North America's shale drilling revolution is taking a toll on natural gas producers.
The reason? The shale boom has generated a tremendous oversupply of Natural Gas Liquids (NGLs) – These are the byproduct gases and liquids like ethane, pentane, and propane which come out of the well alongside oil and regular natural gas.
The supply glut, for its part, has forced a sharp drop in the price of NGLs in North America. And that is crunching the profits of gas producers.
You see, for the last two years, many natural gas producers have been acquiring and drilling gas plays with high liquids content. NGLs are typically valued as a percentage of crude oil prices, and are worth 2-10x what dry gas is worth.
In fact, junior Canadian and American gas producers have been positioning themselves as “liquid rich” gas producers. Analyst reports from brokerage firms promote their increasing NGL production.
The problem for the gas producers is—the oil producers have been acquiring and drilling them, too.
Between oil and gas NGL production, supply has overwhelmed the petrochemical industry, which uses most of these NGLs as feedstock.
Prices have rebounded from lows seen in late June, but are still down a lot from last year:
• Ethane at 31 cents/US gallon is down 61% from last July
• Propane at 85 cents/US gallon is down 44%
• Butane at 121 cents/US gallon is down 31%
• Condensate at 192 cents/US gallon is down 24%
Profitability is down even more—add another 15% to each of those numbers. (This means ethane profits are down 70% or more.)
These prices come from Mont Belvieu, Texas, which is the main pricing hub for NGLs in the US. What Cushing is to oil in the US, Mont Belvieu is to NGLs.
Even these numbers don’t tell all the pain—some gas processing plants aren’t accepting ethane at all, which of course lowers the price to crazy levels—the 2nd NGL hub in the US, in Conway Kansas, has seen ethane prices fall to 8 cents a gallon.
Here's a brief background on these products.
The “C2” type number you see beside each entry is how many carbon atoms a molecule of each product has, and the industry interchanges the names Ethane and C2 (Propane and C3 etc) all the time.
Ethane (C2) – Demand is primarily driven by the ethylene production industry, which uses ethane to meet nearly half of its feedstock needs to produce chemical compounds used in making plastics.
Propane (C3) – Propane use is predominantly split between heating, which is seasonal, and for certain petrochemical applications.
Butane (C4) – Demand for butane is usually quite robust since it has a wide range of uses. It has both industrial and residential heating uses and is often blended with propane to produce liquid petroleum gas. Butane pricing is most similar to that of crude oil.
Pentanes or Natural gasoline (C5-C9) – The heaviest of the non-condensate liquids. It's frequently used as a fuel additive and blended with regular gasoline as well as a petrochemical feedstock. Receives a premium to crude oil at times.
Condensates (C10+) - It is basically equivalent to crude oil with many of the same end markets. Its pricing is also similar to crude oil.
As juniors—and even seniors like Encana (ECA-NYSE; TSX) and Chesapeake (CHK-NYSE)—have tried to increase NGL production, the market has not been impressed. The stock prices of these gas producers has not improved much of the last year. My experience is that until the juniors have reached about 70% oil and NGLs of overall production, the market doesn’t care.
This huge rise in NGL production is primarily due to the Shale Gas Revolution—especially in Texas where a lot of the new “oil” plays are really 25%-35% gas and NGLs.
Then there’s also the Marcellus and Utica shale gas plays in the US Northeast and the Granite Wash play in western Oklahoma that have NGLs, along with Canada’s Montney and Duvernay plays on the BC/Alberta border... which are also NGL rich—and just ramping up.
In 2011, NGL production hit a then record of about 2.2 million barrels a day. The U.S. Department of Energy estimates that in March of this year (the latest data available), NGL production rose to 2.3 million barrels a day. This figure is a jump of nearly 50 percent from January 2009 levels.
In fact, NGL output in the first quarter of 2012 accounted for a record of almost 30 percent of the U.S. oil production. At the beginning of this decade, according to industry estimates, this figure was only 20 percent.
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It looks like the shale boom will only make the pricing situation worse in the years ahead. Bentek Energy estimates NGL production will increase by more than 950,000 barrels a day to over 3.1 million barrels a day by 2016, adding to the NGL surplus.
BENTEK’s Jack Weixel adds that “as (NGL) pricing continues to decline, operators will continue to pursue even oilier plays, with the activity in the Utica being the best example of this.”
The US is exporting more NGLs to help relieve this production glut. About 220,000 bopd are exported, mostly to Latin America, and by 2016 BENTEK expects that to be 400,000 bopd of mostly ethane and propane. Canada is doing its part, as US condensate exports to the US—where it’s used to dilute heavy oil; make it flow better—have increased 10x in the last year.
However, Weixel adds “the real constraint is domestic demand. While several world scale ethylene crackers have been proposed, until facilities are actually built that can use product such as ethane and propane, we’ll continue to see downward price pressure.”
US public companies whose stock prices are tied to NGL profitability include Targe Resource Partners (NGLS-NASD) and Enterprise Products Partners (EPD-NYSE).
The conclusion: The NGL surplus could stick around for several years, which is good for the petrochemical firms but bad for gas producers.
Wells Fargo Bank, one of the biggest lenders to the U.S. natural gas industry... with intimate knowledge of the industry, recently sounded a pessimistic note. It warned that the price downside for NGLs had a “few more legs” to go and that “the pain could continue into 2013."
By. Keith Schaefer, Publisher, the Oil & Gas Investments Bulletin
