While media coverage of the shale revolution tends to focus on domestic crude oil and natural gas production, the esoteric world of natural gas liquids (NGL) invariably receives shorter shrift. However, these commodities continue to play an important role in the ongoing evolution of the US energy landscape.
This group of heavier hydrocarbons occurs underground with natural gas (methane) and comprises five distinct commodities: ethane, propane, butane, isobutene and natural gasoline. The price of these hydrocarbons, some of which can replace naphtha and other oil derivatives in industrial and petrochemical processes, has traditionally tracked movements in the price of crude oil.
Beginning in 2010, exploration and production companies began to trumpet the margin-boosting effects of growing production in NGL-rich basins.
At the time, natural-gas prices ranged between $4.00 and $5.00 per million British thermal units (mmBtu) - well off the high of $13.69 per mmBtu in 2008 and $6.24 per mmBtu in 2009. Surging natural gas production from unconventional plays without a meaningful uptick in demand accounted for the vast majority of this pricing pressure. Natural gas prices would plummet even lower during the no-show winter of 2011-12 hen abnormally warm weather reduced demand for heating.
Facing lower price realizations and contracting margins in basins that primarily contain natural gas, exploration and production companies ramped up their drilling activity and capital expenditures in plays that contained significant volumes of NGLs. (See Breaking Down the US Onshore Rig Count.)
The oil and gas industry's predictable stampede into liquids-rich basins has catalyzed a dramatic upsurge in domestic NGL output. In 2012 US field-plant production of NGLs averaged a record 2.399 million barrels per day, up 8.3 percent from a year ago and 34.5 percent from five years ago.
This uptrend has continued into 2013. Through the end of May, US NGL production had increased by 2.1 percent relative to the first five months of 2012. Meanwhile, the Energy Information Administration's (EIA) August 2013 Short-Term Energy Outlook calls for the nation's average daily NGL production to increase by 3.4 percent this year, to a record 2.48 million barrels per day. This estimate of 2012 NGL volumes represents an upward revision from the first month of the year, when the EIA pegged production at 2.45 million barrels per day.
The prototypical mixed barrel of these commodities-calculated based on annual field - plant production - is heavily weighted toward ethane (41 percent) and propane (30 percent), the so-called lighter end of the NGL spectrum.
Given their abundance, ethane and propane volumes have driven much of the growth in domestic NGL production, boosting US inventories of these commodities and depressing prices.
Fortunately for midstream and upstream operators with exposure to fluctuations in ethane prices, we don't expect the price of this NGL to drop much lower in the near term. However, additional downside could occur over the next two years as new pipelines come onstream to transport NGL volumes from the Marcellus Shale to the Gulf Coast.
The ethane market has two primary release valves: the domestic petrochemical industry and ethane rejection at gas-processing plants - a phenomenon that occurs when the margins from separating the NGL from the gas stream turn negative.
The two most prominent olefins, ethylene and propylene, serve as the basic building blocks for three-quarters of all chemicals, plastics and synthetic fibers. Petrochemical firms produce these commodity chemicals in crackers that heat ethane and propane with steam. The majority of this capacity is located on the Gulf Coast.
More recently, seaborne ethane exports have emerged as an option, though the considerable expense associated with shipping the commodity has dissuaded many from pursuing this approach.
Switzerland-based petrochemical outfit INEOS in fall 2012 inked a 15-year ethane supply agreement with Range Resources Corp (NYSE: RRC), a leading producer in the liquids-rich portion of Pennsylvania's Marcellus Shale. These volumes will be shipped from Sunoco Logistics Partners LP's (NYSE: SXL) Marcus Hook facility in Pennsylvania to INEOS' ethane crackers in Europe. Customized vessels built for Evergas will transport the ethane. Versalis, the chemicals division of Eni (NYS: EE), reportedly has also expressed interest in importing North American ethane to feed its ethylene production plants.
In short, the spot price of natural gas sets a floor in the US for ethane prices. With the spot price of ethane in Mont Belvieu hovering near the equivalent price of natural gas at the Henry Hub, processing plants are rejecting about 250,000 barrels of NGL per day. The rate of ethane rejection increases the further away you move from Mont Belvieu, an area that's home to the vast majority of the plants that separate the mixed NGL stream into purity components.
We expect ethane prices to remain depressed for the next few years, with scant relief in sight until the petrochemical industry brings a number of planned expansions and world-scale ethane crackers onstream. (We discuss one of our favorite plays on this trend in America's Industrial Revolution.)
The price of propane, which can be used as a petrochemical feedstock and a heating fuel, plummeted after the unseasonably warm 2011-12 winter sapped demand and pushed inventories to a record high. But propane prices have rallied significantly since the end of the second quarter, hitting a 12-month high of about $113.00 on Aug. 23, 2013 - an improvement of 34 percent from year-ago levels.
What factors have driven the recent recovery in propane prices? A normal 2012-13 winter helped to reduce US propane inventories by 9.3 percent from year-ago levels in June 2013, though the volume in storage was still 9.4 percent above the five-year average for this month.
At the same time, rising seaborne exports of propane and propylene have also provided support to domestic propane prices. This upsurge in exports reflects the intersection of several trends, including favorable US propane prices relative to international benchmarks, expanding export capacity on the Gulf Coast and robust demand growth for seaborne cargos in emerging markets.
Through the end of May 2013, the US had exported about 37.1 million barrels of propane and propylene, equivalent to 32 percent of the volumes produced by domestic field plants over the same period. We expect this export growth to ramp up through year-end.
Terminals operated by Enterprise Products Partners LP (NYSE: EPD), the largest publicly traded partnership by market capitalization, accounted for about 85 percent of US seaborne propane exports in 2012. The blue-chip master limited partnership earlier this year commenced operations at its expanded terminal on the Gulf Coast, an asset that sports a maximum capacity of 7.5 million barrels of liquefied petroleum gas per month.
In the Feb. 24 issue of Energy & Income Advisor, we highlighted how Targa Resources Partners LP's (NYSE: NGLS) growing exposure to propane and butane exports provides an operational hedge to its gathering and processing business. The master limited partnership's (MLP) $480 million expansion of its Galena Park terminal enable the facility to export international-grade propane (HD-5 grade, the domestic standard, contains up to 5 percent ethane) and load four very large gas carriers (VLGC) per month by the third quarter of 2013.
Sunoco Logistics Partners LP also exports propane produced in the Marcellus Shale from its Marcus Hook terminal in eastern Pennsylvania.
A number of master limited partnerships and other energy companies have followed the leaders, announcing their own export projects. Although we don't expect all of these schemes to go through, the amount of planned export capacity suggests that propane prices could enjoy further upside in the intermediate term.
(click to enlarge)
Source: Bloomberg, Company Reports, Energy & Income Advisor
Investors seeking to take advantage of this boom in propane exports should focus on the early movers in this space and names that can provide a fully integrated suite of NGL handling services. These names have likely secured the best contract terms, thanks to a scarcity premium.
At the same time, a recovery in propane prices also bodes well for Linn Energy LLC (NSDQ: LINE) and other upstream operators that produce significant volumes of NGLs. Midstream energy companies that operate gathering and processing assets under contracts that include exposure to NGL prices should also enjoy some relief. In the next Graph of the Week, we'll explore pricing and supply-demand trends in butane and natural gasoline, the so-called heavier end of the NGL barrel.