Ethane or Gas?
In the great majority of producing basins, underground raw natural gas has some amount of ethane in it. Over the last month, there has been a new unexpected source of supply increase in the Lower 48 US, ethane rejection. Ethane rejection occurs when producers economically decide to leave ethane into the underground raw natural gas stream and sell it as natural gas into the marketplace. It occurs when the MMBtu price of ethane trades under the MMBtu price of natural gas in a specific region. At that point, there is more money to be made by not extracting ethane from underground raw natural gas and instead leaving ethane in underground raw natural gas to be sold as natural gas. Most of the time, ethane on a per MMBtu basis trades over the price of natural gas on a per MMBtu basis, making it more profitable to extract ethane from underground raw natural gas and sell it as ethane into the marketplace. In the US, around 50% of ethane production is derived from underground raw crude oil and the other 50% of ethane production is derived from underground raw natural gas. This causes ethane prices to be impacted by both oil prices and natural gas prices. Ethane is used predominately by chemical manufacturers to crack into ethylene, which is then used to make plastics. Ethane demand fundamentals are primarily driven by the chemical manufacturing sector.
Over the last month, Henry Hub natural gas prices have been trading over the MMBtu price of ethane at Mont Belvieu. Mont Belvieu is the main trading hub for ethane. This has caused some amount of ethane to be left into the natural gas stream and sold as natural gas into the marketplace. It is estimated that around 500 MMcf/d of ethane has been left into the natural gas stream over the past month, causing overall natural gas production in the US to increase by 500 MMcf/d. This is an unexpected source of US supply increase compared to a few months ago, when the price of Mont Belvieu ethane was higher than the price of Henry Hub natural gas. The great majority of the ethane rejection is currently in the Haynesville producing region where natural gas prices are trading over ethane prices. It is estimated that the total amount of ethane rejection capacity is around 2 Bcf/d in the US. There is only so much ethane that will be allowed to be rejected and left into the natural gas pipeline stream due to natural gas pipeline safety requirements.
The forward curve for Henry Hub natural gas is currently trading over the forward curve for Mont Belvieu ethane on a per MMBtu basis out to the end of March 2023. This implies that we will continue to see this 500 MMcf/d of additional production supply in the US until April 2023 when natural gas prices go back below ethane prices. The additional production supply will primarily be in the Haynesville producing region where the Henry Hub trading point resides. Ethane & Gas Futures Curves
In the past, when Henry Hub natural gas prices were trading over Mont Belvieu ethane prices on a per MMBtu basis, it was always a short-term temporary event where it was profitable to short Henry Hub natural gas when it was trading over Mont Belvieu ethane.
A Longer Term Trend
However, the forward curve may be telling us that there is a potential regime shift going on in the natural gas market, where Henry Hub natural gas is trading over Mont Belvieu ethane and ethane rejection becomes a common daily occurrence during the winter months for the foreseeable future. The cause of this regime shift is coming from the European natural gas market where most US LNG exports come from the Henry Hub market area in Louisiana.
European natural gas is currently trading at a MASSIVELY higher premium to US Henry Hub natural gas. European natural gas is trading on average at around $55.00/MMBtu at the Dutch TTF hub out to the end of 2023, while US Henry Hub natural gas is trading on average at around $6.64/MMBtu out to the end of 2023. The call on Henry Hub natural gas from Europe is causing the Henry Hub natural gas market to trade at a relative premium to other US trading hubs, thus causing ethane rejection in the Haynesville producing region.