Friday, October 19, 2012

Rush to liquids backfires for natural gas producers - Globe and Mail

By Carrie Tait
September 26, 2012

It was the natural gas industry’s big new thing.

Major producers, long suffering from an industry oversupply of natural gas and ultra-low prices, in the past year or two spent bundles to boost production of obscure energy products such as butane and condensate – also known as natural gas liquids – which had been enjoying solid demand and strong prices.

But the party didn’t last long. As companies rushed to ramp up output from fields rich in natural gas liquids, prices tumbled as supplies jumped – dragging down the performance of gas companies using the diversification strategy.

Two major gas producers, Talisman Energy Inc. and Encana Corp., began their shift toward natural gas liquids in late 2010, when prices were buoyant.
The benchmark blended price for a gallon of NGLs was $1.0567 (U.S.) in early January, 2011; it rallied to $1.2983 in May, 2011, and stayed in the triple digits until last February, according to data collected by BMO Nesbitt Burns Inc.

But recently the market has been plunging. On Tuesday, the benchmark price for a gallon of NGLs sold for 68 cents – a 44-per-cent drop from a year earlier.

The natural gas liquids business “is not all it is cracked up to be in some cases,” said Luc Mageau, an oil and gas analyst at Raymond James in Calgary.

And the tumble in gas-liquids prices came just as natural gas prices rallied, though they remain at historically low levels.

“Today, you’ve had almost a 50– or 40-per-cent increase in [natural] gas prices, but the offsetting decline in NGL pricing has effectively made average pricing for a gas-focused producer the same,” Mr. Mageau said. “You’re realizing the same price today as you were in April.”

NGLs – condensate, butane, propane, and ethane – are extracted as producers pump natural gas. Energy companies are paid based on the volume and value of each separate commodity in the mix; the blended price reflects the varying prices and the fact that some NGLs make up a greater percentage of production.
In Canada, condensate and butane are the most valuable liquids, while ethane and propane are weak. Condensate, for example, typically trades at a premium to West Texas Intermediate crude.

Condensate, which is similar to a light oil and can be used to transport bitumen, is a key part of the liquids game. Dean Foreman, Talisman’s chief economist, said that in his company’s Eagle Ford play, about two-thirds of the production value is wellhead condensate, and the rest is gas and less valuable liquids.

“That’s the prize. That’s what people are searching for,” he said. While ethane and propane supplies are outstripping demand, that will not “fundamentally undermine” liquids-rich plays, he said, given the price that condensate commands.

Talisman, whose shares have lagged other energy companies amid criticism about its strategy, installed Hal Kvisle as its chief executive two weeks ago after abruptly removing John Manzoni from the top spot.

Ethane, which is expensive to extract from the natural gas mix but can be abundant, is a particularly weak slice of the liquids market. It trades in lock-step with natural gas in Canada, Mr. Mageau said, noting that two buyers, Dow Chemical Co. and Nova Chemicals Corp., dominate the market and their plants are running at 70-per-cent capacity. “Ethane doesn’t do anything for you,” he said.

Encana Corp. believes its long-term contracts to sell ethane to Dow and Nova at a premium to Alberta’s gas benchmark will help buffer problems in that market, said Encana spokesman Jay Avrill. He argued that Encana can ride out any bumps in the NGL market. “This is a long-term strategy. It is not to say: ‘Hey, let’s cash in and get by for the next couple of years until natural gas comes back,’” he said. “We’re not going to switch and jump based on short-term volatility and price volatility.”

Encana added $600-million to its 2012 spending budget in June, a move aimed at increasing liquids production. It is also searching for oil as it tries to distance itself from dry natural gas. The shift came after Encana spent years married to its strategy to increase natural gas production despite languishing prices. Shares dropped and investors howled, and they remain nervous as Encana chases new plays.

“You’ve seen a significant increase, particularly in the United States, in natural gas production that is rich in liquids. Probably a 25– to 30-per-cent increase in supply over the last four years or so,” said David Smith, chief executive at Keyera Corp., which processes natural gas streams. “So that has created additional volumes of all the NGLs – ethane, propane, butane, and condensate.”

Friday, March 23, 2012

Hedging NGL Production

Recent report by Platts:

"Some producers are having difficulty hedging their rapidly expanding natural gas liquids production, as currently available financial products lack sufficient liquidity or product correlation. In essence, producers are still learning how best to hedge their liquids output, according to Michael Zenker, director at Barclays Capital. Some producers will lock in an NGL hedge as a percent of oil production, which results in a proxy hedge that may leave them vulnerable to situations when the prices of oil and liquids do not correlate." Also reported by Gas Business Briefing

My point of view:

The financial products priced at Mt. Belvieu, Texas (MTB) and Conway, Kansas (CWY), both do provide sufficient liquidity. MTB is better since there are more traders and more contracts exchanged daily (estimates placed at between 150 - 300 contracts per day).  CNW is less liquid (50 - 75 contracts per day). Depending on your company's thresholds, typically established by internal risk and credit groups, these volumes may not be liquid enough based on the standards used for buying/selling natural gas.  LESSON: Using financial instruments for NGL is not the same as natural gas... you need to recalibrate the liquidity thresholds based on the NGL marketplace and match back to your own NGL production profile.  This will require educating your risk and credit groups... good luck, some of them may still think NGL is text-shorthand for "not gonna lie".

In 2005, our team developed several regression models comparing historical pricing between Edmonton, Alberta, Canada (EDM), CWY and MTB.  EDM was the most illiquid.  In fact price discovery was outright non-existent, if it wasn't for our actual production that was being produced and sold out of Taylor, British Columbia, Canada (Younger Extraction Plant) and central Alberta. CWY was better, but still had issues. Some of them well published through the press and legal courts since there are fewer major players that act as traders out of this hub.  MTB remains the best NGL trading hub, based on the aggregation of supply and the large petrochemical industrial demand

That being said, simply executing hedges priced at MTB and CWY will still leave you open to other forms of risk, since your sales point may not be close to MTB or CWY.  Many producers contract to sell their natural gas and NGL at delivery points thousands of miles/kilometers upstream of MTB and CWY. As a result, producers are subject to basis risk, or the pricing differential between their sales point and the end market consumers of NGL. LESSON: To reduce basis risk, enter into NGL sales contracts that are priced off of MTB or CWY with a firm deduction that would approximate transportation, marketing and ancillary fees.  This will allow you to receive MTB- or CWY-based pricing for your production, and will enable you to hedge by using financial instruments priced at these locations... thereby reducing basis risk.

On another note, I am not necessarily a big proponent of hedging NGL.  The market for NGL has disconnected from natural gas prices (other than ethane, which is still highly correlated to natural gas).  The historical frac spread for NGL gapped out in 2006 and has not returned to long-term averages (1995 to 2004) since then, except for brief couple weeks in late 2008. However, if your company needs price certainty to support the quarterly earnings, met dividend commitments or show stability for bankers or credit rating agencies, using NGL hegdes to lock in frac spread or NGL margin, the above strategies will help... but be prepared... these instruments typically settle out of the money, since price certainty comes at a price.  Just like insurance.

Other sources: