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 dropped last week by 2%, range-bound over the medium term, though rising natural gas prices could be negative
Last week, natural gas prices were up. Meanwhile, natural gas prices traded mixed, with ethane and propane up, but butane, isobutane, and natural gasoline down. Ultimately, this resulted in slightly lower frac spreads (as measured by a custom index created by Bloomberg, using assumptions provided by Ceritas Group).
Note: The custom frac spread is based upon 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.
The heavier NGLs (such as natural gasoline) tend to trade directionally with crude oil, which fell on the week. Plus, ethane tends to trade more in line with natural gas, which rose last week and has had a strong rally over the past month. (For more on why ethane is linked to natural gas, please see Why ethane stopped trading like crude and started trading like nat gas). The higher natural gas prices over the medium term are negative for frac spreads and natural gas processors with certain contracts.
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 has been demonstrated by the recent increases in propane exports.
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.
Natural gas and propane demand also affected by colder weather
Propane prices may have increased last week in part due to colder weather, as propane is a major fuel used for home heating. Also, as natural gas is also used for home heating, natural gas prices may also have increased due to forecasted colder temperatures. That propane prices increased more than natural gas prices last week was ultimately positive for frac spreads.
Last week, frac spreads traded down slightly, though over the medium term, frac spreads have been mostly range-bound between $28 per barrel and $30 per barrel since early October. A higher frac spread 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).
More From Market Realist