Key words: natural gas liquids, NGL, fractionation spreads, frac, keep whole contracts, percentage of proceeds contracts, fee-based contracts
Frac Spread

Similar to the Crack spread, the frac spread has developed in the gas markets.

There are primary three sources of raw gas. Gas produced from a gas field called none associated gas. Secondly, associated gas produced as a byproduct from the same wellhead as oil. Gases produced in refineries during various distillation processes are called still or refinery gases.

Midstream industry turns raw gas into usable products delivering dry gas to interstate pipelines and finished NGLs to petrochemical industry, refineries and industrial heating sector.

Midstream companies involved in gathering, processing, fractionating and marketing segments. Gathering segment transports gas from the wellhead to the processing plants. Gas extracted from the ground is a raw gas and consists of wet gas and hydrogen sulfide components to be removed before further processing. Processing converts wet gases (underground they are in a liquid state) into methane (dry gas) and natural gas liquids (NGLs). Fractionation is the process to turn NGLs into marketing products.

NGLs are a mixture of gases including ethane C2, propane C3, butane nC4, isobutene iC4 and natural gasoline C5+(pentanes).

The blend of NGLs extracted vary and typically when it is uneconomical to process wet gas, i.e. separate methane from NGLs, a producing company can sell “as it is”. This gas is called natural gas and consists of up to 95% of methane.

In the Unites States, NGLs stored and sold at one of two main hubs, Mont Belvieu (Texas) and Conway Hub (Kansas).

Midstream business pays close attention to NGLs prices, namely to a difference between wet gas prices and each of the NGLs price. This difference called fractionation spreads (frac spreads) and simply this is the profit of drying wet gas into its NGLs components. Low gas prices and high NGLs prices give favorable processing economics and vice versa. Typically, frac spreads are negatively correlated with gas prices and positively correlated with NGLs.

NGL mix can consist of ethane (40-45%), propane (25-30%), isobutene (10%), normal butane (5-10%) and natural gasoline (10-15%).

Many companies try to shift their production towards NGLs formations because NGLs price has a significant premium to natural gas.

Gas processing involves converting mmBtu from gas to liquids. NGLs are typically priced in cents per gallon. Natural gas is traded in dollars per mmBtu. Btu is British thermal units and 1 Btu is the energy required to heat one pound of water by 1 Fahrenheit degree. In order to calculate the frac spread we need to convert all numbers to barrels taking into account that 1 barrel consists of 42 gallons. We assume that NGL shrink per barrel is a fix cost.

In order to calculate frac spread we assume the following NGLs mix: ethane (45%), propane (30%), isobutene (5%), normal butane (10%) and natural gasoline (10%). We calculate frac spread as $/barrel.

I have constructed a simple frac spread Excel file. The table below shows simple calculation of the frac spread.

The NGL Margin or frac spread is $21.179.
Currently, NGLs trade at a premium to natural gas so the frac spread is positive. If frac spread turns to be negative, gas processors reject ethane keeping it in the gas.

Raw gas processing and midstream profitability are tied to three main types of contracts.

Under Keep-whole (KH) contracts processor compensates the producer for the whole amount of gas removed from the gas stream, i.e. retains NGLs and returns the value of the gas to the producer. Under this contract the processor is long NGLs and short gas thus exposed to the market price changes.

Under percentage of proceeds contracts (POP), processors receive a percent of the outlet stream, NGLs or dry gas. The processor is long either dry gas or NGLs.

Fee-based contracts allow processors to receive fixed fee based on how much gas they process and therefore it is also referred as throughput volumes contracts. Processors are not sensitive to market prices.