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Implications of a Tightening Ethane Supply and Demand Balance Part 3

March 30, 2016 | By Sam Duran

In this third installment of our Get the Point analysis of the U.S. ethane market, we look at how developments on the supply side could lead to a tighter market for ethane in 2016 and 2017 – making it one of the brightest spots in an oil and gas industry that is still struggling with oversupply and low prices.

Recap

In the first installment of the series, Implications of a Tightening Ethane Supply and Demand Balance, we discussed how today’s massive level of ethane rejection, now just under 600,000 b/d, has been driven by a disconnect between supply growth and demand growth. We also discussed how new demand growth over the next few years will likely outpace supply growth, leading to less ethane rejection.

In the second installment of the series, Implications of a Tightening Ethane Supply and Demand Balance Part 2, we discussed the market mechanisms that will create an economic incentive to make ethane recovery take place again. In particular, Mont Belvieu ethane prices would need to cover transportation and fractionation costs to the Gulf Coast in order to incentivize producers to opt to recover ethane at respective processing plants in different producing regions of the U.S.

A Change in Message from U.S. Oil and Gas Producers

After a warm winter, natural gas inventories are expected to exit March around 2.5 Tcf. This would be the highest level of inventory exiting a winter on record, which creates a problem for natural gas markets. In order to ensure natural gas inventories exit the summer injection season below the Energy Information Administration’s (EIA)  demonstrated maximum working gas storage capacity of 4.3 Tcf, the price of gas must encourage maximum demand and/or a decline in production. Prices have done just that with NYMEX prompt prices under $2 per MMbtu. Combine this with a low crude oil price environment, and we have a recipe for a slowdown in the growth rate of NGL production.    

In 2015, the message from oil and gas producers in the U.S. was that they were cutting CAPEX, but production momentum was slower to respond, resulting in net growth versus 2014. In 2016, the message from oil and gas producers is that they are once again cutting CAPEX, but at least for many producers, the result will be that production must flatten out and decline across many producing areas in the U.S. The chart below shows the year on year cut in CAPEX across a group of the top 40 non-major producers in the U.S. The average announced cut is just under 50%.  

Change in CAPEX 2015-2016

2016 Ethane Production Forecast

The steeper CAPEX cuts in 2016 are expected to lead to a net declining natural gas production profile over the course of the summer. In our recent Get the PointA V-Shaped Outlook for Natural Gas Production and Prices, we forecast a far less prolific natural gas supply profile in 2016 than in 2015, followed by a sharp recovery to meet growing natural gas demand. That said, from an ethane perspective, it is crucial to understand how much natural gas production is expected to come from associated gas and liquids rich plays, and how much is coming from dry gas supply sources.

Our view, outlined in the table below, is that associated gas and liquids rich producing areas are expected to hold up much better in 2016 than dry gas sources, even with oil prices at their depressed levels today.

Associated Gas and Liquids

With associated and liquids rich basins holding up much better than dry gas, we expect pre-rejection ethane production to show 3% YoY growth vs. a -1% decline for gas. With nearly all of the YoY increases front loaded, it is important to note that we show declines vs. current levels over the course of the summer, but then we see supply growth picking back up as we enter the winter months and continue into 2017. The chart below shows the expected profile of pre-rejection ethane production over the next two years.

Pre-Rejection Ethane Production

A regional breakdown of the change between December 2015 and December 2016 ethane gas plant production shows ethane supply declining over the course of 2016; declines in the Rockies and Texas will offset growth in the Northeast.

Change in Ethane Production

Are Declines Already Taking Place?

Using PointLogic energy’s daily natural gas production analysis, we have developed a model for the daily supply of NGLs, including the supply of ethane before rejection. By our estimates, pre-rejection ethane production peaked in late January and has been declining slowly ever since.

Daily US Ethane Production

Enter Demand Growth

If production growth were to continue on its previous track, there would be no question that ethane supply would be adequate to match growing ethane demand over the next 2 years.

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Now, with flat or declining gas production in 2016, the story gets a little more interesting. Will there be adequate ethane supply for new ethane capacity expected to come to service over the next few years? The answer is most likely yes, but it rests on top of a heap of uncertainty in the uncharted waters of today’s oil and gas market.

According to the public statements of Enterprise Products Partners and the plethora of chemical companies developing new ethane cracking capabilities, the U.S. will add roughly 500 Mb/d of ethane cracking and exporting capabilities by the end of 2017. EIA reported product supplied (implied demand) of ethane in PADD 3 was 1,075 Mb/d in November 2015. Adding new demand provides a rough estimate of potential PADD 3 ethane demand at the end of 2017 of 1,575 Mb/d. By comparison on the supply side, PointLogic Energy expects to come out of 2016 with pre-rejection ethane production of just over 1,825 Mb/d (after production growth picks up in the later part of this year).

So, ethane supply in 2016 already exceeds 2017 demand, problem solved? Not so fast...this supply still needs to get to market.

Getting Ethane to the Gulf

Recalling the discussion from the previous issues of Get the Point, we know that it doesn’t just matter how much total ethane supply grows, it also matters where it grows. All of the 500 Mb/d of capacity growth is expected to take place on or near the U.S. Gulf Coast. Referencing the map above, ethane supplies in areas with easy access to the Gulf Coast are expected to be in decline, while areas with limited ethane infrastructure access to the Gulf Coast are expected to grow. To sum it up, just because the market has ample amounts of ethane being rejected doesn’t mean we have the infrastructure to send that rejected ethane to new export and cracker facilities.

While PointLogic expects ethane supply available in the Northeastern U.S. to be roughly 340 Mb/d by the end of 2016, capacity to take that ethane to the Gulf Coast is currently limited to 130 Mb/d on Enterprise’s ATEX pipeline. Limiting the Northeast’s potential supply contribution to the Gulf at 130 Mb/d and subtracting out non-Gulf demand competing for the same supplies means that the Gulf Coast will have a total of 1,505 Mb/d of supply available by the end of the year 2016.

Ethane Supply Available vs. Demand in PADD 3

In order to adequately meet all new potential ethane demand growth in 2017 without new infrastructure, pre-rejection ethane supply outside of the Northeast will need to grow by roughly 80 Mb/d from 2016 to 2017. That’s a seemingly achievable task if NGL growth gets back on track in 2017. The average YoY growth for the past five years in ethane supply in regions outside of the Northeast has been 113 Mb/d, the most being in 2014 when ethane supply outside of the Northeast grew by 174 Mb/d.

Demand Assumptions

Before we go further, this is a good time to visit our demand assumptions. There are five major projects expected to increase the consumption of ethane in 2016 and 2017. The Enterprise Port Morgan ethane export terminal is expected to come online in the second half of 2016. The terminal has a capacity of 200 Mb/d, which Enterprise claimed was 90% contracted before the company’s recent deal with Braskem. The four chemical projects expected to come to service in 2017 are Dow’s new Freeport Cracker, CP Chem’s Baytown Cracker, Exxon’s Baytown Cracker and OxyChem/Mexichem’s Ingleside project.

At maximum utilization, these chemical projects will add just over 300 Mb/d of demand. A 90% utilization of the chemical projects and 70% utilization of Enterprise’s export dock in 2017 implies a combined 418 Mb/d of additional demand by the end of 2017.

Helping to keep demand from outpacing supply in the near future is the delay of Sasol’s Lake Charles project until at least 2019. The project has the capacity to crack as much as 90 Mb/d of ethane and was initially slated to start up as early as the end of 2017.

Back to the Stack

Going back to Part 2 of this series on ethane markets, we outlined the ethane supply stack. The chart below shows volumes of ethane available in various regions on the x-axis and the price Mont Belvieu ethane needs to reach in order to incentivize processing plants to switch away from ethane rejection mode to ethane recovery mode on the y-axis.

With a forward view of ethane supply and demand, we can make a call on which producing areas in the U.S. will be the marginal suppliers of recovered ethane at the end of 2017. The two vertical bars show potential and realistic demand (based on the above operating rates) projections for 2017, highlighting which producing areas will be marginal suppliers of recovered ethane.

Ethane Supply Stack into USGC

While this picture shows that we expect there will be adequate supply of ethane to meet new demand requirements in 2017, it also shows how far from the Gulf Coast the market will need to reach in order to meet ethane demand requirements. By the end of 2017, the Gulf Coast ethane market will need the Rockies and perhaps areas as far away as the Northeast to switch to ethane recovery mode to help meet new growing demand requirements. From a pricing perspective, this means that the Gulf Coast will need to cover transportation and fractionation costs from the Rockies and perhaps ATEX at times to ensure adequate supply. Assuming $2 per MMbtu natural gas, we see ethane prices needing to increase to over 30-40 cents per gallon to achieve this goal.

Risks and Drivers of 2017 Production Growth

There’s one more factor to consider. Ethane is a byproduct of oil and gas production. This means that, in general, ethane production will be driven more by factors in crude oil and natural gas markets than by factors in the ethane market alone.

The longer crude oil prices remain depressed, the greater the potential to see supply-driven tightness in the ethane market on the Gulf Coast. The chart below shows non-Northeast ethane production and a strong correlation with associated gas production.

Gas and NGL Production

This correlation exists because the gas production with the highest gallons per Mcf (GPM) tends to be in associated gas production areas. Associated gas can have a GPM as high as 6-10, much higher than the GPM in typical non-associated liquids rich plays. Over the past 5 years, NGL production outside of the Marcellus and Utica basins has been driven by production growth in Permian, Bakken, Eagle Ford (oil and liquids window) and Denver Julesberg basins. So while NGL supply growth in the Northeast is less sensitive to crude oil economics -- because oil production in that region is quite small -- NGL production in these areas closer to the Gulf Coast market tends to be more sensitive to crude oil production economics.

While the outlook for crude oil production in the U.S. is uncertain, natural gas production will need to get back into growth mode in 2017 to meet growing demand from new LNG and Mexican export capacity. In the absence of a strong push of associated supply from crude oil production, it’s conceivable that liquids rich plays that aren’t associated with crude oil production can contribute to ethane supply growth. That said, if non-associated gas production needs to grow, much of the non-associated gas production would be expected to take place in the Northeast U.S. where infrastructure constraints are an issue.

While our view is that there will be no need for expanded infrastructure to move ethane to Gulf Coast over the next two years, the need and possibility of an ATEX expansion or other infrastructure opportunities increases in a prolonged low oil price environment in the longer term.

Wrap Up

This issue of Get the Point highlighted a lot of uncertainties, but there is a clear takeaway: declining oil and gas production in the face of growing demand accelerates the ethane market’s move up the ethane supply stack. The degree to which supply does or doesn’t decline over the course of the summer depends on a number of factors, but evidence shows that pre-rejection ethane supply is, in fact, in decline.

Despite expected declines, PointLogic doesn’t expect to see demand destruction economics or the dire need for new ethane infrastructure any time in the immediate future. That said, the longer crude oil prices remain low, the greater the risk for a tighter ethane market on the Gulf Coast. 

 

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