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Why natural gas liquids prices can affect upstream producers

Avik Chowdhury

Why oil and natural gas prices have traded down recently (Part 3 of 4)

(Continued from Part 2)

Natural gas liquids (or NGLs) are another component of upstream energy production

Natural gas liquids, or NGLs, are a group of hydrocarbons (ethane, propane, butanes, and pentanes) that are often found alongside dry natural gas (methane). Many upstream companies (companies that produce crude oil and natural gas) garner much of their revenue from producing and selling NGLs—especially those that have a significant amount of “rich gas” assets, or natural gas assets “rich” in liquids. Some of these companies include Range Resources (RRC), Chesapeake Energy (CHK), SM Energy (SM), and Linn Energy (LINE). Price fluctuations in NGLs can affect the ultimate revenue and earnings of upstream companies, so NGL prices are an important indicator to track in the energy sector.

NGLs are made up of different compounds that receive different prices, and production streams are largely ethane and propane

According to a presentation by the Midstream Energy Group, the average NGL barrel composition in December 2011 was ~43% ethane, ~28% propane, ~7% normal butane, ~9% isobutane, and ~13% pentanes or heavier hydrocarbons. Using this representative composite barrel, NGL prices closed at $39.77 per barrel on March 14 compared to $39.90 per barrel for the week ended March 7, 2014.

Ethane, the largest portion of the natural gas liquids barrel, traded down slightly from $0.32 per gallon to $0.29 per gallon. Meanwhile, propane, the second largest portion of the barrel, traded from $1.09 per gallon to $1.06 per gallon. However, natural gasoline or pentane traded up 6% on the week, making up for losses in propane and ethane prices. Ultimately, the representative NGL barrel traded roughly flat on the week.

The representative NGL barrel remains up over 25% since lows in June, a medium-term positive catalyst. Natural gas liquids prices were helped by the rise in WTI crude prices, which shot up from ~$95 per barrel to levels of up to $110 per barrel at points in the second half of 2013, and natural gas liquids prices correlate to movements in crude oil prices. Since then, though, crude prices had retreated somewhat, to ~$99 per barrel currently. However, NGL prices have remained relatively robust. One factor in this trend is that the composite NGL barrel has been helped by an increase in propane prices, which has likely been driven by higher propane exports.

Also, cold weather has helped push propane prices up, as the commodity is used as a home heating fuel, and demand has soared recently, given frigid temperatures across the U.S. Natural gas is also used as a home heating fuel, and the price of the commodity has increased in recent weeks due to cold weather. Also, decline in natural gas inventory during March 2014, after cold weather, has boosted demand. Ethane has started to trade more closely to natural gas over the past year or so (see Why ethane stopped trading like crude and started trading like nat gas for further analysis), and natural gas’s rally over the past few weeks may have helped ethane to trade up.

Background: NGLs have historically tracked movements in crude prices

Natural gas liquids prices have largely tracked crude oil prices historically. However, over recent years, the composite barrel as a percentage of crude prices has declined. This is because ethane and propane make up a large percentage of the average NGL barrel, but these two commodities especially had experienced a surge in supply due to the shale boom and experienced a decline in prices in relation to crude oil.

There’s still a correlation between NGL prices and crude, and movements in oil prices can cause NGL prices to move as well. Plus, the NGL barrel price relative to crude oil has recovered somewhat since June of 2013, as we’ve seen.

This week saw NGL prices trade roughly flat a neutral short-term indicator. However, NGL prices are up significantly since late June 2013, a positive medium-term indicator. From a longer-term perspective, many producers still find current price levels economic enough to continue to target and drill for NGLs, but they’ve suffered from NGL prices coming off highs (~$50 to $60 per barrel through much of 2011 versus ~$40 per barrel now). Major producers of NGLs include CHK, RRC, SM, and LINE—many of which are found in energy ETFs such as the Vanguard Energy ETF (VDE) and the SPDR S&P Oil & Gas Exploration & Production ETF.

Continue to Part 4

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