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Local Factors: Condensate And Natural Gas Liquids In Alberta

|Includes: Seven Generations Energy (SVRGF)

When evaluating oil & gas companies, it is important to keep local factors in mind. One of the most important of these in Alberta is the makeup of produced natural gas.

When it comes out of the ground, natural gas is in fact a complex makeup of various hydrocarbons: methane (natural gas), ethane, propane, butane, pentane, etc. (For those who need a quick reminder of high-school chemistry, methane is a single carbon atom bound to four hydrogen atoms; ethane, two carbon atoms; propane, three; butane, four; pentane, five; etc.)

Each of these hydrocarbons has its own physical characteristics, one of the most important of which is that the longer hydrocarbons contain more energy and (from butane upwards) are either liquid or easily liquified. Although there is some inconsistency in the way these terms are used, the entire complex from butane and upwards are referred to as 'natural gas liquids' (NYSE:NGL). (Note that this is different from liquified natural gas [LNG], which is methane that has been cooled to the point that it is liquid for, e.g., shipping.) Among natural gas liquids, the hydrocarbons longer and pentane, and therefore sometimes referred to as C5+, are often referred to as condensates because they are liquid at room temperature.

Each element of these hydrocarbons has its own physical characteristics and (importantly for our purposes) market, and these markets can be surprisingly localized, with their own pressures of supply and demand. A good illustration of that came two years ago, when supply of propane outstripped demand to such an extent that its price fell to zero in Edmonton for a short period.

When it comes to evaluating gas wells in Alberta, however, it is the condensates that are key. This is because an increasing proportion of Alberta's petroleum production is heavy oil and bitumen (aka, oil sands, tar sands), which have to be diluted to be transported through pipelines or railcars. For diluents, the industry can use either a 50-50 mix with synthetic light crude or a 75-25 mix with condensates, which because of this tends to trade at a premium to light oil.

The value of these NGLs, especially the condensates, is a key factor in evaluating natural gas wells. Gas that contains a lot of NGLs is called 'wet'; gas that contains very little, 'dry'. How important is it to be wet? The wettest wells in Alberta are probably those of Seven Generations (OTC:SVRGF), which run from 55-60% liquids. To give you a sense of the economics of this, a typical 7G well at IP365 produces 3.4 MMcf/d, which at todays price at the local AECO hub (c. C$2.50), is C$8500 = $6400 per day. The C5+ production is 449 bbls per day, which at roughly US$50, is US$22,500. In the wettest of wells, then, the value of the condensate stream can be double or (here) triple the value of the gas stream.

One more point. A commonly cited metric that one finds in these discussions is expressing the NGL production as a ratio. The 7G wells mentioned above have a ratio of 133 bbls per MMcf of gas (which is a crazily high ratio; anything over 25bbls per MMcf is often described as wet). Here the important thing to remember is that the ratio has to be compared to the underlying gas production. Two points. First, 25 bbls per mmcf on (say) 3 mmcf/d is more lucrative than 30 bbls at 1.5 mmcf/d. The rate is less important than the actual production. Second, companies with slightly more productive wells and slightly higher NGL ratios might be a lot more profitable.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.