A Look At The Basics Of Gas Processing And The Growth Trends At Work In This Market

Includes: EPD, NGLS
by: Elliott Gue

In the field, raw natural gas often occurs with other hydrocarbons such as ethane, propane, butane and iso-butane. These heavier hydrocarbons are collectively known as natural gas liquids (NGL).

Processing involves separating the NGLs from the raw gas, which ensures that the methane (natural gas) meets purity requirements for transportation on the interstate pipeline network and delivery to homes and businesses.

More important, NGLs have value as discrete commodities; the relative spread between the price of natural gas and a barrel of NGLs drives demand for processing. That is, if natural gas prices are low compared with the price of a barrel of NGLs, companies have an incentive to extract as much of this content as possible from the raw gas. Conversely, if gas prices are expensive relative to NGLs, demand for processing would suffer. In this instance, companies would leave as much NGLs as possible in the gas stream without violating pipeline requirements.

Fortunately, the market value of a barrel of NGLs tends to follow the oil prices rather than the price of natural gas, as ethane and propane can replace naphtha and other crude derivatives in certain petrochemical processes. The combination of elevated oil prices and depressed natural gas prices has been a boon for MLPs that own processing capacity, though NGL prices have softened somewhat of late.

Source: Bloomberg

Several factors are behind the moderate decoupling between oil and NGL prices. Frenzied drilling activity in liquids-rich plays such as Appalachia's Marcellus Shale, south Texas' Eagle Ford Shale and parts of the Barnett Shale near Fort Worth, Texas, have led to a surge in NGL production.

Nevertheless, investors shouldn't fret that NGL output will swamp demand and weigh on prices. For one, international demand for U.S. propane exports has outstripped existing capacity, prompting Enterprise Products Partners LP (NYSE: EPD) and Targa Resources Partners LP (NYSE: NGLS) to announced plans to build or expand their terminals on the Gulf Coast. Propane and other NGLs are far more expensive in other areas of the world, giving U.S. exports a competitive advantage against local supplies.

The revivification of the domestic petrochemical industry also ensures that NGL prices won't tank. To take advantage of low U.S. NGL prices and plentiful supplies, several major chemicals manufacturers have reopened manufacturing facilities in the U.S. and announced plans to build new ethane and propane crackers. With demand for natural gas processing expected to remain robust in the current pricing environment, I consider Enterprise Products Partners LP and Targa Resources Partners LP to be solid MLP Investments.

Disclosure: I am long EPD, NGLS.