A long anticipated market milestone either has happened, is happening, or soon will happen. No I’m not talking about one-handle natural gas prices. That’s old news. The much more amazing number is a 50X crude-to-gas ratio. Whether it has happened yet or not depends on which prices you use to calculate the ratio. More on that below. But regardless of your math, one thing is certain. The value of extracting a hydrocarbon molecule in gaseous form and selling that molecule as a liquid has never been higher. It is a golden age of natural gas processing. It is a business that over the past two years (since March 2010) has experienced a decline in feedstock costs of more than 50% and an increase in its traditional measure of profitability – the frac spread –by +33%, from $9/MMbtu to almost $12/MMbtu.
The arrival of any golden age, especially one in a highly cyclical industry like gas processing, begs many questions. At this extreme level of pricing, what kind of market behaviors are we likely to see? Will strange things start happening as producers and processors jump through hoops to capture these margins? Who is making most of the money anyway – Producers? Processors? Wall streeters that did the other side of their hedge deals? How much money does a typical gas processing plant make? Who is being hurt by these margins? How much higher can the crude-to-gas ratio go? Why are frac spreads only realizing a portion of the differential implied by a 50X crude-to-gas ratio? How will we know when the end is near? When it does correct (and it will someday), how will it happen and what will it mean to processors, producers and end users?
That is far more questions that can be addressed in a simple daily blog piece. So here over the next couple of weeks we’ll look at many of these topics as a multi-part series. So you don’t get oversaturated with NGLs, we will continue to intersperse the daily RBN blogs with other equally significant natural gas and crude oil topics. But every day or two we’ll circle back to the Golden Age of Natural Gas processing.
The Golden Age of Natural Gas Processors – Part I
Flying away from reality
Whatever happened to gravity?
I see it clear, a shooting star[1]
There is no uncertainty about one factoid. It is the crude-to-gas ratio that underpins the Golden Age. Gas is cheap. Crude is expensive. NGLs tend to track crude prices. Gas processors extract NGLs from natural gas. That’s about all you need to know to understand what is going on in this market.
Here I calculate the ratio by simply dividing the WTI crude price by the price of natural gas. April CME/NYMEX Crude oil closed on Friday at $107.06/bbl, up $1.95. Natural gas for April closed at $2.326. But ICE cash at Henry Hub came in at $2.0118/MMbtu. So the ratio is 46X on futures and 53X on cash. Either way, it is way high. Last year at this time it was about 25X and most thought that number was high. High is a relative thing.
Some analysts prefer to calculate the ratio on a BTU basis. Looking at the numbers that way, the ratio is 12.6% (futures) or 10.9% (cash) versus 22.3% this time last year. [ratio = gas price / (crude price/ 5.8)]. In my opinion, looking at the ratio this way doesn’t tell you anything more than the simple price ratio and to me it is less intuitive. So here we will stick with ratio = crude price / gas price.
The IRS defines the number of BTUs in a barrel of crude oil as 5.8 × 106 BTU. This is the factor used to calculate “barrels of oil equivalent” or BOE in financial statements. One BOE is roughly equivalent to 5,800 cubic feet of natural gas – about 6X in terms of our ratio.
There was a time decades ago when conventional wisdom said the crude-to-gas ratio should gravitate back to this 6X number. That has not been true for a long time. From 1990 to the late 2000s the number averaged 10X-11X. 2009 = 16.5X; 2010 = 18.8X; Last year the ratio ranged between 20X and 35X. So far this year, it has been in the ridiculous range (from a historical perspective) - 35X up to 48X.
One last point on the ratio. On March 15th EIA announced that the ratio hit 54.36X on March 6th. Sort of. They calculated the ratio as Brent Crude / Henry Hub. Not to be too nit picky, but using a North Sea crude price compared to U.S. natural gas seems a little misleading. But who am I to question the U.S. government. If they say we are already there, fine.
In the next Golden Age blog we’ll look at what the 50X ratio has meant for NGL prices, the relationship of each NGL – Ethane, Propane, Normal Butane, Isobutane and Natural Gasoline – to each other and to crude oil. That will help explain why NGL prices have declined in relation to crude prices, and what that implies for the NGL market.
[1] The Golden Age is a song by The Asteroids Galaxy Tour, a Danish pop band consisting of vocalist Mette Lindberg and producer Lars Iversen. Google found the Asteroids for me and I’ve included them here to prove that all of my musical themes don’t come from 20 or 30 or 40 years ago. Check out ‘Around the Bend’ used in the Apple iPod Touch commercial a few years back.
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