The frac spread—the difference between the value of a typical basket of NGLs and the price of natural gas, in $/MMBtu—has averaged a paltry $2.28 for the past two years, by far the longest period of depressed NGL values since the start of the Shale Revolution. That’s bad news for natural gas processing economics, which are most favorable when NGL prices are strong and natural gas prices are weak. But things are about to get a lot better. Today we consider the currently low frac spread, what it means for natural gas producers and processors, and why a big turnaround may be in the offing.
The frac spread (short for “fractionation spread”) and its kissing cousin, the NGL-to-crude ratio, have been frequent topics in the RBN blogosphere, and for good reason. From the beginning, an underlying principal of RBN’s analysis of drill bit hydrocarbons (gas and liquids produced at the wellhead) has been our belief that the relationships between crude oil, natural gas and natural gas liquids (NGLs) have become far more important in the Shale Era than they were a generation ago. Now, what happens in oil markets impacts gas and NGL markets, and vice versa. (See “The Domino Effect” for a thorough review of how this interconnectedness has played out.) As we said in Do It Again, the NGL-to-crude ratio is a weighted average of OPIS/Mont Belvieu NGL prices divided by CME/NYMEX front month crude oil futures. The NGL mix that we use to calculate the ratio is 42% ethane, 28% propane, 11% normal butane, 6% isobutane, and 13% natural gasoline. (We track both the NGL-to-crude ratio and the frac spread every day on our website in RBN Spotcheck, which is available to RBN Backstage Pass subscribers.) For many years the NGL-to-crude ratio averaged about 60%, staying within a 50%-to-70% range most of the time, and rising to a frothy 76% in September 2011. This was The Golden Age of Natural Gas Processors, as we said in a blog series of the same name. But, as we’ve discussed often, rapidly growing natural gas production and increasingly oversupplied market conditions depressed natural gas prices in the early days of the Shale Revolution, which gave producers the incentive to shift their attention and resources toward “wet” gas shale areas that produced significant volumes of NGLs. The resulting NGL supply growth crushed NGL prices, which pushed the NGL-to-crude ratio down to a new plateau: since 2012 the ratio has averaged just over 40%, and even the collapse in oil prices since mid-2014 hasn’t changed the ratio much. (As of November 30, 2016, with NGL prices up in sympathy with the new OPEC deal, it stood at just 45.4%.)
Today we look at the frac spread, which, as we said, is the difference between the value of natural gas and the same weighted-average value of the same NGL mix used to calculate the NGL-to-crude ratio. It’s important to note here that the frac spread is not a measure of natural gas processing margins—making that mistake is all too common. For one thing, the margin for any particular processing plant depends on the liquids content of the raw gas being fed into it, and as you know some gas is a lot “wetter” than others. For another, even if two identical processing plants were fed gas with a liquids content of, say, 3 gallons of NGLs per 1,000 cubic feet of gas processed (a metric called GPM, or gallons per Mcf), the mix of NGLs within those 3 gallons may well be very different: one might have only 35% ethane—the NGL “purity product” with the lowest price—and a lot of heavier, higher-priced purity products like butanes and natural gasoline, while the other may have 65% ethane and far less of the more valuable stuff. What the frac spread does offer, though, is a yardstick measure of the general financial health of the gas processing sector as a whole.