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Analysts Say NGL Price Outlook Grim, Midstream Consolidation Possible

Analysts with U.S. Capital Advisors LLC (USCA) said natural gas liquids (NGL) prices are still "trying to find a floor," thanks largely to a more than 60% collapse in propane and butane prices, as propane inventories increase and several midstream companies begin to emerge as takeover targets and acquirers.

In a note Wednesday, USCA analysts Becca Followill and James Carreker said propane prices had fallen from a 3Q2014 average of $1.04/gallon to 39 cents/gallon on Monday, a 62.5% decline. Butane prices had also fallen off 62% during the same time frame (from $1.25 to 47 cents), as did ethane by 30.3% (24 cents to 17 cents).

"The collapse in propane and butanes is incrementally driving the NGL barrel lower," the analysts said, adding that the fuels account, respectively, for 30% and 14% per bbl of NGL. "Propane production has surprised on the upside driven by continued increases in the [gallon/Mcf] yield.

"At the beginning of the year, we thought the rate of change in propane yield would begin to fall off to around 6% by midyear. Instead, the rate of change held flat and even accelerated over the last two months [February and March] of data. That combined with slightly higher gas production means we went from forecasting a slight draw in propane inventories in 2015 to a big build."

Due to the increased gallon/Mcf yield, the analysts said propane production for 2015 was on pace to be 4% higher than a previous estimate last January, and they now project it to be 1.7 million b/d for the year ending in October. As a consequence, propane production is now projected to increase by 10% in 2016 (to 1.85 million b/d) and 13% (1.98 million b/d) in 2017. They added that increased production, stagnant domestic demand and record levels in storage would lead to more NGL exports.

"In January, we thought that propane exports would be constrained by supply, resulting in only 600,000 b/d of exports in 2016 and 625,000 b/d in 2017," the analysts said. "We now see the need for 700,000 b/d in 2016 and 800,000 b/d in 2017.

"But importantly, with exports accounting for approximately 40% of U.S. propane demand, propane will have to be priced to take market share in other countries via export."

Ethane inventories were projected to decline back to five-year average levels, and are estimated to hit 31.5 million bbl at the end of December 2015. By comparison, ethane inventories totaled 37.9 million bbl at the end of 2014.

"The swing factor in our view has been increased ethane rejection, which is 130,000 b/d [higher] in 2015 versus our January forecast," Followill and Carreker said. "We also think some ethane storage may be being converted to propane use to take advantage of the seasonal arbitrage.

"Given continued ethane rejection, we continue to assume that no matter the increase in ethane demand from cracker expansions/conversions and additional exports over the next three years, it will not be enough to move ethane prices above their methane equivalent."

According to the analysts, the current environment has compelled USCA to lower its NGL price assumptions to 42 cents/gallon for 2H2015, down from 50 cents. The firm also lowered its prior assumptions for 2016-2018 by 10 cents for each year -- to 50, 60 and 70 cents, respectively.

The note also looked at several midstream companies. USCA upgraded stock ratings for Oneok Inc. and Oneok Partners LP, but downgraded MarkWest Energy Partners LP, SemGroup and Targa Resources Corp. The firm's "top picks" include the Oneok firms, Enterprise Products Partners LP, Cheniere Energy Partners and Tallgrass Energy Partners.

The analysts said that although enterprise value/earnings before interest, taxes, depreciation and amortization (EV/EBITDA) was a valuable tool elsewhere, it was tricky to use for midstream companies due to their myriad of entities. Instead, they looked at the sector from a merger and acquisition perspective.

"Based on this analysis, the Oneok, Targa, Markwest and SemGroup families screen cheap. We also think that makes each of these entities takeout targets," the analysts said. They added that the companies "with the strongest currencies, which we also think means they will be acquirers," included Magellan Midstream Partners, Kinder Morgan Inc., Plains All American and Energy Transfer.

On Monday, analysts with Raymond James & Associates Inc. also said the outlook for NGLS was bleak, noting they expect composite prices to increase only slightly this year and average 49 cents/gallon, with a peak of 54 cents in 4Q2015 (see Daily GPIJuly 6).

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