Enterprise Products Partners Drive To Extend The Petrochemical Value Chain

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Includes: EPD
by: Ron Hiram

Summary

EPD’s PDH facility constitutes the bulk of the $2.9 billion of growth projects being placed into production in 2017; a new isobutane dehydrogenation unit should be completed in 4Q19.

These investments are at the core of EPD’s strategy to extend the petrochemical value chain and set it apart from other MLPs.

Due to plentiful supplies and low prices of natural gas, the U.S. chemical industry is making large investments in ethane crackers; this will curtail supplies of propylene and isobutene.

EPD is betting its new plants will help meet market demand where traditional supplies have been reduced.

Given the delays and cost overruns, it remains to be seen whether the PDH facility is able to produce the returns typically achieved by EPD organic growth projects.

Enterprise Products Partners L.P. (NYSE:EPD) has approximately $8.4 billion of organic growth projects currently under construction, of which $2.9 billion is being placed into production in 2017. EPD's propane dehydrogenation ("PDH") facility constitutes the bulk of that $2.9 billion. It will have the capacity to produce up to 1.65 billion pounds per year (approximately 750 thousand metric tons per year or 25 MBPD) of polymer grade propylene ("PGP"). The PDH facility is expected to commence commercial production in 3Q17, but is about 2 years behind schedule and suffered cost overruns.

Also included in the $8.4 billion plan is a new isobutane dehydrogenation ("iBDH") unit with the capacity to produce 425,000 tons per year of isobutylene. EPD expects to complete the iBDH project in 4Q19. Isobutylene produced by the new plant will provide additional feedstock for EPD's downstream octane enhancement and petrochemical facilities.

Both facilities are strategically located near a major natural-gas-line hub and chemical-processing plants. Both are underwritten by long-term, fee based, minimum volume commitments, and will be integrated with EPD's storage facilities, pipeline systems and export terminals.

EPD's strategy to extend the petrochemical value chain sets it apart from other MLPs and will be tested once the PDH facility begins production in 3Q17. This article provides a more in-depth review of the strategy and the logic behind it.

Natural gas processing involves the separation of raw natural gas into "pipeline quality" gas and natural gas liquids ("NGL"). There are two kinds of gas processing plants. The first removes NGL from raw natural gas creating a commingled NGL stream (referred to as raw mix or "y-grade"). The second, fractionators, separate the raw NGL mix into individual purity components, primarily ethane, propane, butane, isobutane, liquefied petroleum gas ("LPG") and natural gasoline.

Ethylene is manufactured in greater amounts than any other chemical, as it is a building block for polyethylene, the most popular plastic in the world. Polyethylene comes in several different grades. Depending on its density and molecular branching, it is used to create thin film plastics such as plastic bags and film wrap, or to create sturdier plastics such as detergent bottles, garbage containers, and water pipes.

Propylene is used to manufacture a wider variety of products. In addition to plastics, it is used in the manufacture of paints, detergents, lubricants, foam insulation, and fibers. When ethylene is produced, propylene is produced as a byproduct. Propylene can also be produced from propane using a process called propane dehydrogenation (PDH or propane dehydration). This chemical process directly converts propane to propylene. Propane is also used by the petrochemical industry to produce ethylene and as a heating fuel in the residential and commercial markets.

Ethylene and propylene can be derived either from the oil refining cracking process (using naphtha from crude oil as a feedstock), or from an NGL cracking process (using ethane, propane and butane as a feedstock). The engineering design for the cracking process differs according to the type of feedstock used. Because oil is a global commodity and is easy to ship long distances, many crackers around the world are configured to handle naphtha as a feedstock. Since ethane is more difficult - and expensive - to ship long distances, it can be considered more of a regional commodity. Petrochemical regions with access to an abundant supply of NGL tend to crack ethane. Due to plentiful supplies and low prices of natural gas, the U.S. chemical industry is making large investments based on ethane as a feedstock for the production of ethylene and is thus increasing production of ethylene using ethane as a feedstock. This is one factor behind the record level of NGL consumption reached in 2016 in the U.S.

EPD uses the following diagrams to illustrate its petrochemical strategy:

Source: EPD MLPA presentation 5/31/17.

"Driven by the US shale gas boom, cracking ethane to ethylene became more attractive than cracking liquid feedstocks in the last years. Therefore owners of liquid crackers envisage to minimize liquid feedstocks or even to fully replace by ethane".

Herein is the opportunity being addressed by EPD's strategy: when ethylene is produced using ethane (rather than naphtha), the propylene output rates are negligible. So this reduces the amounts produced of propylene. Similarly, increased ethylene production comes at a cost of decreased production of butylene and isobutylene. Butylene is used to produce lubricants, fuel additive, rubber and other products. Isobutylene is used as feedstock to manufacture lubricants and alkylate for gasoline blendstock, as well as methyl tertiary butyl ether for export.

Decreased production is driving prices higher:

Propane $/gallon

Normal Butane $/gallon

Isobutane $/gallon

Polymer grade propylene $/gallon

1st Quarter 2016

$0.38

$0.53

$0.53

$0.31

2nd Quarter 2016

$0.49

$0.62

$0.63

$0.33

3rd Quarter 2016

$0.47

$0.63

$0.67

$0.38

4th Quarter 2016

$0.58

$0.83

$0.90

$0.36

1st Quarter 2017

$0.71

$0.98

$0.94

$0.47

Table 1: Selected Energy Commodity Price Data. Source: company 10-Q, 10-K, 8-K filings

EPD is betting that the "PDH facility [and] the iBDH plant will help meet market demand where traditional supplies have been reduced" (EPD Form 10-Q 3/31/17).

Given the delays and cost overruns, it remains to be seen whether the PDH facility is able to produce the returns typically achieved by EPD organic growth projects. An order of magnitude increase in EBITDA is about $125 million for every $1 billion placed in production once a project is fully operational. EPD's strategy to extend the petrochemical value chain sets it apart from other MLPs and, if successful, could meaningfully impact EBITDA.

Disclosure: I am/we are long EPD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.