Arbitrage is one of the simplest ways to make big money.
Take something worth little and move it to a place where it’s worth a lot.
In the past, such strategy has made billions for oil traders. Moving crude from developing nations with big production but little domestic market to energy-hungry buyers in North America, Europe and Asia.
But that’s getting harder to do in today’s globalized oil market. Crude today can sail between nearly any two points on the globe—very efficiently. Which has closed a lot of the big geographic differentials in pricing.
So, where to next?
Many investors have focused on the arbitrage opportunities in natural gas. After all, U.S. natgas is going for $4 per mcf, while the same unit in Asia would fetch $15.
That’s indeed an attractive pricing opportunity. The challenge is logistics. America isn’t set up to export gas in large quantities. Doing so requires myriad permitting, and the construction of new facilities to liquefy and load gas supplies.
That means big profits here are likely still years away. But there’s one little-known market that’s beckoning with triple-digit arbitrage upside—one where the gains are already happening, under the nose of the investing public.
Natural gas liquids, or NGLs.
NGLs prices have grown to big differentials in Europe and Asia versus America. Just look at propane. While prices in the U.S. are currently running $620/mt, European prices have hit $938/mt—with Chinese prices even higher at $1,034/mt. A difference of over $400/mt—or 67%.
The potential arbitrage in another NGL—butane—is even larger. With Japanese prices currently sitting more than $550/mt higher than U.S. prices.
Sellers Move To Take Advantage
Those kind of fat margins from exports are starting to attract attention. At least from the few players currently paying attention to this market.
Propane has been the first of the NGLs to respond to the arbitrage opportunity. U.S. propane prices have recently been on a tear—rising over 60% since June as a ratio to the crude oil price.
That’s because propane was one of the few NGLs readily exportable with current infrastructure in America. Pipelines like the Houston Ship Channel System owned by Enterprise Products Partners (NYSE: EPD) transport propane to shipping lanes on the Gulf Coast. Where it can be loaded for transport abroad.
Such shipments of propane are often referred to simply as Liquefied Petroleum Gas, or LPG. No to be confused with liquefied natural gas (LNG)—which is composed of actual methane gas that must be compressed and turned into liquid for transport.
Propane by contrast is produced and transported through pipelines mainly in liquid form. So there’s a lot less heavy lifting to do in readying it for transport.
In fact, LPG transport ships (known as “very large gas carriers”, or VLGCs) regularly land on U.S. shores already. Meaning that pipeline operators have very quickly been able to take propane from burgeoning shale plays and send it overseas.
This has led to a big rise in U.S. propane exports. Since May, total propane shipments abroad have increased to 288,000 barrels per day. A 100% rise in a very short time.
This of course makes perfect sense economically. With prices in other markets running well above the flooded U.S. space, producers and mid-stream operators should be doing everything they can to move propane to new markets—and capture the premium pricing this entails.
But the spike in propane exports—and the juicy jump in U.S. prices it’s created—could be just the beginning of the U.S. NGLs boom.
That’s the bottom line from a report last week by Norweigan investment bank DNB Markets.
The firm cites research suggesting that U.S. exports of LPG may be heading into a massive ramp up.
DNB looks at this from the angle of freight costs. Specifically, day rates for very large gas carriers—of the kind used to carry LPG from U.S. shores to markets abroad.
Such tankers currently contract out for about $37,000 per day. But the bank sees the U.S. export boom driving rates much higher than that.
Over 700% to be exact.
The bank suggests that by 2015, day rates for VLGCs could be going for up to $300,000 per day—as shippers compete with a surge of export sailings coming out of America.
The primary driver for this rise in prices will be LPG shipments from the U.S. to Asia. Spurred by the widening of the Panama Canal in 2015—which will allow larger ships and higher volumes to move eastward from America to markets across the Pacific.
That’s admittedly a few years out. But DNB sees prices rising steadily even before the game-changing completion of the new Canal. The bank has raised its forecast for VLGC rates by 40% for 2014 and 2015. For the coming year they expect rates to run $45,000 per day.
An Even Bigger Opportunity?
These kind of numbers suggest the opening of a massive new business (and investment) opportunity. And it won’t just be in propane.
The next wave of the NGLs boom could be in another commodity: ethane.
Ethane is used globally as a primary feedstock in the making of plastics. Today, it is becoming the go-to choice for chemical makers—being much more affordable than alternative feedstocks like naptha, whose price is linked to oil and thus running high these days.
The problem is that ethane is getting hard to come by in many parts of the world. Major chemical firm Ineos was recently forced to shut down part of its Grangemouth facility in Scotland, largely because of falling ethane production from nearby North Sea oil and gas fields.
This supply pinch has caused ethane prices in Europe to rise. To the point where European ethane users are today paying 80% more than their counterparts in the U.S.
That’s because American ethane production from shale gas wells is surging—up 400,000 barrels per day, or 67%, over the last four years.
That flood of supply has completely cratered domestic prices. Ethane used to sell at a premium of $10 above same energy-content natural gas. But today, it goes almost at parity with the low U.S. natgas price.
In fact, the American ethane price is so low that some firms aren’t even bothering to strip it out of their gas streams. They’re simply shipping it through pipelines along with the gas—a process known as ethane rejection.
This obviously means substantial lost income for producers who pump a lot of ethane. An especially acute problem in growing plays like the Marcellus shale in the northeast U.S.—where drillers are seeing big output of ethane in an area that has very limited pipeline infrastructure for moving this supply to market.
But the ample supply and low prices here are a major opportunity for some firms. Like European chemical manufacturer Ineos that I mentioned above.
That company recently announced plans to build an ethane import terminal serving the remaining processing plants at its Grangemouth processing facility in Scotland.
The stated idea being to replace declining and expensive European ethane supplies here with imported U.S. product.
Such a strategy would be a win-win. Imported American ethane would almost certainly be cheaper—even after shipping costs—and would definitely be more reliable. And such shipments should help boost the tepid U.S. ethane price—restoring profits for producers in this market.
It could also be a big win for investors.
Firstly, those holding stocks in ethane-producing E&P companies. Who will see their profits suddenly take off when ethane exports start capturing higher pricing abroad.
The Marcellus and Utica shales are ground zero for such opportunities. With ethane here already starting to move to export markets in Canada via the Mariner West pipeline operated by Sunoco (NYSE: SXL). Such shipments will soon increase via the Mariner East pipeline to the east coast, as well as the ATEX line that will take ethane to petrochemical facilities on the Gulf Coast. An emerging producer like PDC Energy (Nasdaq: PDCE) will benefit from these developments.
The other way to play the NGLs boom is with midstream pipeline operators. The companies that will move propane and ethane to port for export.
Enterprise Products Partners is a leader in this space. Operating the ATEX line mentioned above—as well as various gathering facilities along the Gulf Coast, the northeastern states and producing basins in the foothills.
Widerspread NGLs exports should in fact give a pricing boost to the U.S. natgas sector nearly across the board. Perhaps providing a rational for investors to hold onto stocks in hot shale plays—in anticipation of another leg up, from an unlikely source.