Knowing When To Produce Or Reject NGLs Drives Bottom-line Results: Sproule And GTI

Canadian natural gas prices remain mired in a prolonged slump, trading at a historically wide discount to U.S. gas, even as world gas prices — sapped by the flood of shale gas and expansion of the liquefied natural gas trade — themselves remain at subdued levels.

Yet that situation is expected to change in the medium to long term, as demand for the relatively clean fossil fuel rises in developing countries. In Canada, several new projects are underway that will increase demand for both natural gas and natural gas liquids (NGL), including new pipelines, propane and LNG export terminals and petrochemicals projects.

In addition to LNG Canada’s massive export facility expected to enter service in the 2024 timeframe (with capacity of 2.1 billion cubic feet per day of gas, possibly doubling soon after), TransCanada Corp.’s pipeline expansion program is slated for completion in 2022 (adding about 3.2 bcf/d of new capacity). Several other projects are in various stages of development. Chevron and Woodside recently applied for a 40 year licence to export up to 2.75 bcf/d from their proposed LNG export facility in Kitimat. AltaGas’s Ridley Island propane export terminal is scheduled to start-up in April 2019 and will be capable of exporting 40,000 bbls/d of propane. Pembina’s Prince Rupert Terminal will have 25,000 barrels per day of LPG export capacity starting in 2020. Nauticol’s new methanol facility near Grande Prairie will start up in 2022 (consuming about 300 mmcf/d). Inter Pipeline and Pembina are each constructing two propane dehydrogenation and polypropylene petrochemical facilities near Edmonton. Inter Pipeline’s facility is scheduled to start up in 2021 and Pembina’s facility starts operations in 2023.

In a basin producing about 16 bcf/d, the combination of projects will have a big impact on the market for gas producers. The projects will also further complicate the production mix that producers are aiming for with respect to how much natural gas and NGL to produce to maximize value.

Historically, it was a given that producers would strip out the NGL for their higher return, said Gerry Goobie, Principal at Goobie Tulk Inc. (GTI). This is no longer a certainty, Goobie said.

Spread game

“Producers and plant operators tend to charge ahead and keep producing NGL because they get more revenue when they generate more volume, but that's not necessarily the right thing to do because the natural gas liquids business, and certainly in the processing and producing side of it, is really a spread game. Your profitability is based on the price that you can get for the product that comes out less the value of the gas that’s utilized to produce it,” said Goobie.

“In other words, if you have rich gas and you don't process it, you just sell it as gas, you get gas value. If you strip out all of the ethane, propane and butane, for example, and sell what you have taken out of the stream, you have foregone the gas value for those molecules, though you will get the propane value, the butane value, less the production and transportation costs,” he said.

“So it’s really a spread between, the value of propane and the value of gas, and that spread may or may not be sufficient to cover all the costs that producers incur to get it to market”

Producers have to start thinking about profitability versus revenue when it comes to their NGLs, added Liam O’Brien, petroleum engineer and market analyst at Sproule.

“In the current pricing environment, not all NGLs are created equal. If you have condensate you are in good shape. If you have high liquids yields but the majority of those yields are made up of C3s and C4s [propane and butane], then you really have decisions that you have to make in terms of whether or not you want to produce those liquids or you want to leave them in the gas stream,” O’Brien said.

As would be expected in a low gas price environment, producers have shifted their development to areas they see as having higher liquids recoveries. In 2018, natural gas production increased by about five per cent, while propane, butane and condensate production were up 14, 13 and 15 per cent respectively, notes O’Brien.

“That shows the shift in development. In Alberta we are unique in that we have a robust condensate market underpinned by diluent demand for shipping bitumen, but the market for propane and butane isn't quite as robust. And so, we see a fairly significant overhang in inventory levels for both propane and butane, and that's what's really driving prices down and leading producers to be thinking about whether there is profit in extracting NGLs outside of their condensate.”

GTI has seen the heating value of various export gas streams rising in response to the situation in Canada. “We have seen an increase in the liquids composition of the gas in the Alliance pipeline in the last year or two, which is driven by the fact producers are not making very much money on these products in Western Canada. When you put them in the pipeline and send them down to Chicago, there is more value for those products.”

Similarly at Empress, there is evidence producers are not extracting all of the liquids. “They are likely leaving some ethane and possibly even propane in the gas stream, largely because the profitability is not there and they are better off to leave those products in the gas stream, realizing it is more valuable as gas,” said Goobie.

Goobie said GTI data indicates that while NGL revenue may be a significant portion of a company’s total revenue, when companies allocate costs to the NGLs recovered, NGLs are a much smaller portion of total income, and in fact propane and butane have recently turned negative. Butane is likely to return to positive territory by the end of this year but propane probably won’t, he said.

Profitability versus revenue

 “Producers need to be thinking a lot more about the actual profitability of their gas processing operations as opposed to just getting more revenue. Producing more liquids is not necessarily a wise decision because producing these liquids doesn't necessarily mean more bottom-line profit, and that’s really the issue that producers and mid streamer operators have to be thinking a lot about in this difficult environment that we are in,” said Goobie. “Maximizing your profitability used to come from simply producing more liquids, but it’s a much more complex business now. In today’s challenging environment you really do have to pay close attention to quite a few factors to ensure that you are operating your facilities in a matter to maximize profitability”

Companies need to be careful and deliberate in their strategy as to where they are going to drill, how much they are going to produce, what is it that they are going after and how to optimize their operations to get the maximum out of everything they are producing.

The answers are not intuitively obvious as to what companies should do on an ongoing basis, as there are a number of factors that play into the equation, he said.

Looking at prices alone doesn’t indicate whether the mix of products being produced is optimized, he added. Nor does it help with longer-term strategic issues, such as whether to target rich gas or light tight oil with rich associated gas, how much processing to do or whether to enter into long term agreements to strip out all the liquids.

As an industry insider, Goobie said he likes to challenge producers to closely examine their spreads, their bottom line, and whether they are making money on a day-to-day and month-to-month basis producing various liquids.

“You really have to look at several factors and pay close attention to the price of your products and the price of the gas that went into it, your operating costs, what contractual agreements have you entered into, all those sorts of things.”

It can be a delicate balance to maintain, and one that calls for a better reading of all the factors at play, from price and supply forecasting to analysis of all the other variables involved, like netback analysis by component and the market dynamics that are impacting prices.

“There is a whole variety of levers that companies can play with and historically a lot of them haven't been doing that. In our experience companies have not being spending enough time looking at this, and it’s these things that are key to your success in a difficult environment.”

Such factors are examined in a new monthly NGL report that Sproule and GTI have partnered to produce. It looks at the profitably of NGLs depending on aspects like transportation, processing and other market forces — factors that are making and breaking gas producers today, the companies said. “We are in a very difficult environment right now and it’s likely to stay this way for a while,” O’Brien said. “And the successful companies are going to be the companies that pay close attention to the molecules they produce.”