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NGLs and the Wet Uplift

January 18, 2017 | By Robert Applegate

PointLogic Energy has recently released its Natural Gas Liquids (NGL) module showcasing our NGL supply models on a daily basis.

In this issue of Get the Point, we look at one of the uses of that information by asking if today's oil, gas and NGL prices will encourage the return of a "wet uplift” drilling strategy by gas drillers and possibly influenced the $6.6 billion ExxonMobil purchase of Permian acreage this week.

To conduct this analysis, we utilize our daily information about NGL supply and ethane rejection, as well as the daily natural gas production and price information from Oil Price Information Service (OPIS). By modeling the NGLs frac spread today and in the future, we can offer insight about what strategies might maximize the value of oil and gas produced.

When talking about NGLs, we must first put into context where they lie in the hydrocarbon spectrum with respect to price and, specifically, how they relate to natural gas and oil. Methane, or natural gas, has a lower heat content than NGLs, which have a lower heat content than oil, so looking at each hydrocarbon at an equivalent $/MMbtu shows how each product relates to the others. Additionally, ethane has a lower heat content than propane, which has a lower content than heavier NGLs like butane.

The easiest way to look at NGLs as a single product is to look as a composite barrel, and use weighted prices to create a single unit price. PointLogic uses a standard composite barrel of 42% ethane, 28% propane, 17% butanes and 13% pentanes+.

Typically, when pulling methane, NGLs and oil out of the ground, the NGLs will be made from part of the barrel of each product typical of the region or play. Thus, using a composite barrel price simplifies the calculations for return on investment in drilling a well.

Figure 1 shows this comparison between natural gas, oil and a composite barrel of NGLs.

Gas, Oil, NGL on equivalent $/MMBtu basis

Figure 1 shows the impact during the last decade of abundant new sources of hydrocarbons as the fracking revolution hit full steam, how surging U.S. oil and gas supply created volatile pricing conditions and new pricing relationships.

In the first phase of the shale revolution, both oil and gas quickly overwhelmed demand, and prices for both dropped rapidly.

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In the next phase, from about 2009 through most of 2011, the shale resource base, resulting from the technology advancement of horizontal drilling and hydraulic fracking, was so massive that it exceeded market demand and forced a concentration of development of the resource that provided the largest return (or lowest development cost). Revenues from liquids produced with gas effectively enhanced returns or reduced the break-even price of the dry gas produced. In this time period, dubbed the "wet uplift," gas producers targeted wetter areas to get not only the natural gas, but also to reap a boost in wellhead return from the NGLs. As demand led to constrained production and dry gas prices fell, producers focused on plays with the highest returns, which had more oil-priced components (i.e. NGLs), ultimately knocking NGL prices down in late 2011.

Then, when oil prices moved up towards $100/bbl, producers responded by targeting oil-rich plays with the fracking technology that had originally been developed for gas. The return of Libya, Iraq and Iranian oil coinciding with growing U.S. production then threw global oil markets oil exces. That's when oil prices abruptly fell, and producers began cutting back.

We witnessed various cycles: producers grew gas production and flooded the market; they increased oil production and flooded the market; at various times, NGLs from both oil and gas flooded the market.

Meanwhile, the demand side of the market adjusted, too. With gas less costly, new gas-fired power plants were built. With gasoline cheap, people began driving more miles and in less-efficient cars. For the NGL part of the barrel, U.S. producers targeted exports of condensate, and new steam crackers in the U.S. also helped to push up demand. Eventually, the prices of the hydrocarbons began moving higher together again, which brings us to today.

Propane and Natural Gas

Some people would say Btu’s are interchangeable and that you can switch one for another as long as you are burning them. While in a broad sense that is correct, different hydrocarbons are used for different purposes, and many cannot be switched out for another.

Natural gas and propane are a good illustration. Both can be used to heat homes and commercial spaces in the winter. But gas is also heavily used in the electric power sector, so demand for gas is strong in the summer, too, unlike propane.

As Figures 2 and 3 show (below), this has created very different supply and demand pictures for natural gas and for propane over the last five years. Propane stocks began 2016 at record levels and stayed that way until November.

As we moved into the current winter, production declines combined with the seasonal draws for heating demand resulted in both gas and propane stocks dropping from their record highs. Note that the relative range for natural gas is smaller than the relative range for propane levels. January gas storage levels over the past five years have stayed within about a 1 trillion cubic foot (Tcf) range, or within about 27%. Propane inventories in January, on the other hand, has ranged from 35 million barrels (MMb) to nearly 88 MMb or a range of 60%. With storage levels for propane more volatile, we should expect prices to be more volatile, too.

US Propane/Propylene stocks

US Natural Gas Inventory

While propane's price can arguably be tied to weather, especially in the winter when heating demand can make or break the market (as happened during the polar vortex of February 2014 when propane prices blew out), a different part of the NGL barrel, ethane, has had its prices historically tied very closely to natural gas. For the purposes of calculating the NGL frac spread, ethane makes up over 40% of the composite NGL barrel, so its price is very important to the frac spread.

In the past, there were really only two things one could do with ethane; sell it as gas by "rejecting" it and leaving it in the gas stream, or "recovering" it for steam crackers to turn into ethylene. Until recently, exporting ethane was not an option, but after the fall of ethane prices, new sources of demand were found. In the U.S., as well as other countries like India, new ethane-only steam crackers were proposed and built to use this new, abundant, cheap ethane from the U.S., and because of this, new ships capable of moving ethane were constructed.

Increases in new demand sources like ethane and propane exports, as well as new steam crackers, combined with the propane inventory levels being back below 2016 levels has already begun to push up the NGL frac spread, as seen in Figure 4 below.

While the frac spread tends to be seasonal as gas prices rise and fall, the overall trend has been an increase in the frac spread. It's possible that ExxonMobil’s $6.6 billion deal for Permian acreage announced thsi week reflects a belief in a long-lasting higher frac spread. It's possible we will see more Permian deals if other companies see the same future. 

Mont Belvieu to Henry Hub NGL Frac Spread

Ethane exports began last year out of Marcus Hook, Pa. and Morgan’s Point, Texas. IHS Markit (parent company of PointLogic Energy) estimates ethane exports for 2017 will average approximately 200 Mb/d higher than 2016.

With PointLogic Energy currently estimating ethane rejection around 550 Mb/d, this expanded demand source could substantially strengthen the market and further drive up the NGL frac spread. This could push the U.S. further back into the wet uplift market, in which gas producers target wetter plays with higher NGL content.

The U.S. Energy Information Administration (EIA) foresees this possibility. EIA has projected that U.S. ethane production will rise by as much as 35% in the next 18 months (see U.S. Ethane Production Projected to Rise 35% by 2018), given gas producers' incentive strong incentives to target NGLs when drilling for gas.

For more information on our NGLs analysis, go to the PointLogic website and the NGL Dashboard link. Our Dashboard includes NGLs and ethane frac spreads, gas processing plant information using meter-point level data and more.

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