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How Last Week’s Fall in Fractionation Spread Could Affect Investors

Kurt Gallon

MLPs Closed Last Week 0.5% Higher despite Decline in Oil Prices

(Continued from Prior Part)

Fractionation spread

The Henry Hub–Mont Belvieu fractionation spread fell to $10.4 per barrel in the week ending April 1, 2016. The spread was $11.5 per barrel in the previous week. The Henry Hub–Mont Belvieu fractionation spread measures the spread between Henry Hub natural gas and Mont Belvieu composite NGLs (natural gas liquids) prices.

The composite NGLs price is based on spot prices for ethane, propane, isobutane, n-butane, and natural gasoline at Mont Belvieu. The decline in NGL prices combined with the rise in natural gas prices last week contributed to a decline in the spread between the two during the week. We’ll discuss last week’s change in ethane prices in the next article.

The above graph shows the weekly fractionation spread over six weeks. MPLX LP (MPLX), Tallgrass Energy Partners (TEP), and Western Gas Partners (WES) are some of the MLPs involved in fractionation.

How are MLPs impacted by the fractionation spread?

Natural gas recovered from a wellhead must be processed in order to meet specifications before it can be delivered for final use. In addition to natural gas, processing produces mixed NGLs that are separated through fractionation.

The spread between NGLs prices and natural gas prices impacts natural-gas-processing MLPs involved in fractionation. These MLPs typically benefit when the fractionation spread is high, which means that prices for NGLs are high compared to natural gas prices. This benefit stems from the keep-whole and percentage-of-proceeds contracts that these MLPs maintain.

Keep-whole contracts

Keep-whole contracts are sensitive to commodity prices. Under keep-whole contracts, the processing MLP generally keeps a portion of the NGL extracted through fractionation as payment. The MLP replaces the energy content of the NGLs that it retained with natural gas. A fall in NGL prices relative to natural gas prices makes the spread less favorable for fractionating MLPs under keep-whole contracts.

Percentage-of-proceeds contracts

In percentage-of-proceeds contracts, the MLP gathers and processes natural gas on behalf of producer customers. It sells the residue gas and NGLs produced from processing. The company remits an agreed-upon percentage of the proceeds to the producer and retains the rest. As a result, the prices of natural gas and NGLs impact the revenue of MLPs that hold these types of contracts.

Percentage-of-proceeds contracts account for nearly 85% of the total volume of ONEOK Partners’ (OKS) Natural Gas Gathering and Processing segment. To learn more about this segment, please read Natural Gas Liquids Segment Drives ONEOK’s EBITDA Growth.

ONEOK Partners forms 0.1% of the PowerShares Dividend Achievers Portfolio (PFM).

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