An Ethane-Methane Catch 22

The Daley Note: October 18, 2022

Plummeting natural gas prices in the Permian Basin are creating knock-on effects in NGL markets by encouraging more ethane recovery. But there’s a catch, as infrastructure constraints for one commodity may exacerbate constraints on the other.

Waha prices recently have been trading almost $3.00/MMBtu below the Henry Hub, a result of supply growth in the Permian hitting the upper limits of the basin's pipeline takeaway. One market response has been to increase ethane extraction from natural gas processing. Frac spreads in the Permian, currently at $0.18/gal, certainly are encouraging more ethane recovery. However, downstream fractionation constraints at Mont Belvieu, lower ethane demand, and rapidly increasing storage levels may limit how much more ethane can be recovered.

Market participants saw a similar scenario in September 2018, when Permian gas egress and Mont Belvieu fractionation capacity were both constrained. The Permian frac spread jumped to $0.42/gal, the highest in the last five years, as Waha traded $1.50/MMBtu behind Henry Hub (see figure). The difference then, however, was that Mont Belvieu ethane prices also spiked to $0.53/gal. Six new steam crackers had recently come online in the Gulf Coast market, increasing US ethylene production by 40%. As a result, ethane prices also spiked, further incentivizing ethane recovery.

This year, Mont Belvieu ethane prices have declined 9% from September to October, to $0.42/gal, and are expected to average $0.35/gal in 2023. The decline mostly reflects lower natural gas prices, but the lack of demand growth is notable as well. Total’s Baystar cracker is now up and running, but otherwise no new crackers have started this year on the Gulf Coast. In addition, Argus reported that demand conditions have been weakening, with downstream Gulf Coast facilities operating at reduced rates and Asian petrochemical facilities extending turnarounds this summer.

A solution in the past has been to store more Y-grade. However, there are signs that Y-grade NGL storage ramped up tremendously over the summer. Weekly propane/propylene inventories, which also estimate the propane held in Y-grade storage, have jumped from five-year lows in July to above the five-year average in late September. Eventually, this Y-grade in storage will need to be fractionated, which could dampen purity product prices in the future.

With little additional ethane demand and surging NGL storage levels, producers may need to look at other options soon to ease their gas constraints. In the meantime, midstreamers like Enterprise Products (EPD), Energy Transfer (ET), and Targa Resources (TRGP) that have access to spot fractionation capacity, NGL storage, and natural gas marketing, will benefit from the increased volatility. Please log in to see our latest 3Q22 Blueprint Financial Models and accompanying Earnings Previews for these  companies. – Ajay Bakshani, CFA Tickers: EPD, ET, TRGP.