Why frac spreads dropped nearly 15% last week

Natural 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 an indication of the profitability of some natural gas processing companies. Frac spreads depend on natural gas liquids (NGLs) 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.) Generally, companies with natural gas processing operations such as MarkWest Energy (MWE), Targa Resources (NGLS), Williams Partners (WPZ), and DCP Midstream Partners (DPM) realize more profits when frac spreads increase.

2014.02.12-Fractionation Spread SREnlarge Graph

Frac spreads dropped nearly 15% last week, from $34.78 per barrel to $29.57 per barrel

Last week, the price of a representative barrel of natural gas liquids rose from $46.81 per barrel to $49.06 per barrel, a 5% increase on the week. The rise was mainly driven by the rise in ethane and propane prices, which are mainly the composition of NGLs. Due to chilly weather last week and strong demand for heating fuel, ethane and propane prices traded up 15% and 7%, respectively, driving NGL prices up. However, Henry Hub natural gas spot prices, which are used to calculate the frac spread, rose by more than 17%, to close at $5.88 per MMBtu. Consequently, frac spreads were down nearly 15% over the prior week.

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.

Summary

Last week, frac spreads traded down by nearly 15% compared to the previous week, which is a negative signal for natural gas processors such as MWE, NGLS, WPZ, and DPM—many of which are also components of the Alerian MLP ETF (AMLP). However, over the medium term, frac spreads are still up significantly from lows of ~$22 per barrel in mid-2013, which is a positive catalyst for the midstream energy names mentioned above.