Natural Gas Liquids Concerns Increase

By Eric Fox | August 24, 2010 AAA

Some investors are starting to be concerned about the fundamentals of the various markets for natural gas liquids as the flood of development of areas that are rich in these liquids may upset the balance between supply and demand and drive prices lower. This might lower returns for exploration and production companies that have adopted business models of higher liquids production.
Natural gas liquids are present in the natural gas stream in certain formations, and are removed so that the natural gas can be transported to the end user. The natural gas liquids are then separated and sold to other customers. Natural gas liquids include ethane, propane, butane and several other liquids.

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The managements of various exploration and production companies spent time during second quarter of 2010 conference calls trying to allay concerns about an oversupply of natural gas liquids.

Betting On Demand
Chesapeake Energy
(NYSE:CHK) is making a major push into oil and liquids, and during the recent quarterly conference call, management seemed almost to be counting on the end user to build enough capacity to absorb the possible oversupply.

"We're certainly taking our message to consumers of natural gas liquids that we're going to be increasing supply for a long time to come and they should make appropriate investments to be able to handle our new NGL production," said Aubrey McClendon, the CEO of Chesapeake Energy. The company is also betting that an export market for those natural gas liquids that can be transported outside the U.S. will help with demand.

Ethane Weakness?
Devon Energy
(NYSE:DVN) is a major producer of natural gas liquids and during the second quarter of 2010 it received approximately $31 a barrel for its liquids. The company expects realizations to improve by the fourth quarter but said "supply growth in the U.S. could put negative pressure on natural gas liquids prices over the longer-term." The management expressed the most concern over ethane, which is used to make plastics. However, the company believes that even if ethane prices weaken it would still trade at a premium to natural gas.

Forest Oil (NYSE:FST) blamed the weakness in ethane prices on the shut down of two chemical plants during the second quarter of 2010, and believes that this demand will return to the market at some point. Operators also have the option of rejecting ethane and leaving it in the natural gas stream if prices fall too low.

Optimistic Outlook
Spectra Energy
(NYSE:SE) is involved in several infrastructure businesses including the processing and transporting of natural gas. The company's DCP Midstream segment owns fractionation capacity where the various natural gas liquids are separated into individual liquids.
During a recent conference call, the management of Spectra Energy said the company was "pretty positive on natural gas liquids from a long-term perspective," and blamed second quarter of 2010 price weakness on shutdowns by several end users.

Pioneer Natural Resources (NYSE:PXD) reported during the second quarter of 2010 earnings call that the company would still earn a decent rate of return even if natural gas liquids prices fell further. Pioneer Natural Resources said that even if natural gas liquids prices fell to 25% of the WTI oil price, the company would still earn a 40% before tax rate of return.

The Bottom Line
The rush to develop liquids rich plays in North America may be starting to alter the supply and demand for many of these liquids, potentially lowering the prices and returns for some of the company's that have adopted this business model. (To learn more, check out our Oil And Gas Industry Primer.)

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