Why frac spreads matter for MLP names like MarkWest and Targa
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 one 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.
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Frac spreads traded lower last week, to close at $24.78 per barrel
Last week, natural gas spot prices traded higher, finishing at $4.49 per MMBtu compared to $4.28 per MMBtu the previous week. Meanwhile, the price of the composite NGL barrel traded slightly lower due to a drop in ethane and natural gasoline prices and flat prices for other components. Ethane traded up 3%, from $0.28 per gallon to $0.29 per gallon. Natural gasoline traded down by 2%, from $2.28 per gallon to $2.24 per gallon. Propane prices closed at $1.08 per gallon, compared to $1.06 per gallon the previous week. Butane prices finished at $1.21 per gallon last week—the same prices as the previous week. Given the drop in ethane and natural gasoline prices and the relatively flat prices of other components, the composite NGL prices finished slightly lower last week, to close at $41.52 per barrel compared to $41.72 per barrel the previous week. As a result, frac spreads finished 4% lower, to close at $24.78 per barrel, compared to $25.75 the previous 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.
Supported by strong crude and propane prices, frac spreads had kept increasing from $20 per barrel in June 2013 to around $35 per barrel in December 2013. Since January 2014, however, frac spreads dropped significantly due to the steep rise in natural gas prices. During the past few weeks, frac spreads gradually trended upward as natural gas prices retreated, and are currently around $25 per barrel.
Last week, frac spreads traded narrower, which was a short-term negative signal for natural gas processors. Over the medium term, while frac spreads are still up from mid-2013 lows, they’ve retreated significantly over the past few months, given higher natural gas prices. This is a negative medium-term catalyst for natural gas processors such as MWE, NGLS, WPZ, and DPM—many of which are also components of the Alerian MLP ETF (AMLP).
To learn more about investing in energy MLPs, see the Market Realist series Why rising propane and butane exports affect some US energy MLPs.