The potential for ethane recovery is currently all the rage, with first-quarter 2016 earnings calls inundated with questions from analysts regarding asset positioning and company-specific upsides. The number of times the word “ethane” was mentioned during quarterly earnings calls for a sample of midstream companies was up 500% since third-quarter 2015. Over the past few months, the expectation of new ethane demand coming online from North American ethane steam crackers and ocean-going exports has garnered significant attention.
So what’s the uproar about? Processing ethane would not increase the amount of product sold. It would simply change the product sold from gas to purity product to realize marginal price uplift.
For many midstream companies, the ethane molecule passes through more fee-based revenue opportunities as pure liquid ethane than in gaseous form. The more fee-collecting NGL tolls the midstream operator owns, the more potentially beneficial the impact ethane recovery will have to its margin.
Furthermore, owning NGL assets down the entire chain allows midstream operators to base load their downstream assets with their own gathering and processing NGL supply first and offer its E&P customers a bundled service from wellhead to the demand market for the NGLs produced. This is the point where ONEOK Inc. and Targa Resources Corp. begin to look different when it comes to the opportunities to see incremental uplift from ethane recovery.
ONEOK is a good example of a company with significant upside potential as it has the ability to pick up value across its vertically integrated midstream assets. In a recent company presentation, the company stated it is able to recover 140,000 barrels per day (bbl/d) of incremental ethane from the Midcontinent (Midcon) region.
The first area for potential uplift is through commodity-exposed gathering and processing contracts. East Daley Capital Advisors estimates minimal ethane uplift for ONEOK as it has worked to convert its contracts with producers to fee-based structures. About 75% of ONEOK’s Midcon and Bakken gathering and processing asset contracts are fee-based, leaving 25% of gathering and processing contracts with commodity-exposed ethane upside. However, ONEOK should realize upside from assets further downstream like NGL pipelines and fractionation facilities.
The backbone of ONEOK’s liquids empire is its network of pipelines that transport NGL. The company owns four pipelines (Arbuckle, Sterling I, II and III) out of the Midcon that connect into Mont Belvieu, Texas.
East Daley’s volume flow data indicate there is capacity on these pipelines to transport significant ethane to market with no additional pipeline capex spend. The company will realize an NGL transport fee of about $0.099 per gallon (/gal) for volumes transported down Arbuckle and between $0.054 and $0.079/gal down the Sterling NGL pipelines (see table). Additionally, ONEOK owns 839,000 bbl/d of fractionation capacity at Conway, Kan., and Mont Belvieu, of which 280,000 bbl/d is not currently utilized (see Figure 1).
ONEOK also has upside related to its gathering and processing assets in the Williston Basin totaling about 35,000 bbl/d of potential ethane recovery.While there is upside out of the Williston Basin, ethane currently being rejected would need to overcome T&F of about $0.32/gal. This is in addition to the fact that ethane prices would have to be at least as good as gas prices on a per MMBtu basis.
Similar to ONEOK, Targa has some ethane upside through its commodity-exposed gathering and processing contracts. Of Targa’s field gathering and processing assets, roughly 30% of its 2016 forecasted margin is commodity-based.
It is apparent that a large piece of Targa’s NGL value chain is missing. In contrast to ONEOK, Targa does not own any NGL pipelines that connect its gathering and processing assets to its fractionators.
This break in the NGL value chain means Targa must rely on other midstream pipelines to transport NGL from its gathering and processing basins to its fractionators. The benefit of incremental ethane recovery on Targa’s gathering and processing assets is shared with whatever third-party pipeline operator carries the liquids downstream.
However, like ONEOK, Targa does have open fractionation capacity. The company currently has 393,000 bbl/d at its Cedar Bayou fractionator in Mont Belvieu and 55,000 bbl/d in Lake Charles, La. These facilities had a utilization of only 66% as of first-quarter 2016 (see Figure 1). Targa is expanding its fractionation capacity by 100,000 bbl/d, giving the company incremental space for all NGL, including ethane.
Figure 1 - 1Q16 Fractionation Utilization
An important aspect of vertical integration is influence of NGL supply into a company’s downstream assets. In second-quarter 2015, Targa made a step toward increasing its vertical integration after completing a merger with Atlas that added substantial gathering and processing to its asset base.
Sources: SEC filings, company websites
The acquisition was important because it increased the amount of NGL supply Targa could direct toward or retain on its own fractionators. As shown in Figure 2, the yellow line illustrates how Targa’s gathering and processing volumes now comprise a larger share of its total fractionated volumes.
Figure 2 - Targa Fractionation Volumes & Capacity (East Daley forecast does not include ethane recovery)
While this article focused on the benefits of ethane recovery uplift, there are other business segments not analyzed within the scope of this topic, such as Targa’s LPG export terminal or ONEOK’s gas pipeline business.
Focusing on three components, Targa has 30% of commodity-exposed gathering and processing contracts and ONEOK has 25% of commodity-exposed gathering and processing contracts providing each company with similar exposure to ethane processing upside.
Secondly, Targa and ONEOK each have about 33% of spare fractionation capacity that also provides margin upside to incremental ethane recovery.
However, the two companies are different in regard to the NGL pipeline component of vertical integration. While both companies play an important role in the U.S. NGL market, ONEOK is in a position to realize ethane recovery uplift from the open capacity in its NGL pipelines, giving it the ability to generate earnings all the way down the NGL value chain with little or no capital spend.
Jim Simpson, CEO of East Daley Capital Advisors, has 19 years of experience analyzing and managing energy information and commodity risk in both the gas and power industries. Prior to starting East Daley, Simpson was vice president and general manager for the Platts Power Group. Previously, he was part owner of Bentek Energy LLC and worked in gas and power transactions for Enron North America.
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