Why rising frac spreads are benefitting select MLP names

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 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 were roughly flat last week, up only 0.6%

Last week, natural gas prices were down slightly. Meanwhile, NGL prices were flat to marginally down, and ethane traded down slightly, from $0.32 per gallon to $0.29 per gallon. Ultimately, this resulted in nearly unchanged frac spreads (as measured by a custom index created by Bloomberg, using assumptions provided by Ceritas Group). Frac spreads have been highly volatile year-to-date, trading from a range of ~$35 per barrel to ~$15 per barrel when natural gas prices spiked. Currently, they’ve settled at a level of ~$25 per barrel.

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.

Outlook

Last week, frac spreads traded up slightly, and over the medium term, frac spreads are up significantly. 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).

To learn more about investing in energy MLPs, see the Market Realist series Why rising propane and butane exports affect some US energy MLPs.

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