Natural gas liquids' profitability weakens amid rising U.S. supply

      Natural gas liquids' profitability weakens amid rising U.S. supply

According to Ernst & Young Oil & Gas Center's quarterly outlook

PR Newswire

HOUSTON, Oct. 22, 2012

HOUSTON, Oct. 22, 2012 /PRNewswire/ -- Prices for natural gas liquids, or
NGLs, have dropped precipitously this year amid growing supplies, weakening
the profitability of a key driver of the U.S. shale development. Extracting
NGLs, such as ethane, propane and butane, is still more attractive than
producing dry natural gas, but it's not as robust as it was nine months ago,
according to Ernst & Young's Oil & Gas Center's quarterly analysis.

NGL production has surged over the last few years as oil and gas producers
dramatically changed their drilling focus from dry to liquids-rich gas in a
bid to boost profits. But supply has outpaced demand, primarily from chemical
plants that use NGLs as feedstock for plastics. The result has been lower

"Companies still have plenty of incentive to produce NGLs. Prices remain
significantly higher than natural gas. But we're seeing a marked shift in
demand," said Marcela Donadio, Americas Oil and Gas Leader, for the Ernst &
Young organization. "The market for liquids seems to be leveling out," Donadio

Further pressuring the "frac spread" has been the recent increase in natural
gas prices, which have been driven upward by improving fundamentals – a
slow-down in production growth, increasing demand (particularly in the power
sector, where year-to-date gas consumption is up 30%), and a reduction in the
massive storage overhang that had persisted over most of the past year. Spot
natural gas prices have climbed over $3.25 per million BTUs. While this is
about 50% higher than the second quarter, it is still low by historical

After a long time of being significantly above normal levels, natural-gas
storage levels in the US are approaching a more average range.This is
encouraging for natural gas producers as prices would be strengthened by a
cold, early winter and lower storage levels.

Oil prices remain high, with UK Brent crude trading over $110 a barrel and US
WTI crude trading over $90 per barrel. Despite worldwide economic uncertainty
and growing political tensions in the Middle East, supply and demand have been
relatively balanced, with no real supply shortages or supply excesses in
sight. An important recent development is the strong comeback of Iraq's oil
production, which reached its highest-level in more than 30 years.
Particularly if global oil demand remains relatively weak, this is likely to
pressure OPEC members to cut back production in order to make room for Iraq's
new output.

US oil production continues to grow amid increased shale drilling, but
infrastructure bottlenecks remain a serious issue. Defying the historical
trend, moving crude by rail has become a crucial piece of the US energy
infrastructure and the solution continues to gain ground. 

Profit margins for the global refining business strengthened compared to the
second quarter as product prices stayed relatively high. Much of the recent
strength in the global downstream segment has come from improved margins from
distillates, such as heating oil, gas oil and diesel fuel. Global distillate
demand growth has remained relatively strong, while gasoline demand worldwide
has been fairly weak.

Looking ahead, the future for the downstream sector continues to present
challenges. A lot of new refining capacity is expected to come online in the
next three to five years, which would erode refining margins across the board
and could force less-profitable plants in the US and Europe to close.

Oilfield services
Spending by oil and gas producers worldwide is still cautiously increasing,
but at a slower pace. Drilling in the Gulf of Mexico has come back fairly
strongly this year with a steady increase in rigs count. In the US, total rig
count has declined slightly over the last few months as new oil and
liquids-directed drilling has not fully offset a continued decline in natural
gas drilling. Globally, except for some offshore drilling, cost pressures for
oil field services are being somewhat tempered by gains in efficiency.

Oil and gas transaction activity in North America was up slightly in the third
quarter, driven mainly by the $15.1-billion bid of China's CNOOC for Canada's
Nexen Inc. The move underscored the continuing strong interest of Asian
companies in North American unconventional oil and gas assets. Merger and
acquisition activity is expected to stay strong as companies with weakened
balance sheets and limited cash flows move toward strategic and/or
deep-pocketed buyers – in particular, the majors or NOCs.

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Katy Hancock

SOURCE Ernst & Young

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