Natural gas processors can be sensitive to commodity prices in the form of frac spreads
Some market participants view fractionation spreads (also called “frac spreads”) as one indication of the profitability of some natural gas processing companies. Frac spreads depend on natural gas liquids (NGLs) and natural gas prices, and they increase when NGL prices increase relative to natural gas prices. (For a detailed explanation of fractionation spreads, please refer to Why fractionation spreads affect some MLP stocks.) Generally, companies with natural gas processing operations such as MarkWest Energy (MWE), Targa Resources (NGLS), Williams Partners (WPZ), and DCP Midstream Partners (DPM) realize more profits when frac spreads increase.
Frac spreads rose from $32.28 per barrel to $34.78 per barrel last week, reaching the highest point since last May
Both natural gas and NGL prices dropped last week as the market expected milder-than-normal weather to hit. Natural gas slipped 5% last week, to close at $4.94 per MMBtu last Friday—down from $5.18 per MMBtu the prior week. Propane price rose slightly, from $1.52 per gallon to $1.53 per gallon last week, as households continued to have strong demand for propane for home heating during the cold weather. The price of the composite natural gas liquids barrel, however, decreased from $48.20 per barrel to $46.81 per barrel as the price of ethane, a main component of the composite barrel, fell by nearly 20% last week. Ethane over recent years has begun to trade in line with natural gas, so bearish movements in natural gas likely drew ethane prices down. Altogether, with natural gas’s decline in prices, frac spreads traded slightly higher.
Note: The custom frac spread is based on assumptions provided by Ceritas Group. To see how the custom frac spread is calculated, please refer to An in-depth look at the mechanics of fractionation spreads.
More infrastructure for processing ethane and propane would support prices
Once more capacity for processing ethane and propane comes online or more NGL export capacity is constructed, this could provide additional long-term demand for these commodities and result in higher frac spreads, as recent increases in propane exports have shown.
Several midstream companies have noted that they’re working on such projects. However, the timeline for the completion of these works is over the next several years. Even if demand for these NGLs grows as a result of completed infrastructure, the supply of NGLs also continues to grow—and if supply meets or outstrips demand, the prices of ethane and propane may remain depressed.
Last week, frac spreads traded up by 8% over the previous week. Plus, over the medium term, frac spreads are up significantly, as propane prices have helped to buoy the natural gas liquids complex. This is a positive catalyst for natural gas processors such as MWE, NGLS, WPZ, and DPM—many of which are also components of the Alerian MLP ETF (AMLP).
For more background, see the Market Realist series What’s driving higher propane prices and how it could affect your portfolio.
More From Market Realist
- Introduction to the Permian Basin — Part 2: Geography of the Permian Basin
- MLP (master limited partnership) tax considerations
- Why MLPs provide excellent risk-reward for investors
- Commodity Markets
- natural gas processing
- natural gas prices
- Natural gas