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TheStreet Open House

Propane: The Other Natural Gas Market

With apologies to J.J. Cale...

If you wanna hang out, you've got to take her out / Propane
If you wanna get down, down on the ground / Propane
Up in price, up in price, up in price / Propane

Organic chemistry, for those who never had the pleasure, has certain Tinkertoy qualities. You can keep linking carbon atoms in chains and rings and hanging things off the side to produce larger and more interesting molecules. As is the case elsewhere in life, however, the simplest things are the most important.

The natural gas we're most familiar with is at least 96% methane, which has one carbon atom. The gasoline you pour into your Bronto SUV is a mixture centered on octane, which has eight carbon atoms. The petrochemical industry relies on the lighter, smaller molecules with two to four carbons: ethane, propane and butane, and their close derivatives. As these oscillate between their gas and liquid states, depending on temperature and pressure, and are extracted from raw natural gas, they are called natural gas liquids, or NGLs. Of these, propane is the most important economically and serves as the principal price-discovery mechanism.

Carry the Torch

The price of NGLs is normally quite volatile, and both producers and consumers have developed hedging strategies to protect themselves as best as they can.


A Tiger in the Tank
Source: CRB Infotech

But earthquake insurance is much cheaper in Chicago than it is in Los Angeles, and the cost of hedging any commodity that tripled in real-dollar prices between 1999 and 2001, then fell by half and redoubled again going into 2003, must reflect that volatility. Moreover, regardless of the price of propane at Mont Belvieu, Texas, the delivered price to users outside the Gulf Coast likely will reflect transportation costs more than material costs. As a result of this volatility/location combination, the New York Mercantile Exchange's propane futures contract has never had more than trivial volume.

Hedging propane with natural gas -- a common technique known as cross-hedging -- doesn't solve the problem either. The relationship is decidedly non-linear, and for good reason: Much of the natural gas market is destined for non-interruptible uses, such as residential heating, and customers are decidedly not price-sensitive when the choice is pay more or freeze to death (sorry, commodities are not pretty). In addition, few residential customers have available storage in their backyards. Commercial propane use is more interruptible; the consumer can reduce demand in the face of higher prices. And many propane customers have storage tanks on site.

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