Why ethane stopped trading like crude and started trading like nat gas (part II)
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Ethane prices have collapsed as a result of the supply surge. The commodity averaged roughly $0.75/gallon in 2011, but in 2012 averaged ~$0.40/gallon, and year-to-date has averaged ~$0.25/gallon. Additionally, the relationship between ethane prices and crude has broken down. Where ethane used to trade at roughly 30-40% of WTI crude oil prices, over the past year it has traded to between 10-20%.
Meanwhile, the correlation between ethane prices and crude oil prices has recently decreased while the correlation between ethane prices and natural gas prices has increased.
The relationship between ethane and natural gas
As demonstrated above, ethane used to trade closely to crude, and in the early years of the shale boom prices remained relatively robust and linked to crude. However, recently ethane prices have fallen dramatically due to demand not keeping up with the surge in supply, and ethane has begun trading more closely linked to natural gas. This is because natural gas provides a price floor to ethane.
When natural gas is produced, natural gas processors refine and separate the raw natural gas stream into separate components, such as dry natural gas and NGLs like ethane. However, the processors have a choice as to whether or not to remove the ethane from the stream or leave it there, and this decision is based mostly on economics.
If ethane prices are higher than natural gas on an energy equivalent basis (where it has traditionally traded), it makes economic sense for a natural gas processor to separate ethane out as a distinct stream and sell the commodity at its market price. However, if ethane prices were to fall below natural gas prices, it would make no sense to separate ethane from other NGLs; the act of leaving ethane in the natural gas stream is called “ethane rejection.” At lower ethane prices, natural gas processors would rather leave ethane within the natural gas stream and sell the methane (dry natural gas) and ethane together at the going price for natural gas. Because of this, natural gas provides a natural floor to ethane prices. Therefore, at these currently low ethane prices, it makes sense that the correlation between natural gas and ethane has strengthened. We continue our discussion of this topic in “Why ethane stopped trading like crude and started trading like nat gas (part III).”
Return to Part I