Some market participants view fractionation spreads (also called “frac spreads”) as one indication of the profitability of some natural gas processing companies. Frac spreads are dependent on natural gas liquids (NGL) and natural gas prices; they increase when NGL prices increase relative to natural gas prices (for a detailed explanation of fractionation spreads please refer to “Why fractionation spreads affect some MLP stocks” and “An in-depth look at the mechanics of fractionation spreads”). Generally, natural gas processing companies such as MarkWest Energy (MWE), Targa Resources (NGLS), Regency Energy (RGP), and Copano Energy (CPNO) realize more profits when frac spreads increase. Last week, natural gas prices fell relative to NGL prices ultimately resulting in an increase in frac spreads which was a positive for gas processing names such as the ones mentioned above. The below graph shows frac spreads over the past year.
Last week, natural gas prices declined more than natural gas liquids prices, which resulted in a higher frac spread. Natural gas prices fell on the week as last week’s inventory report showed that natural gas inventories declined by 157 billion cubic feet compared to an estimated previous figure of 166 billion cubic feet. This shows that either natural gas demand was less than expected, natural gas supply was more than expected, or both. For more on natural gas inventories, please see “Another nat gas inventory draw below expectations, bearish for energy stocks.”
The movement in NGL prices was more complex, with ethane and butane prices relatively unchanged, propane and natural gasoline prices up on the week, and iso-butane prices down on the week. NGL prices generally move in the same direction, and have historically tracked crude prices. However, fluctuations in supply and demand for the individual commodities can cause the prices to move in different directions. For instance, propane can see higher demand in winter months as it is used as a heating fuel, causing prices to rise, whereas other NGLs are not usually used for heating purposes. Overall, the movements in all of the NGL prices and natural gas prices last week resulted in a positive change in frac spreads.
Note: The custom frac spread is based upon assumptions provided by Ceritas Group. To see how the custom frac spread is calculated, please refer to the article “An in-depth look at the mechanics of fractionation spreads.”
Fractionation spreads moved up on the week, and despite some recovery from June 2012 lows, frac spreads are still significantly below where they were a year ago as seen in the below graph.
For a period, frac spreads increased to $40-50/bbl due to depressed natural gas prices while NGL prices had remained relatively robust. Over the last year, frac spreads have declined largely due to the sharp drop in prices in ethane and propane (see chart below).
This has been a consequence of the “shale revolution” boom, as natural gas shales rich in NGLs have experienced rapid development, resulting in the market being flooded with new NGL supply. While the excess supply of ethane and propane had been absorbed at first by the chemicals industry, much of the capacity for chemical companies to process ethane and propane has been soaked up. Future articles will further discuss the dynamics of other NGL prices.