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Implications of a Tightening Ethane Supply and Demand Balance Part 2

February 10, 2016 | By Sam Duran

In our recent issue of Get the Point, Implications of a Tightening Ethane Supply and Demand Balance, we discussed how the discrepancy between ethane supply and demand growth has led to record levels of ethane rejection. Further, we discussed the impact of new ethylene cracker projects and export terminals will have on how much ethane will enter the natural gas grid in the future.  

In this week’s issue, we will take the analysis one step further with a deeper discussion of the market mechanisms that will ensure that ethane supply and demand remains in balance. Then we will discuss the impact of new sources of ethane demand on ethane prices and the production value uplift of NGLs in the gas stream.  

Recap

Before we dive deeper, let’s recap the previously mentioned issue of Get the Point. Ethane rejection averaged over 600 Mb/d (thousand barrels per day) in 2015. These record levels of rejection are the result of the rapid gas plant supply growth of ethane that has not been matched with demand growth. Demand growth will be arriving in the next few years, however, as ethane export projects and world-scale ethylene crackers targeting ethane as a feedstock come to service. (See the table below from an Enterprise Products Partners investor presentation outlining major ethylene cracker projects and expected ethane consumption.)  

U.S. World Scale Ethylene Plants Under Construction

As these projects come to service, ethane rejection will need to slowly erode to ensure there is adequate supply to meet new demand.  

Also discussed in the previous issue of Get the Point was the pricing incentive for ethane rejection. Most processing plants have the option to reject or recover ethane, and they elect to do so based on whether they capture more value for ethane blended into natural gas or if they capture more value for ethane shipped to a fractionator and sold as a purity product. With supply growth outpacing demand growth over the past few years, ethane prices declined significantly relative to natural gas, a price incentive to see more rejection. With this in mind, we’re ready to go one step further.  

Getting Ethane to the Gulf Coast

When considering the locations of the projects cited above, a pattern emerges. Most of the major ethylene cracker projects coming in the next three years are slated to be constructed on or near the Gulf Coast – with the Mariner East project in the Northeast U.S. as the prominent exception. While Mariner East will get started first, the much larger Enterprise ethane export project coming on the Gulf Coast later this year has the capacity to move up to 200 Mb/d.

Here arises the problem. While some ethane supply growth has taken place in Texas, Louisiana and elsewhere in the Gulf, ethane supply is growing much faster in areas like the Marcellus and Utica Shales. The chart below demonstrates how, over the past year, the Marcellus/Utica-driven supply growth in Petroleum Administration Defense Districts (PADDs) 1 and 2 has outpaced that of PADD 3, the area where demand growth is expected to take place.

Pre-Rejection C2 Supply Growth Since February 15

The good news is that over the past several years we have seen an extensive build out of new natural gas liquid (NGL) pipeline capacity to serve new and growing supply areas. The Front Range, Texas Express, Southern Hills and Sterling III projects, to name a few, were each designed to connect growing NGL supplies to export and petrochemical markets on the Gulf. Perhaps the most notable project in getting ethane to the Gulf has been ATEX, a pipeline capable of moving 130 Mb/d of ethane from the Marcellus and Utica to the area. Enterprise, which owns ATEX, states that the project is expandable to 260 Mb/d.  

Cost to Market vs. Ethane Recovery Economics

While these projects present a valuable outlet, new pipelines that traverse long distances tend to charge more to ship product than older and shorter pipelines. For several producing areas, the map below shows representative rates (in cents/gallon) to transport ethane to the Gulf and separate it from other NGLs in raw mix.

Transportation and Fractionation Costs

It should come as no surprise that producing areas with highest transportation costs have the worst ethane recovery economics. The map below shows the value of ethane in the Gulf coast, netted back in various producing areas, less the local value of natural gas on a dollar per million Btu basis ($/MMbtu). The negative values on display show that there is very little economic incentive to recover ethane in today’s market.  

Local Ethane Frac Spreads

Incentivizing Ethane to Move to the Gulf

In order to create an incentive to move ethane to the Gulf, prices need to rise. Not only will they have to rise, they also will have to rise high enough to move the above ethane fractionation (frac) spreads into positive territory. As prices increase, more regions in U.S. will be incentivized to switch to full ethane recovery mode and allow ethane supply to keep up with new sources of demand.

The chart below gives a very general idea of how much ethane is economically recoverable at various Mont Belvieu prices, given PointLogic’s model of current ethane production, today’s gas prices and what we know about the cost of moving ethane to Gulf Coast markets.  

Ethane Supply Stack into USGC

Clearly, there are some ethane supplies available at current prices. U.S. Energy Information Administration (EIA) data shows an average of 1,104 Mb/d of ethane was recovered in 2015 despite dismal ethane recovery economics. We’ll assume this ethane will continue to be recovered at today’s prices, at least in the short run. The remainder is ethane that is waiting for a price signal to be recovered and delivered to the Gulf Coast.  

Remember that roughly 500 Mb/d of ethane cracking capacity will be added over the next three years in the U.S., but the amount of export demand will depend on the timing of global pull and ethane vessel availability.

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With as much as 700 Mb/d of new ethane demand on the Gulf, ethane markets could easily begin to pull from as far as the Rockies or Northeast U.S. to fulfill demand requirements over the next three years. At today’s natural gas prices, ethane prices will need to nearly double to at least 30 c/gal to begin to incentivize ethane recovery in more distant marginal supply areas like the Rockies. Put another way, ethane prices will need to increase over $2.00 relative to natural gas on a $/MMbtu basis to incentivize the Rockies to switch into full recovery mode.  

There are a lot of uncertainties and moving pieces in this analysis -- not the least of which is ethane supply growth. The chart above is simply a snapshot of ethane supply availability today. The more ethane supply grows in areas with a lower cost to access to the Gulf, the less the ethane market will need to rely on more “costly” supplies from areas like the Northeast.

Furthermore, gas prices and basis differentials are relevant as well. The lower natural gas prices are, the less Mont Belvieu ethane prices need to increase to in order to incentivize ethane recovery at processing plants in a particular area. Additional risks include the scale and pace of development of local demand in regions other than the Gulf, as well as development new infrastructure in areas like the Northeast to move ethane to the Gulf.  

Good News for Oil & Gas Producers

Despite these risks and uncertainties, the fact remains that Gulf Coast ethane prices will likely need to rise in order to incentivize a move deeper into this supply stack to allow recovered supplies to meet growing demand.

While the changes likely aren’t coming soon enough, this is good news for producers, who would love see better realizations for their NGL reserves than they are seeing today. Current NGL frac spreads are at some of the lowest levels seen in years. For a variety of reasons, the prices of heavier NGLs like propane, butanes and natural gasoline are sensitive to the price of oil. With WTI trading in the low $30/bbl range and ethane prices already extremely low, the production value uplift of NGLs has suffered tremendously.  

 Mont Belvieu NGL Frac Spread

This said, ethane represents just under 50% of the volume of a typical NGL barrel, and NGL frac spreads are more sensitive to ethane prices than that of any other NGL. The chart below shows the sensitivity of the NGL frac spread to different ethane prices, while holding the value of other NGLs at their currently dismal prices.      

Frac Spread Sensitivity to Ethan Prices

In other words, even if oil prices stay near $30/bbl over the next three years and hold down the prices of heavier NGLs, it’s possible to see frac spreads double from current levels. Say what you want about a $3/MMBtu frac spread, but at $30 oil and $2 gas, any additional value will be welcomed by producers.

It’s also important to note that regardless of what oil prices do, these crackers are on track to get built and crack ethane. So a potential $1.00-$1.50/MMbtu uplift on NGL values is likely to come, regardless of what happens in the oil market -- or perhaps come in addition to any kind of price recovery in next three years.      

In a sense, ethane prices were one of the first dominos to fall as the shale revolution unleashed new supplies of NGLs onto the U.S. and, now, the global market. As low ethane prices created an incentive for ethylene crackers at home or abroad to target the feedstock, the seeds were planted for U.S. ethane prices to begin their recovery. With weaker crude and heavier NGL prices, there is now no guarantee that the next wave of crackers will target ethane as a feedstock, but we can be certain that the projects slated to come online within the next 3-5 years will have a positive impact on North American ethane and NGL prices.  

 

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