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Cost Management Solutions LLC“Your Market Informant!”

The Propane Price Insider Reports

2016 M-PACT

Mark Rachal – Director of Research/Publications

Disclaimer

The quotes and information contained herein are believed to be accurate and reliable, however Cost Management Solutions LLC does not guarantee or warrant the information in any way, nor do we assume any responsibility for the accuracy or completeness of the information. The prices addressed herein are affected by a variety of factors, including market events & trading activities of market participants. Recipients of this information are solely responsible for their decisions with respect to their transactions.

“Your Market Informant!” 3

Presentation Goals


Project future propane prices.

Justify projections with fundamental data.

Look at actions propane retailers should consider in response to recent fundamental changes.

Suggestion


The process of projecting future prices can be a worthwhile exercise.

But the high number of variables that affect propane prices can cause unforeseen events making any projection irrelevant.

We highly recommend focusing more on the factors used to make the projections rather than the projections themselves, then diligently monitoring them for accuracy going forward.

We fully expect to have to modify our projections in the future. The key is knowing what to watch and how to respond.

Crude Price Forecast


Any projection of propane’s price has to begin with projecting

crude’s price.

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Crude Mont Belvieu

Propane and Crude Prices Since 2013


Propane prices can separate from

crude

But for the most part crude sets the price

direction

The Decline of Crude Prices

“Your Market Informant!”8

$20$30$40$50$60$70$80$90

$100$110$120$130$140$150$160

1/2/20085/2/20089/2/20081/2/20095/2/20099/2/20091/2/20105/2/20109/2/20101/2/20115/2/20119/2/20111/2/20125/2/20129/2/20121/2/20135/2/20139/2/20131/2/20145/2/20149/2/20141/2/20155/2/20159/2/20151/2/2016

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WTI Crude Closing Prices Trading History

Copyright © 2016 [Cost Management Solutions LLC]. All rights reserved.

West Texas Intermediate crude reached $145.29 on July 3, 2008.

Prices collapsed to $35.40 on January 15, 2009 near the beginning of the Great

Recession, but soon recovered much of the loss.

By late 2014 prices were beginning to slip again, but this time for a

totally different reason.

Light Tight Oil


U.S. Light Tight Oil (LTO) Production


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Axis Title

From 2000 through 2005 LTO production was fairly flat with WTI crude averaging $35.28 during that period.

By 2006 demand from emerging countries such as China and India were stressing oil supplies putting upward pressure on prices. Crude averaged $66.24 that year and interest in LTO production began to increase.

Despite the drop in oil prices in 2008 and 2009 production of LTO continued unabated until March 2015.

Total U.S. Crude Production


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In 2008 total crude production in the U.S. was down to 4,940 thousand bpd.

By 2015 U.S. crude production had increased 4,371 thousand bpd to 9,344 thousand bpd.

An 88% increase due primarily from LTO production.

The Decline of Crude Prices


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1/2/20142/2/20143/2/20144/2/20145/2/20146/2/20147/2/20148/2/20149/2/201410/2/201411/2/201412/2/20141/2/20152/2/20153/2/20154/2/20155/2/20156/2/20157/2/20158/2/20159/2/201510/2/201511/2/201512/2/20151/2/20162/2/2016

Dollars

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WTI Crude Closing Prices Trading History

Copyright © 2016 [Cost Management Solutions LLC]. All rights reserved.

By mid-2014 growing U.S.

production was starting to drive down oil prices.

As prices fell through $100 per

barrel crude traders expected

OPEC to announce a production cut.

Country IMF APICORP

Algeria 112.80$ 124.20$

Angola 94.00$

Ecuador 121.00$

Iran 130.50$ 144.20$

Iraq 109.40$ 122.10$

Kuwait 52.30$ 66.00$

Libya 184.20$ 112.30$

Nigeria 123.80$

Qatar 71.10$ 57.90$

Saudi Arabia 86.10$ 98.40$

UAE 74.30$ 98.20$

Venezuela 113.20$

Average 102.59$ 104.80$

2014 Crude Price

Needed for Balanced Budget

When OPEC met in November 2014 it shocked markets by not announcing a production cut.

In fact it announced it was changing its strategy from controlling prices to gaining market share.

WTI crude plunged after the

announcement eventually hitting a

low of $26.24 on February 11, 2016.

OPEC’s Strategy


With the abundance of LTO OPEC knew any production cut it made would be offset by LTO producers.

Its only logical choice was to use its considerable production cost advantage to drive high cost LTO producers out of the market.

It assumed that LTO production would decline rapidly once prices fell below $70-$75 per barrel, which in 2014 was the breakeven point for most LTO production.

OPEC’s Strategy (continued)


It also assumed a recovering global economy would demand more oil.

The expectation was that falling U.S. production and growing demand would allow more production by OPEC to be absorbed.

It knew oil prices would be lower for a while, but the plan was to offset the lower cost per barrel by taking market share and selling more barrels.

U.S. Light Tight Oil (LTO) Production


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Axis Title

Parts of the OPEC strategy have worked.

U.S. LTO production peaked in March 2015 at 4.636 million bpd, just 4 months after OPEC’s November 2014 announcement.

North American Active Oil and Gas Rig Count


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1,794 rigs were drilling for oil in North America the day

OPEC announced its new strategy.

By 3/11/2016 only 414 rigs were actively drilling for oil, 386 in the U.S. and 28 in Canada.

OPEC’s Successes


U.S. drilling activity has dramatically declined.

U.S. crude output is declining.

In addition to decreases in LTO production other high cost projects, such as deep water projects, are being shelved.

Consumption of gasoline is up.

Alternative fuels projects and conservation efforts struggle in the current low-price environment.

Russia and other major producing nations are projecting production declines as depleting wells are not replaced or well workover projects are delayed.

OPEC’s Miscalculations


U.S. LTO production held up better than expected for three primary reasons:

• Cost cutting dropped the breakeven point for LTO production to below $40 per barrel in many cases.

• LTO producers had a backlog of drilled, but not fractionated, wells that were put into service adding to production even as drilling declined.

• Many LTO producers had pre-sold (hedged) much of their production allowing them to continue making a profit even as prices declined.

The global economy continued to struggle with expectations of growth in crude demand for 2016 of 1.2 million bpd down from 1.8 million bpd in 2015.

Sanctions against Iran have been lifted.

• Its crude exports had dropped from 2.5 to 1.1 million bpd while sanctioned.

• It increased exports to 1.5 million in February, projects exports of 1.625 million in March. Potentially another 875,000 bpd additional exports in coming months.

Saudi Arabia, Russia (world’s two biggest producers), Venezuela and Qatar have agreed to freeze crude production at January 2016 rates.

Factors Affecting Oil Prices in 2016


The backlog of uncompleted wells by LTO producers is gone.

Most LTO companies did not hedge for 2016 as they expected a price recovery by now.

Cost cutting measures have already been deep, not much left to be done.

LTO companies are projecting a 300,000 bpd decline in production this year. The EIA is projecting a 600,000 bpd drop in U.S. production. The IEA forecast non-OPEC production to decline by 750,000 bpd.

LTO companies say they will start drilling again when prices reach $40-$45 per barrel.

Brent WTI Brent WTI Brent WTI40.56$ 38.83$ 54.11$ 52.10$ 61.69$ 58.53$

55.00$ 50.00$ 79.00$ 75.00$ 80.00$ 78.00$

30.00$ 28.50$ 40.00$ 38.50$ 45.00$ 44.00$

Price Projections by 34 Analysts

Low Projection

2016 2017 2018

High Projection

Projections as of

February 2016

Average Projection

Crude Average Price Projection


WTI crude has averaged $32.64 this year (through March 17).

Thirty-four analysts have made price projections for the next three years: Firms such as Goldman Sachs, Citigroup, EIA, Morgan Stanley and other major brokers and agencies.

Combined these companies and agencies have tremendous resources and knowledge of oil markets.

2016 Crude Price Forecast


In the first half of 2016 expect mild March weather, crude storage concerns and more Iranian crude coming to market to limit the upside.

In the second half expect lower global crude production, increasing gasoline demand, and cold winter to firm up prices.

First Half Jan Feb Mar Apr May Jun

Crude 31.78$ 30.62$ 36.00$ 34.00$ 32.00$ 30.00$

Second Half Jul Aug Sep Oct Nov Dec

Crude 32.00$ 34.00$ 36.00$ 38.00$ 40.00$ 42.00$



In the first half of 2017 price will reach the point of triggering more LTO drilling, but impacts won’t be felt for a few months. Prices will rise waiting on LTO production to pick up and offset demand.

In the second half prices will settle down as LTO production impacts are felt and seasonal driving demand slows.


Crude 44.00$ 48.00$ 52.00$ 56.00$ 58.00$ 60.00$


Crude 58.00$ 56.00$ 54.00$ 52.00$ 50.00$ 50.00$



In the first half of 2018 prices will be held in check by increasing production from LTO.

In the second half prices will start firming as improving global demand picks up and supply begins to lag demand somewhat.


Crude 50.00$ 50.00$ 50.00$ 52.00$ 54.00$ 56.00$


Crude 58.00$ 60.00$ 62.00$ 64.00$ 66.00$ 68.00$

PROPANE


Propane Fundamentals


Propane fundamentals are pointing toward a higher relative price for propane going forward.

New export capacity and slow growth in propane production should allow supply and demand to balance.

We need to look at trends in production, imports, exports, and petrochemical use to help evaluate propane’s price direction.

Propane’s Value as Percentage of WTI


Rising production sent Mont Belvieupropane’s relative value as low as 25% of WTI last year.

New export capacity and slower growth in production already have propane’s relative value above its five-year average.

Propane from Natural Gas Processing


Propane production from natural gas processing was up 164,000 bpd last year for an increase of 17.2%.

Fuel-Use Propane from Refineries


Fuel-use propane production from refineries declined 23,000 bpd, a 7.5% decrease.

Total Fuel-Use Propane Supplied


Fuel-use propane supply increased 141,000 bpd last year or 11.2%.Natural gas processing provided 79.8% of U.S. propane production and refineries 20.2%.

2015 Production vs Rate of Production Growth


The growth in fuel use propane production certainly looks healthy through 2015.2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

-8 35 -14 13 31 33 86 119 154 140

Change from Previous Year

But the rate of growth between 2014 and 2015

slowed

Rate of Growth in Propane Production


Month 2013-2014 2014-2015Rate of Growthfrom previous

year

Jan 138 168 30Feb 132 183 51Mar 136 214 78Apr 183 194 11May 154 153 -1Jun 185 98 -87Jul 205 77 -128Aug 188 66 -122Sep 159 77 -82Oct 153 125 -28Nov 174 98 -76Dec 222 41 -181

2014-2015 2015-2016Jan 168 103 -65Feb 183 105 -78

Year-to-Year Changes

in Fuel Use

Propane Production

(thousands of bbls per day)

The trend had been for the rate of propane production during a month to be higher than the previous year.

For example from 2013 –2014 propane production increased by 138,000 bpd.

From 2014 – 2015 it increased 168,000 bpd.

Year-over-year growth accelerated by 30,000 bpd.

But now year-over-year growth is slowing. This slower rate of growth is allowing demand and export capacity to catch up with production.

So far in 2016 we estimate fuel-use propane production has averaged 1,540 k bpd. That is the same 140 k per year growth rate seen in 2015.

Natural Gas Supply


2013 2014 2015 2016 2013-14 2014-15 2015-16Gulf of Mexico 3.59 3.44 3.63 3.30 -0.15 0.19 -0.33

Other U.S. 66.45 71.46 75.30 76.38 5.01 3.84 1.08Net Imports 3.59 3.24 2.60 1.09 -0.36 -0.64 -1.51

Total 73.63 78.13 81.53 80.76 4.51 3.40 -0.77

U.S. Natural Gas Production and Importsbillion cubic feet per day

Annual Growth

But we are concerned about the sustainability of that growth rate for the remainder of the year.

Natural gas production/processing drives propane supply.

The EIA estimates total U.S. natural gas supply will drop this year when all production and imports are considered.

Total natural gas supply was up 4.51 bcf or 6.1% between 2013-14.

Total natural gas supply was up 3.40 bcf or 4.4% between 2014-15.

Total natural gas supply is projected by the EIA to be down 0.77 bcf or -0.9% between 2015-16.

Canadian Exports to U.S.


However, we believe 2014 exports dropped off because of

the closing of the Cochin pipeline. So we think the true comparison is between 2013

and 2015.

Canada shipped 41 million barrels to the U.S. last year. That was up 8 million from 2014.

The difference between 2013 and 2015 was only 4.5 million barrels.

Canadian Inventory


Canadian inventory has dropped 3.6 million barrels year-over-year.

That is almost exactly how much exports

changed between 2013 and 2014.

That accounts for much of the difference in exports of 4.5

million barrels between 2013 and 2015.

Canadian Exports Conclusions


Canadian exports increased 8 million barrels between 2014 and 2015.

However, we believe 2014 exports were off 3.6 million barrels due to the closure of the Cochin pipeline to propane service.

Canadians simply caught up on those exports in 2015 to bring down inventory.

We conclude Canadian import projections for 2016 should not be increased to reflect the increased imports in 2015.

In fact drilling activity would suggest the opposite.

• As of March 11 Canada had only 70 rigs actively drilling for natural gas, down from 135 a year ago.

• The decreased drilling activity is likely to result in decreased exports to the U.S.

We expect exports from Canada to the U.S. closer to 2013 levels of around 100,000 bpd and possibly less if their own domestic demand is strong this winter.

Other Imports


Due to lower imports from Canada and expected higher U.S. propane prices we expect to see increased waterborne imports into the U.S. East Coast over the next year that could result in 10,000 bpd or more of additional supply.

Combined with Canadian imports that would put total imports at 110,000 bpd.

Petrochemical Propane Demand


In 2013 petrochemicals decreased the consumption of propane and

increased ethane. At the beginning of the year propane was over 30% of

the feedstock stream dropping to 22% by year’s end. Ethane increased

from 57 to 63%.

Ethane Propane

Ethane %

of Propane

Jan-13 23.5357 83.3751 28.2%

Dec-13 28.0327 127.4494 22.0%

Oct-14 22.4592 93.6467 24.0%

Feb-16 14.6313 37.3969 39.1%

Ethane’s value dropped from 28.2% to 22% of propane

resulting in the decreased demand for propane.

By Oct 2014 ethane was at 24% of propane

and rising, causing propane use to

increase in the coming months.

From Oct 2014 to Jan 2016 petrochemical consumption jumped

from 252,000 to 393,000 bpd.

In February ethane was trading at 39.1% of

propane likely pushing petrochemical demand to

over 400,000 bpd.

Petrochemical Outlook


In March propane prices have outpaced ethane prices to the upside due to new propane export and propane dehydrogenation (PDH) capacity coming on line in December.

Enterprise increased its LPG loading capacity from 16,500 bbls/hour to 27,500 bbls/hour. That increases export capacity from 9 million to 16 million barrels per month.

DOW Chemical completed it PDH plant in Freeport, TX with a capacity of about 35,000 bpd.

During March ethane has averaged 34.9% of propane down from 39.1% in February. We expect propane prices to continue to outpace ethane prices in the short term, slowing petrochemical consumption.

Ethane prices will get support in the third quarter upon the expected completion of Enterprise’s ethane export project with a capacity of 10,000 bbls per hour or about 5.4 million barrels per month. That could once again tighten ethane/propane values and increase propane consumption.

The new DOW PDH unit will certainly help keep petrochemical propane consumption elevated.

But, as seen, petrochemical companies are extremely price sensitive and we can see a scenario where they drop from around 400,000 bpd of spec propane consumption to 250,000 sometime during the next 12 months.

Yearly Propane Exports


In 2005 the US exported 13,686,000 barrels of propane.

Just 10 years later it exported 224,651,000 barrels.Exports increased by

70,282,000 barrels between 2014 and 2015.

2015-16 Exports by Month


Industry data shows exports continued to grow in

January and February likely exceeding 27.8 million

barrels up from 23.3 million barrels in December

Monthly exports increased by nearly 8 million barrels between January and December of last year.

Barrels per Day of U.S. Exports


Exports have increased between 299,000 and 329,000 bpd year-to-year.

Retail Market Demand


US retail propane demand dropped off last year to 541,000 bpd down from 626,000 bpd in 2014.

We believe the winter of 2016-17 we be a high demand winter and result in demand over the next 12 months close to 2014.

Propane Inventory Change


Before looking at 2016 let’s review the inputs for supply and demand we

have discussed for

previous years.

Per

Day Annual

Per

Day Annual

Per

Day Annual

Fuel Use Propane 1,108 404,497 1,279 466,786 1,401 511,463

Imports 107 38,908 97 35,461 104 37,869

Supply total 1,215 443,405 1,376 502,247 1,505 549,332

Exports 208 76,095 374 136,615 548 200,125

Petrochemicals 462 168,462 289 105,604 360 131,267

Retail 602 219,674 626 228,598 541 197,394

Demand total 1,272 464,231 1,290 470,818 1,449 528,786

Inv Build (Draw) (57) (20,826) 86 31,429 56 20,546

Annual Inventory

Change Reported

by EIA

(20,769) 31,343 20,490

Annual Price

Change36.25¢ -77.25¢ -9.75¢

Data in

thousands of

barrels

2013 2014 2015

Then we’ll look at the impacts on inventory and price.

In 2013 supply averaged 1,215 k bpd.

Demand averaged 1,272 k bpd.

The result was a 57 k bpd average draw on inventory.

The result was a 20.826 million

annual build in inventory, essentially

what the EIA reported.

The inventory

draw resulted in

higher prices.

2014 & 2015 saw

supply outpace demand

resulting in big

inventory builds and drops in

propane’s price.

2016 Projections


Per

Day Annual

Fuel Use Propane 1540 562,100

Imports 150 54,750

Supply total 1,690 616,850

Exports 711 259,515

Petrochemicals 393 143,445

Retail 541 197,465

Demand total 1,645 600,425

Inv Build (Draw) 45 16,425

Data in

thousands of

barrels

2016 If we ignore some of our projections and just look at data as it occurred in December, U.S. propane supply would increase 16.425 million barrels over the next 12 months.

That would put them at around 88 million barrels at the end of next March.

We do not believe this scenario likely.

Per

Day Annual


Imports 150 54,750


Exports 960 350,400


Retail 541 197,465


Inv Build (Draw) (204) (74,460)

Data in

thousands of

barrels

2016

2016 Projections


If we just change the exports to reflect industry reports for February it would result in a 74,460,000 draw on inventory.

Obviously this can’t happen, but the only thing to keep it from happening is higher prices.

Per

Day Annual


Imports 110 40,150


Exports 775 282,875


Retail 625 228,125


Inv Build (Draw) (90) (32,850)

Data in

thousands of

barrels

2016

2016 Projections


Rising propane prices will change all of the input sources over the next 12 months, helping bring domestic supply and demand more in balance.

However we think the prices necessary to do this will not be achieved until the market sees a significant decline in inventory.

The result will be a nearly 33 million barrel drop in propane inventory over the next 12 months that will leave them more in line with traditional end-of-winter levels.

The price pressure is likely to remain beyond the winter of 2016-17.

Current U.S. Inventory Trend


U.S. propane inventory has dropped 33.841 million barrels this year in what has

been considered a mild winter.

The five-year average drop during this period has been 19.295 million barrels.

That makes this year’s draw so far 14.546 million barrels higher than average.

Such a significantly above average drawdown in

inventory illustrates the conditions are in place to

pressure inventory and that will only be changed by higher

prices.

Summary of Supply Demand Factors


We believe the growth in fuel-use propane supply will slow again this year. From growth of 140,000 bpd to 110,000 bpd. Fuel-use production will be 1.510 million bpd, up from 1.400 million bpd in 2015. Slower growth will come from decreased natural gas drilling activity resulting in lower or even negative growth in total U.S. natural gas supply.

Propane from Canada will slow due to decreased drilling and the elimination of the 2014 inventory overhang during 2015. Imports from Canada will likely drop from 112,000 to 100,000 bpd. As a result of higher prices the U.S. is likely to see increased waterborne imports into the U.S. East Coast from Europe and Africa.



U.S. exports of 960,000 bpd that were present in February cannot be sustained.

Prices will have to rise to slow exports.

What is hard to know is the long term contract arrangements with buyers of U.S. exports.

These arrangements may limit the price sensitivity of exports for a while.

Exports will increase this year to 775,000 bpd, up from 616,000 bpd in 2015.

Exports could be much higher in the short term.



Petrochemicals will be highly sensitive to the increase in propane prices over the coming 12 months.

They will decrease use of spec propane from around 400,000 bpd at the start of the year to 250,000 bpd.

Average consumption for the year estimated at 310,000 bpd and could be much less if winter demand puts upward pressure on propane prices.



U.S. retail demand is likely to see a significant increase over the next twelve months as possible La Nina conditions cause severe winter conditions.

Increasing prices could cause conservation and limit growth.

Last year averaged 541,000 bpd in retail demand.

We expect retail demand to average 625,000 bpd in the coming 12 months assuming normal to below normal winter temperatures and an average crop-drying season.



Even though propane prices have been on the rise this year, the uptrend is likely to be controlled over the next few months.

However, by fall we think the inventory trend will be putting significantly more pressure on prices especially if the outlook for crop drying and winter heating demand are bullish.


Crude 31.78$ 30.62$ 36.00$ 34.00$ 32.00$ 30.00$

Propane percentage

of crude 44% 51% 52% 54% 55% 56%

Propane per gallon 0.34$ 0.37$ 0.45$ 0.44$ 0.42$ 0.40$


Crude 32.00$ 34.00$ 36.00$ 38.00$ 40.00$ 42.00$

Propane percentage

of crude 58% 62% 64% 66% 70% 75%


Propane Price Forecast 2016


Propane relative value to crude is likely to rise for the remainder of the year. Any pullback in propane prices will likely be connected to a fall in crude prices.

We expect propane’s price to increase by 30 cents between March and December.


Crude 44.00$ 48.00$ 52.00$ 56.00$ 58.00$ 60.00$

Propane percentage

of crude 85% 95% 100% 90% 80% 75%



Crude 58.00$ 56.00$ 54.00$ 52.00$ 50.00$ 50.00$

Propane percentage

of crude 75% 75% 75% 75% 80% 85%




The drawdown in propane inventory this winter will push propane to 100% of crude by March at $1.24 per gallon.

Tighter inventory conditions will keep propane prices at around 75% of crude even during the summer months.

Propane’s relative value will move higher in the winter months as domestic demand competes with exports for supply.


Crude 50.00$ 50.00$ 50.00$ 52.00$ 54.00$ 56.00$

Propane percentage

of crude 90% 95% 85% 80% 75% 75%



Crude 58.00$ 60.00$ 62.00$ 64.00$ 66.00$ 68.00$

Propane percentage

of crude 75% 75% 75% 75% 80% 85%




We expect the propane to crude relationship to repeat what occurred in 2017 with the exception of a softer landing coming out of winter as markets are less shocked by the tighter inventory conditions.

However, by this time the price of propane will be rising as the price of crude increases reaching $1.38 by December 2018.

Conclusion and Recommendations


We believe the pendulum has swung for propane prices.

The low price cycle experienced over the last year has ended.

Consequently retailers should consider taking increased action to protect their customers from higher prices.

We recommend aggressively hedging future supply needs early in this new cycle.

Price protection against rising price is available through February 2019. Obtaining price protection over this entire period should be considered.

Financial swaps should be the primary tool used for price protection as they allow the holder to close early should the pricing environment forecast here be incorrect.

Call options should be considered for shorter-term needs. As always, pre-buys should remain an important part of a supply price risk management program, as should building as much supply allocation as possible.

With the potential for much stronger demand over the next twelve months

and the possibility of an upward trending price cycle we believe retailers that

hedge aggressively early in this cycle will have the opportunity to realize

excellent margins and build goodwill with customers.

Drivers of Propane’s Value


PropaneFundamentals

Propane’sValue

Natural Gas Value

Crude Value

WeatherHeat Demand

WeatherElect Generation

WeatherTrop Storms

Inventory

WeatherHeat Demand

Inventory

Demand

World

Supply

U.S.

Economy/Currency

EmergingCountries

Inventory

Days ofSupply

GeopoliticalThreats

RefineryUtilization

Gasoline

Imports

Imports

Production

ReserveCapacity

PetrochemicalDemand

Crude

DistillatesHO/Diesel

Exports

Propane/Propylene from Refineries


Total propane/propylene production from refineries declined 28,000 bpd last year for an decrease of 4.8%.

Cost Management Solutions LLC -...

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