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
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.