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The Natural Gas–NGL Price Spread’s Impact on Energy MLPs Last Week

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Fractionation spread for the week

The Henry Hub–Mont Belvieu fractionation spread dropped to $8.40 per barrel for the week ended July 24, 2015. The spread was $8.90 per barrel in the previous week. This article discusses the spread and how it affects MLPs in the energy sector.

NGLs (natural gas liquids) are liquid elements generally extracted from natural gas wells. They’re hydrocarbons, just like natural gas. While natural gas is primarily methane, NGLs primarily consist of ethane, propane, butane, isobutane, and natural gasoline. Natural gasoline is composed mainly of pentanes and heavier hydrocarbons.

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Midstream energy MLPs such as Energy Transfer Partners (ETP), Enbridge Energy Partners (EEP), MarkWest Energy Partners (MWE), ONEOK Partners (OKS), Tallgrass Energy Partners (TEP), and Targa Resources (NGLS) are involved in the gathering and processing of natural gas. Natural gas recovered from a wellhead must be processed so that it meets specifications before it can be delivered for final use. In addition to natural gas, processing produces mixed NGLs. These NGLs are then separated through fractionation.

ETP forms ~7.6% of the Alerian MLP ETF (AMLP). Both AMLP and the ETRACS Alerian MLP Infrastructure Index ETN (MLPI) track the Alerian MLP Infrastructure Index (AMZI).

Why do MLPs benefit from a higher spread?

Natural gas processing MLPs typically benefit when NGL prices are high relative to natural gas. This is because of the “keep-whole” and “percent-of-proceeds” contracts that these companies enter into.

Keep-whole contracts are commodity price–sensitive. Under keep-whole contracts, the processing company generally keeps a portion of the NGLs extracted through fractionation as payment. The company replaces the energy content of the NGLs that it has retained with natural gas. A fractionation spread or “frac spread” is the difference between the amount earned from NGL sales and the cost of natural gas. A decline in NGL prices relative to natural gas prices makes the spread less favorable for fractionating MLPs.

Percent-of-proceeds contracts

In percent-of-proceeds contracts, the MLP gathers and processes natural gas on behalf of producer customers. The residue gas and NGLs produced from the processing are sold on the market. The company then remits a pre-agreed percentage of these proceeds to the producer and retains the remainder. As such, the prices of natural gas and NGLs affect revenues for MLPs with these kinds of contracts.

A decline in NGL prices may result in less demand for fractionation and processing services, which affects the MLPs providing these services.

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