SIMON SAYS: Watch what might bite you from behind!

Submitted by Simon Hill on Tue, 10/22/2019 - 17:00
Watch what might bite you from behind!

It’s one of the most exciting parts of trading is not just buying a cargo somewhere, anywhere, but being able to fix a ship to load it, especially a Very Large Gas Carrier (VLGC). Of course, I like the pressurised, semi-refrigerated, mid-sizes etc., but to me the big ships are the heart of international LPG trading. I explained in Monday’s SIMON SAYS how the two cost elements of the ARB are the terminal fees, and the freight rate applicable for the Houston to Chiba, Japan voyage. Yesterday I explored the reasons for not trying to immediately fix the sale of the cargo, as well as explaining the paper ARB indices. Then it was the virtual trade, cargo, paper, ship and deal done.

What I need to explain is the timing of the cargo and other possible costs and exposures, it’s never an easy ride. At SwissChemGas we were once able to load a new Panamax P66 vessel in Nederland at thevery beginning of the month, and she whizzed through Panama and across the Pacific like a knife through butter. She arrived in Japan well within the month, and we were able to capture the cash inter-month differentials, which is the best proxy available to show premiums or discounts paid for spot cargoes against the FEI index. But this is something that occurs very rarely, and the vast majority of the cargoes load and discharge in different months.

As we hedged the ARB for the month of November in the case we explained yesterday, by buying November LST and selling November FEI. We therefore need to buy the November and sell December FEI spread. This transfers the FEI index on a back-to-back basis to the delivery month. Of course, we would normally like to do the shift for free, or even manage to put a little more profit in the bag, but today the market is backwardated, so the cost is $12.32/ Mt. The question will ultimately be whether this premium above the FEI index is going to be maintained once it comes to physically selling the cargo for December delivery. Just to repeat, if a buyer needs a cargo, then he is likely to pay a premium to the monthly average index, and if the buyer is not keen to purchase, then sellers have to look at discounts against the monthly index.

As sellers, we will look to at least recover the cost. If the physical buyer and the paper market are trading at $12.32/ Mt, then life is easy, and we sell the cargo and get out of the paper spread at the same time. However, it never is that easy, and if the physical premiums are trading lower than the paper, at say $10/ Mt versus paper value at $11/ Mt, then we end up losing $2.32/ MT on the physical sale versus the proxy ($12.32 - $10.00), while having made $1.32 on our proxy (12.32 - $11.00), for a net loss of $1.00 on this portion of the hedge vs actualization. That’s not good news. Now selling the physical at a premium of $13/ Mt and being able to get out of the paper spread at $12/ Mt would be good news, as also would be going into pricing, and averaging over the month a premium that is below the one achieved for the physical sale. Paper can get complicated and hedges are never perfect, because physical cargoes don’t always do what they should, and loadings are never measured in 1000 Mt denominations. But that’s just the way it is.

There are also three potential costs that all ARB players should be aware of and make financial allowances for. The first one is a potential spread between loading terminal prices in the U.S.. i.e. TET, Non-TET, Other Non-TET (which in order is LST, Enterprise and Targa). I think a lot of people in the market have assumed that Mont Belvieu is what it says on the can, but this has not always been the case. The prices are determined according to deals done in each system, and therefore the market and logistical requirements for say TET versus Other Non-TET, may result in one price being higher or lower than the other. A significant differential has happened at least twice in the last 3 years, first in July 2019 with what appears to have been operational issues at their complex, the other, after a similar gyration the other way in February 2018. Some traders were hedged on the ARB with TET (LST) priced Bbls, but suddenly faced a price that was over $50/ Mt higher for nearly half of the month, as their price was on a Non-TET basis under their physical lifting contract, pushing the average for the Non-TET index up by at least $20/ Mt, costing some traders in excess of $1 million. This will easily wipe out profits locked-in or anticipated, and can be alleviated by hedging the spread, which we did in our virtual trading deal

The second issue that always comes up to bite, is ethane. Over 20 years ago I remember taking petrochemical gases over to the U.S. from Europe, and then bringing back propane on a mid-sized, semi-refrigerated vessel, capable of chilling the cargo on route back to Europe, as it was still hit and miss at the time whether the propane loaded would only be in the higher -30 degrees Celsius range. We would always get boil-off as the cargoes were carrying around 4% ethane, and we always faced a claim from the receiver of the cargo when the discharged quantity was well under the Bill of Lading, and for that matter above the 0.5% loss clause. This led to the exporters tightening up the HD-5 spec., to produce an export specification with a 2% maximum ethane content. I can understand the exporters wanting to maximise the ethane content, as they are able to do domestically by up to 5%, as there is both a volumetric advantage as well as a price advantage. My experience with export cargoes has been to see 1.7% ethane content levels in the export grade propane. What happens is that the vessel loads say 46,000 Mt, as per the Bill of Lading figure, which is just under 24 million gallons, but the Bill of Lading also says 24.1 million gallons. In fact, over 130,000 gallons more than I was expecting, and all because of ethane. Of course, in the U.S. we pay for our cargoes in gallons, a volume measurement, but end-up selling them into Asia by weight, in metric tons (Mt). Even at a low price of 40 cents/gallon this is still an additional $50,000 loss. And the paper hedges are all calculated on a conversion factor of 521, which in reality is more like 524 given the additional ethane.

The third issue we always need to be aware of, is market “slippage” occurring at the time of trying to put the hedge on. Although liquidity has improved in the LPG paper market, it tends to evaporate when there’s been a biggish move in prices. We see major price moves in most commodity markets, but it appears to be far more accentuated in LPG. There is also the mix of players, that in LPG can easily skew one side of the bid/ offer range, as certain groups tend to be trying to achieve the same goals. But that said, it is possible to hedge the types of quantities required for loading a cargo out of the U.S. Gulf, although certain trades, such as LST, are far more liquid than others. So back to slippage, which can also work in your favour, but normally the more you buy the higher the price tends to go, as you become a significant demand number in the market. Also, if you go to a specific big player who can handle the whole quantity, it tends to come at a premium. Therefore, it’s important to build in a couple of dollars for slippage, on the way into the hedge and on the way out.

So, let’s keep our eyes on the market and see how we can make sure we protect the margin we have been able to lock-in, and maybe even squeeze out a bit more. But for sure, cutting risk also cuts reward, so the profitability of any trade, is as much the risk profile of the player as it is the position they hold.