The Henry Hub-Mont Belvieu fractionation spread, or frac spread, fell by 13.8% to $7.7 per barrel by the end of the week ending July 29, 2016. It was $8.9 per barrel in the previous week.
The Henry Hub-Mont Belvieu frac spread measures the spread between Henry Hub natural gas and Mont Belvieu composite NGL (natural gas liquids) prices. Midstream companies including Western Gas Partners (WES) and MPLX LP (MPLX) are negatively impacted by a decline in the frac spread. More that 50% of the Alerian MLP ETF’s (AMLP) holdings provide fractionation services.
The composite NGL price is based on spot prices for ethane, propane, isobutane, n-butane, and natural gasoline at Mont Belvieu. A decline in NGL prices and the rise in natural gas prices last week contributed to a fall in the spread between the two that week.
How are MLPs impacted by the fractionation spread?
Natural gas recovered from a wellhead must be processed to meet specifications before it can be delivered for final use. In addition to natural gas, processing produces mixed NGLs. They’re separated through fractionation.
The spread between NGLs prices and natural gas prices impacts natural gas-processing MLPs involved in fractionation. These MLPs typically benefit when the fractionation spread is high. This means that NGL prices are high compared to natural gas prices, and the benefit stems from the keep-whole and percentage-of-proceeds contracts that these MLPs maintain.
Keep-whole contracts are sensitive to commodity prices. Under keep-whole contracts, the processing MLP generally keeps a portion of the NGL extracted through fractionation as payment. The MLP replaces the energy content of the NGLs that it retained with natural gas. A fall in NGL prices relative to natural gas prices makes the spread less favorable for fractionating MLPs under keep-whole contracts.
In percentage-of-proceeds contracts, the MLP gathers and processes natural gas on behalf of producer-customers. It sells the residue gas and NGLs produced from processing. The company remits an agreed-upon percentage of the proceeds to the producer and retains the rest. As a result, the prices of natural gas and NGLs impact the revenue of MLPs that hold these types of contracts.
In the next part, we’ll discuss the latest in ethane.