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 (NGL) and natural gas prices, and 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.
Natural gas down, NGLs up, and frac spreads up
Last week, natural gas prices increased 1%. NGL prices increased to a greater degree, with a large positive benefit to frac spreads. Using a custom frac spread index, fractionation spreads increased to $24.84 per barrel, up from $22.90 per barrel.
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.
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, as did ethane. For more on why ethane is linked to natural gas, please see Why ethane stopped trading like crude and started trading like nat gas.
Frac spreads have generally decreased since mid-February, when they reached ~$30 per barrel. Since then, frac spreads declined to levels as low as ~$20 per barrel—mostly due to the strong rally in natural gas prices. Frac spreads have recovered since then, as oil has seen significant gains while natural gas prices have stagnated.
Depressed ethane and propane prices have caused frac spreads to trade down over the medium-to-long term
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.
The decline in ethane and propane prices has been a consequence of the “shale revolution” boom, as natural gas shales rich in NGLs have experienced rapid development, resulting in the market flooding 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.
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. But 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 8%, which was a 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).