Are we Headed Over the Frac Spread Cliff?

The values of the crude-to-gas ratio and the Frac spread have fallen fifty percent from their highs this year. Frac spreads represent the difference between the value of natural gas and natural gas liquids (NGLs), which are heavily influenced by the price of crude. Thus the Frac spread is in effect tied to the gas-to crude ratio. Current forward curves suggest that the crude-to-gas ratio will fall another 50 percent over the next few years. Today we ask whether the Frac spread will continue it’s fall next year and beyond.

Back in August (2012) we looked at the relationship between crude and natural gas prices (see Easy Come Easy Go – Crude to Gas Ratio Back Down to Earth Again). At that point the crude-to-gas ratio between NYMEX West Texas Intermediate (WTI) crude futures and NYMEX Henry Hub natural gas futures was around 32. [A ratio of 32 means the price of NYMEX WTI in $/Bbl is 32 * the price of NYMEX natural gas in $/MMBtu see “The Golden Age of Natural Gas Processors – NGLs in a 50X Crude to Gas Ratio” for more on the RBN Energy approach to the crude-to-gas ratio calculation.] Chart #1 below on the left shows the crude-to-gas ratio over the past year. After trading to a high of 54 in April 2012 when natural gas prices fell to below $2/MMBtu the ratio has drifted down fifty percent to its current value of 26. Chart #2 below on the right shows the NYMEX crude and natural gas prices that make up the crude-to-gas ratio. Since April, natural gas prices (red line) increased through mid-November before falling back a little to $3.35/MMBtu. Crude oil prices (blue line) have fallen from a high of $110/Bbl in February, recovered between June and September and then fell again to about $87/Bbl on December 17, 2012. The overall decline in the crude-to-gas ratio has been caused by rising natural gas prices and lower crude prices since the ratio reached 54 in April.

Source: CME Futures Data from Morningstar [Click Chart to Enlarge]

In our Golden Age of Natural Gas Processors blog series we learned that a high crude-to-gas ratio underpins strong natural gas liquid (NGL) processing margins. If natural gas is less expensive and crude oil is more expensive then NGL processing margins tend to be higher. That is because NGL processors transform hydrocarbons in a gaseous form (natural gas) into hydrocarbons in a liquid form (NGLs) that tend to track the price of crude oil – at least some of the time.

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