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Implications of a Tightening Ethane Supply and Demand Balance

December 2, 2015 | By Sam Duran

It’s no secret that ethane rejection has been prolific in recent years, but the sheer volume of ethane rejection seen today in the U.S. natural gas marketplace is blowing previous records away.

At Pointlogic Energy, we estimate that rejected ethane volumes in the lower 48 states have increased to over 600 Mb/d (thousand barrels per day) in 2015. This week’s edition of Get the Point details where we are seeing this increase and addresses why the lower 48 is so awash in ethane. 

Before we get into the drivers of elevated ethane rejection levels and a regional breakdown of where this rejection is taking place, let’s first take a step back and talk about what 600 Mb/d of ethane rejection really means. One gallon of ethane is roughly 66,000 Btus. This implies that 1.6 Bcf/d worth of natural gas production on a Btu-equivalent basis is hitting the gas grid today in the form of rejected ethane.

The chart below shows how the portion of ethane rejected versus recovered ethane has increased over the past few years.  

Lower 48 Ethane Recovery vs. Rejection

Ethane rejection volumes into the natural gas supply stream are uniquely important because they can disappear and reappear from the gas stream as the ethane market dictates. Ethane demand growth is expected to outpace supply growth in upcoming years. It is likely that some ethane rejection goes away to ensure new export projects and world-scale ethylene crackers are adequately supplied.  

This notion is echoed in a recent investor presentation by Enterprise Product Partners. Enterprise projects that the difference between pre-rejection ethane supply and ethane demand will close over the next three to four years as new ethane demand and exports come to service.       

U.S. Ethane Supply / Demand Outlook

What is Ethane Rejection?

Ethane is by-product of oil and gas production and is produced alongside other natural gas liquids like propane, butane and natural gasoline. While some ethane is recovered from oil production at refineries, most ethane is extracted at gas processing plants in the field. Ethane is different from other NGLs in that it can relatively easily be blended into natural gas.  

With this in mind, most major processing plants in the U.S. are set up with two options of how to handle their ethane volumes. The first option is to recover ethane and leave it in the raw mix stream (mixed NGLs) to be eventually be fractionated into “purity” ethane or EP (ethane and propane) mix. It’s important to note that recovered ethane only has one use, as a feedstock in a cracker to produce ethylene and other co-products.

The second option a processing plant has is to reject the ethane and leave it in the gas stream. This second option makes ethane one of the easier NGLs to dispose of -- and with NGL markets vastly oversupplied, the ethane "rejection" option has become a crucial balancing item for the NGL market.  

Basic ethane rejection economics are fairly simple to calculate. They revolve around the value of these two ethane options for a producer at a processing plant. In general, if a producer gets a better netback (market price less transport and fractionation costs) for selling ethane into a market like Mont Belvieu (the largest ethane hub in the United States, located along the Texas Gulf Coast just outside of Houston) than it gets selling ethane as natural gas, then a producer ought to elect to recover the ethane. If the ethane’s value in the gas stream is greater, then the producer ought to reject the ethane. Realistically, the waters are muddied by the fact that all processing plants and processing contracts are not created equal, but the relationship between ethane and natural gas prices still generally drive ethane rejection economics. 

An Assumption

In considering volumes and values of ethane, one way to measure the impact of ethane rejection on natural gas supply is in MMcf/d or Bcf/d of gas on a Btu-equivalent basis. This refers to how much gas would be needed to replace a certain volume of ethane and still have the same amount of Btus.

Ethane has a higher Btu content per Mcf than does natural gas, and there is a difference between the actual volume of ethane rejection in MMcf/d and the Btu-equivalent volume of natural gas. If the reader would prefer to think about ethane rejection in a pure volumetric form, our friends at RBN Energy tell us that one gallon of ethane is about 37 cubic feet. This would imply that roughly 1 Bcf/d of natural gas production today is actually ethane rejection.  

Why is so much ethane rejection taking place?    

NGL production has faced the compounding effect of growing gas production reaching processing plants as well as an increasingly rich gas stream. Not only has NGL production boomed in wet parts of the Marcellus, but associated gas in production areas like the Permian and Bakken tend to have a higher NGL content than many wet gas production areas. As oily and liquids-rich plays have displaced dryer producing areas like the Haynesville, NGL production has boomed.

The chart below shows how total NGL production per gross withdrawals of gas has increased over the past few years.   

NGLs Produced/Gross Withdrawals

Needless to say, NGL production growth rates have exceeded those of natural gas. With ethane just under half of a typical NGL barrel, pre-rejection ethane supply growth averaged 13% over the past five years, reaching a year-to-date average of roughly 1,700 Mb/d in 2015.  

At the same time, ethane demand growth has not kept up. Building a world-scale ethylene cracker is a costly and time-consuming venture, and while ethane supply growth has justified the investment, demand growth has been slow in coming.

As this gap between ethane supply and demand has grown, ethane rejection has come to the rescue to balance the ethane market. Mont Belvieu ethane prices have essentially declined to parity with natural gas on a $/MMbtu basis -- a market signal to maximize ethane rejection on the gas grid.

The chart below shows a basic ethane frac spread: the value of Mont Belvieu ethane less the value Henry Hub natural gas on $/MMbtu basis, or generally, the incremental value one can obtain by capturing ethane as opposed to rejecting it into the natural gas stream at the processing plant assuming no transportation and fractionation charges.

Ethane Frac Spread (MtB/HH)

Another Gear in Late 2014

Oversupply in the ethane market reached a peak in late 2014 when ethane prices averaged $0.41 below natural gas on a $/MMBtu basis and saw a disparity greater than $1/MMBtu over a couple of days in December. Since ethane fractionation spreads went negative last year, ethane rejection has increased by 300 Mb/d, or 0.8 Bcf/d of Btu-equivalent natural gas.  

Where is Rejection Taking Place?

The Energy Information Agency reports NGL monthly production survey information by refining districts in addition to traditional Petroleum Administration for Defense Districts (PADD) level. A map of the EIA-defined areas can be seen below.   

Refining Districts

The chart below shows PointLogic’s estimates of how ethane rejection has evolved in each of these Refining Districts over time as well an indication of what percentage of ethane is being rejected in a given in area in 2015. A couple of conclusions can be drawn from this chart.   

Incremental Rejection & Percent of Total Ethane Rejected

First, we see that the regions that are either infrastructure constrained or have a high cost to market all have a higher portion of ethane rejected. Areas like the Rockies, Marcellus, Utica and the Bakken all have options to move ethane to key NGL hubs like Conway or Mont Belvieu, but producers in these areas must pay relatively higher transportation and fractionation costs to access liquid ethane markets. With higher transportation costs, ethane recovery option is less valuable at the processing plant (thus we see greater amounts of rejection in these areas). Areas like Texas, Oklahoma and Louisiana have much lower costs to market, and ethane recovery economics are therefore more favorable; not surprisingly, rejection is a smaller portion of total ethane supply.  

One might ask how any ethane at all is being recovered in some of markets like the Bakken and Marcellus/Utica where transportation costs to Gulf Coast markets are the highest. Look no further than the petrochemical industry for the answer. Abundant, low-cost ethane is a boon for ethylene crackers in Canada, which were either facing decreasing local supply or higher cost feeds. Vantage Pipeline in North Dakota and Mariner West Pipeline in the Northeast were both designed to connect ethane supply growth in the U.S. to Canadian ethylene crackers.  

Mariner East, which connects to the Marcus Hook waterborne export terminal, is designed to accomplish the same goal overseas, connecting cheap ethane in the U.S. to a global ethylene market accustomed to higher cost feeds. ATEX Pipeline is a seemingly a less appealing outlet for ethane as a shipper pays about 17 c/gal to sell ethane on the Gulf Coast for under 20 c/gal, but for producers, it’s much better to get a less than optimal ethane netback than to shut-in a well because the local natural gas grid can’t take any more high-Btu ethane.

The map below shows various pipeline projects to move ethane out of the Marcellus/Utica area.   

Ethane projects out of the Marcellus/Utica area

It’s important to note that in areas like the Bakken and the Marcellus/Utica, in the near term, access to ethane supply-constrained petrochemical markets will be a more crucial driver of ethane recovery than will be Gulf Coast ethane prices.  

The second conclusion that can be drawn from the above chart is that the areas closer to Mont Belvieu with lower transportation and fractionation costs are now accounting for a much greater proportion of ethane rejection.

Despite being by far the largest single NGL-producing area in the U.S. (roughly 37%), Texas Inland was only contributing to 26 Mb/d, or 9%, of ethane rejection in 2013. The region accounts for 20% of a more robust ethane rejection volume in the U.S. today, around 121 Mb/d.

The chart below shows our model of ethane rejection and ethane recovery for Enterprise’s Yoakum plant, located in Lavaca County Texas -- within the Eagleford. This plant, which supplied 6.5% of U.S. recovered ethane in the first half of 2014, should have some of the best ethane recovery economics due to its owner, Enterprise Product Partners – a vertically integrated midstream company, and the plant’s proximity to Mont Belvieu.   

Enterprise - Yoakum Plant

As the ethane fractionation spread went negative, even the plants with best recovery economics have shown increased levels of rejection. It should be noted that the areas that were the last to start rejecting due to more favorable transportation costs to market ought to be first to start recovering ethane as demand catches up.  

Ethane Demand to Catch Up in 2016-2018

When will demand recover? As mentioned before, low ethane prices are great for ethylene producers who want use ethane as a feedstock for their ethylene crackers. A strong crude-to-gas price ratio over the past couple years makes building an ethylene cracker targeting ethane in U.S. more appealing than building a naphtha-based cracker in another part of the world. For this reason, several world-scale ethylene crackers are slated to come to service over the next couple of years targeting ethane as a feedstock.

Even though the crude-to-gas ratio has become weaker and more volatile, the industry is confident that this first wave of crackers will target ethane as feedstock because most of these plants did not opt to put up the incremental capital for feedstock optionality. Again, data from Enterprise’s investor presentation of ethylene crackers currently under construction:

U.S. World Scale Ethylene Plants Under Construction

On top of this, Enterprise is developing a 200 Mb/d ethane export terminal from the U.S. Gulf Coast slated to come online in the third quarter of 2016.  With another shipper recently signed, Enterprise claims that the facility is 90 percent contracted. With 495 Mb/d of ethane to be consumed at new crackers and as much as 200 Mb/d to be exported, ethane demand is on track to catch up with pre-rejection supply. In the unlikely event that pre-rejection supply goes flat over the next three years in a low-price environment and we see maximum utilization of these assets, we could say that about 1.9 Bcf/d worth of Btu-equivalent gas will be coming off of the gas grid to supply these projects.

The charts below show ethane demand in MMcf/d and ethane rejection by Refining District in MMcf/d.   

Ethane Rejection (MMcf/d) and New Ethane Demand (in MMcf/d)

Of course, several factors may prevent this new infrastructure from running at full capacity, and pre-rejection ethane supply will likely show some growth and continue to supplement natural gas supply in upcoming years. But the fact remains that the ethane supply currently permeating that gas grid has options.  

As ethane demand grows at a greater rate than supply in the upcoming years, producers will be incentivized to utilize their ethane recovery option and bring ethane off of the gas grid and onto the path towards new sources of ethane demand. Given that ethane has been contributing to an already over-supplied natural gas market, more demand for ethane in higher-value petrochemical markets would probably be welcomed by gas producers.

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