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Why higher natural gas liquids prices help natural gas processors

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Nov. 20 2020, Updated 11:34 a.m. ET

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 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 and An in-depth look at the mechanics of fractionation spreads). 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.

Frac spreads move higher three weeks in a row, up almost 50% since late June

Natural gas prices increased at the end of August. However, most NGL prices also increased. Ultimately, this resulted in higher frac spreads (as measured by a custom index created by Bloomberg, using assumptions provided by Ceritas Group).

Note: The custom frac spread is based on assumptions provided by Ceritas Group. To see how the custom frac spread is calculated, please refer An in-depth look at the mechanics of fractionation spreads.

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Frac spreads had generally decreased since mid-February, when they reached ~$30 per barrel. Since then, frac spreads declined to levels as low as ~$20 per barrel in June, mostly due to the strong rally in natural gas prices. Frac spreads have recovered strongly since then, as oil has seen significant gains while natural gas prices have stagnated. Plus, the natural gas liquids complex has been helped over the past few weeks by increases in propane prices, likely due to increases in export capacity (see Why some MLPs are benefitted from increased propane exports for more information). Meanwhile, natural gas prices have remained relatively low, which has caused a medium-term increase in frac spreads.

Background: Depressed ethane and propane prices have caused frac spreads to trade down over the longer term

For a period, frac spreads had increased to between $40 and $50 per barrel (compared to current levels of around $25 to $30 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. However, as we’ve seen, over July and August, frac spreads had recovered somewhat since a sharp spike in oil prices and increased propane export capacity helped to improve NGL prices.

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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, and already, increased propane exports have helped prices over the past few months. But the timeline for completing many of these works is over the next several years. Plus, even if demand for these NGLs grows as a result of completed infrastructure, NGL supply also continues to grow. And if supply meets or outstrips demand, the prices of ethane and propane may remain depressed.

Outlook

Circling back to a short-term perspective, at the end of August, frac spreads traded up, which was a positive catalyst. Plus, frac spreads experienced significant recovery over July and August, resulting in a medium-term positive for gas processors such as MWE, NGLS, WPZ, and DPM—many of which are also components of the Alerian MLP ETF (AMLP).

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