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Why Last Week’s Fall in Fractionation Spread Affects MLPs

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Nov. 20 2020, Updated 4:08 p.m. ET

Fractionation spread

The Henry Hub–Mont Belvieu fractionation spread fell to $6.82 per barrel for the week ended August 28, 2015. The spread was $7.03 per barrel in the previous week. The Henry Hub–Mont Belvieu fractionation spread measures the spread between Henry Hub natural gas and Mont Belvieu composite NGL (natural gas liquids) prices.

Natural gas recovered from a wellhead must be processed in order to meet specifications before it can be delivered for final use. In addition to natural gas, processing produces mixed NGLs. Then these NGLs are separated through fractionation.

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The above graph shows the weekly fractionation spread over six weeks. Midstream energy MLPs such as Enterprise Products Partners (EPD), Targa Resources (NGLS), DCP Midstream Partners (DPM), Tallgrass Energy Partners (TEP), Southcross Energy Partners (SXE), and Western Gas Partners (WES) are involved in fractionation. EPD forms 10.2% of the Global X MLP ETF (MLPA).

How are MLPs affected by the fractionation spread?

Natural gas processing MLPs typically benefit when the fractionation spread is high. This means that 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.

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Keep-whole contracts

Keep-whole contracts are sensitive to commodity prices. 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 it has retained with natural gas. So a fall in NGL prices relative to natural gas prices makes the spread less favorable for fractionating MLPs under keep-whole contracts.

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 a result, the prices of natural gas and NGLs affect MLPs’ revenue with these kinds of contracts.

Percent-of-proceeds contracts accounted for nearly half of the natural gas volume gathered by Targa Resources (NGLS) for 2014. These contracts account for nearly 85% of ONEOK Partners’ (OKS) Natural Gas Gathering and Processing segment’s total volumes. To learn more about ONEOK’s Natural Gas Gathering and Processing segment, read ONEOK Partners Reports Give and Take in 2Q Segment Performance.

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