Why slightly higher frac spread helps gas-processing master limited parnerships

2013.07.08 - Frac Spread STEnlarge GraphNatural gas processors can be sensitive to commodity prices in the form of frac spreads

Some market participants view fractionation spreads (also called “frac spreads”) as one indication of the profitability of some natural gas processing companies. Frac spreads depend on natural gas liquids (NGL) and natural gas prices, and 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), Williams Partners (WPZ), and DCP Midstream Partners (DPM) realize more profits when frac spreads increase.

Some natural gas liquids up, but ethane mostly flat

Last week, natural gas prices increased 1%. Though NGL prices increased, ethane was nearly unchanged, and overall frac spreads were changed little.

2013.07.08 - NGL Prices TableEnlarge Graph

Note: The custom frac spread is based on assumptions provided by Ceritas Group. To see how the custom frac spread is calculated, please refer to An in-depth look at the mechanics of fractionation spreads.

Depressed ethane and propane prices have caused frac spreads to trade down over the medium-to-long term

2013.07.08 - Frac SpreadEnlarge Graph

For a period, frac spreads had increased to $40 to $50 per barrel (compared to current levels of around $20 to $25 per barrel) 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), while natural gas prices have recovered somewhat.

2013.07.08 - NGL SeparateEnlarge Graph

The heavier NGLs (such as natural gasoline) tend to trade directionally with crude oil. Oil prices increased significantly last week, which may have caused the heavier NGLs to trade up. Additionally, ethane tends to trade more in line with natural gas, which increased slightly on the week, and ethane did as well. For more on why ethane is linked to natural gas, please see Why ethane stopped trading like crude and started trading like nat gas.

The decline in ethane and propane prices has been a consequence of the “shale revolution” boom, as natural gas shales rich in NGLs have rapidly developed, resulting in the market flooding with new NGL supply. While the chemicals industry has at first absorbed the excess supply, much of the capacity for chemical companies to process ethane and propane has soaked up.

More infrastructure for processing ethane and propane would support prices

Once more capacity for processing ethane and propane comes online or more NGL export capacity is constructed, this could provide additional long-term demand for these commodities and result in higher frac spreads. Several midstream companies have noted that they’re working on such projects. However, the timeline for the completion of these works is over the next several years. Additionally, even if demand for these NGLs grows as a result of completed infrastructure, the supply of NGLs also continues to grow—and if supply meets or outstrips demand, the prices of ethane and propane may remain depressed.

Circling back to a short-term perspective, last week, frac spreads increased by 1%, which was a slightly positive catalyst. However, frac spreads have mostly trended downward over the past year, resulting in a negative medium-term catalyst for gas processors such as MWE, NGLS, WPZ, and DPM—many of which are also components of the Alerian MLP ETF (AMLP).

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