delivery times to Asia, and allowing new trade opportunities in Mexico and South America. Most propane enters Mexico via truck and rail. But propane is increasingly making its way down the west coast of Mexico and Latin America via waterborne cargoes.2
Recent government reforms in Mexico transitioned the country’s energy markets to a free market structure, opening the borders to imports, while removing a government controlled pricing system that defined the market for nearly 70 years.
Mexico now receives nearly 133,000 bpd of propane from the U.S.3 These new import dynamics, coupled with Mexico’s need for additional propane supply, means local producers and marketers must compete on price globally for the first time. Prior to reform, prices were set by the government, which contributed to underinvestment in exploration and production, storage, and overall infrastructure upgrades putting the country at a deficit in terms of output and competitiveness.
Prices are based on the Mont Belvieu (TX) price plus a transport fee. Mont Belvieu (TX) is the benchmark and main transport hub for LPG in the U.S. It contains the largest storage area in the world, and is linked to a vast network of pipelines, growing export facilities, as well as refineries and gas processing plants throughout the region.
Mont Belvieu (TX) is also playing a role in shifting global trade balances. Historically low prices in the U.S. encouraged some Asian importers to switch from Middle Eastern supply to U.S. supply between 2013 and 2017.4 However, the Middle East remains an important producer and supplier to markets in Europe and India for example.
Middle Eastern producers, such as Saudi Arabia, supply the near totality of Indian LPG imports,5 and benefit from favorable transport economics due to their proximity to the import destination.6 The same applies to Iranian product, provided LPG exports are not impacted by any international sanctions regimes. Following the collapse of the Iran nuclear deal and the re-imposition of U.S. sanctions, the Indian government stated that it would follow U.N imposed sanctions, but not unilateral sanctions imposed by a single country.
India’s growing appetite for LPG is closely linked to government programs that encourage the burning of cleaner cooking fuels in rural regions.7 The program’s success, and lack of sufficient local production, means India is required to import 12 million tons annually (approximately 380,000 bpd), making India the world’s second largest LPG importer.8 The country’s new development needs are currently supported by investments in infrastructure aimed at easing capacity constraints.
In China, demand for LPG is balanced between residential and petrochemicals demand. According to the Energy Information Agency (EIA) data, the country was the third largest export destination for U.S. propane in 2017, only surpassed by Japan and Mexico. From 2012 to 2017, U.S. propane exports to China increased from 3,000 bpd to 123,000 bpd.9 Going forward, petrochemicals demand for LPG is expected to grow in China, and therefore should provide continuous support to the propane complex.
Japan, the largest U.S. propane importer, averaged 205,000 bpd in 2017.10 IHS Markit, an information service provider, estimates that northeast Asia will import more LPG from North America than from the Middle East by the end of this decade – a sizeable shift since U.S. exports to Asia were negligible at the beginning of this decade.11
Europe remains a highly competitive market, where petrochemical industry participants actively switch between propane and naphtha as a feedstock. Although naphtha use is seeing declines, as lighter feedstocks such as propane and ethane become more competitive, the spread between propane and naphtha can be highly volatile. This was observed in September 2017, when supply disruptions in the global propane market – mostly the after-effects Hurricane Harvey hitting the U.S. Gulf Coast and a tight Middle East spot market- helped turn the feedstock spread into positive territory for the first time since late 2013.12 A positive feedstock spread indicates that propane is more expensive than naphtha.
In the winter of 2017 the spread relationship reversed, as weak heating demand brought the price down, resulting in the spread dropping below -100 $/MT, or approximately $8 per barrel (propane is more commonly used for heating than naphtha). The chart below shows the final settlement prices for CME Group’s European Propane CIF ARA (Argus) vs. Naphtha Cargoes CIF NWE (Platts) Futures contract (Code EPN). This contract is one of many spread contracts seeing growing trading activity.
The arbitrage trade between Asia and the U.S. market is one other global spread dynamic that is closely watched. This trade depends on whether the difference between U.S. spot prices and prices at destination covers shippers’ terminal throughput fees and freight rates. Starting in 2016, the Asian premium to U.S. prices has eroded. The following chart shows the price difference between the respective front month contracts of the Argus Propane Far East Index Futures, (Code 7E), and the Mont Belvieu LDH Propane (OPIS) Futures, (Code B0).
The Argus Far East Indices for LPG are widely referenced across the market and serve as a reference price for the Asia-Pacific region, the main demand center for LPG. The Mont Belvieu, LDH Propane (OPIS) Futures contract is financially settled off the Oil Price Information Service (OPIS) price assessment. OPIS is the most widely referenced benchmark for LPG in North America.
Given the lower premium environment, 2017 saw a range of spot cargoes cancelled13, as participants preferred to pay cancellation fees rather than shipping product at a loss.
Since the Panama Canal reopened, two waterborne routes from the U.S. to Asia concurrently exist. The route via the Panama Canal, a 25-day journey, is largely favored by participants against the route via the Cape of Good Hope, a 45-day journey. It has captured about 90% of U.S. to Asia cargoes since the canal reopened, according to data from IHS Markit.14 Despite this, participants may still choose the longer journey via the Atlantic, as those participants may want to capture a seasonal price difference (these cargoes arrive at their destination approximately one month later) and may not want to be subject to the increased canal toll tariffs.
CME Group has seen increased activity in its Argus Propane Far East Index Futures Contract, with average daily volume (ADV) exceeding a record 300 lots per day (1 lot/1,000 MT) in 1Q18.
Significant investment in export infrastructure may remain necessary to ensure the U.S. is well poised to benefit from continued demand for LPG. With the decreased Asia to U.S. premium, and simultaneous growth in export volumes, the industry may be entering a new era of higher global price convergence. Regional supply and demand imbalances and the interdependence with related products will likely continue to influence prices beyond directly affected regions and markets, presenting both challenges and opportunities for risk managers across the globe.
**All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience**