Why narrower frac spreads could hurt energy names like MWE

Market Realist

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 an 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. 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 slid 10% last week, from $29.28 per barrel to $26.45 per barrel

Last week, the price of a representative barrel of natural gas liquids decreased from $50.57 per barrel to $48.37 per barrel, a 4.5% decrease on the week. The drop was mainly driven by the huge fall in propane prices, which are a large part of the natural gas liquids representative composite barrel. Propane prices traded down 14% on the week. Meanwhile, other parts of the NGL barrel traded flat last week. As a result, the price of the composite NGL barrel declined by more than 4%. Henry Hub natural gas spot prices, which are used to calculate the frac spread, traded flat on the week, to close at $5.64 per MMBtu compared to $5.70 per MMBtu the previous week. Due to the decrease in NGL prices, frac spreads finished at $26.45 per barrel, sliding nearly 10% over the prior week.

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.

Summary

Last week, frac spreads traded down by nearly 15% compared to the previous week, which is a negative signal for natural gas processors such as MWE, NGLS, WPZ, and DPM—many of which are also components of the Alerian MLP ETF (AMLP). However, over the medium term, frac spreads are still up significantly from lows of ~$22 per barrel in mid-2013, which is a positive catalyst for the midstream energy names mentioned above.

For a detailed explanation of fractionation spreads, please refer to Why fractionation spreads affect some MLP stocks.

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