1. US Ethane Outlook: The Sequel Implications for Midstream Players
Presented to the 86th Annual GPA Convention
March 13, 2007
Thanks Joel:
I appreciate the opportunity to be here and speak to the GPA about the outlook for ethane and its implications for gas processors and ethylene producers.
Peter Fasullo
En*Vantage, Inc

2. Characteristics of a Sequel: A Warning
A sequel is most likely a work of fiction in that is produced after a
completed work, and is set in the same "universe", but at a later time. It
usually continues elements of the original story.
The popularity of a sequel comes about in large part because it is less risky to build on a known success than to gamble with new and untested characters and settings.
Sequels are often criticized as artistically inferior, and accused of simply repeating the story of the original work.
It was just 2 years ago, that I was here speaking to the GPA about the challenges facing the NGL midstream sector. One of those major challenges concerned ethane.
If you recall, the gas processing industry was suffering from:
The lingering effects of an economic recession
High gas prices relative to crude oil
Poor processing margins which resulted in considerable ethane
rejection.
A depressed petrochemical environment
And a real fear that the US ethylene industry would pack up and
leave as we witnessed Dow permanently shut down 2 ethylene
plants that cracked primarily ethane and E/P mix.

3. A Flashback -- Market Climate Two Years Ago
In early 2005, the market climate for ethane had vastly
improved for US gas processors:
Lingering effects of an 2002/2003 economic downturn were over.
Gas prices were dropping relative to crude oil after being over 100% of crude in 2003 and near 100% in the 1st half of 2004.
US ethylene production had rebounded in 2004 and ethane feedstock consumption was strong.
Processing margins favored full ethane extraction instead of rejection just 2 years before.
Major question back then was: Will the good times last?
It was just 2 years ago, that I was here speaking to the GPA about the challenges facing the NGL midstream sector. One of those major challenges concerned ethane.
If you recall, the gas processing industry was suffering from:
The lingering effects of an economic recession
High gas prices relative to crude oil
Poor processing margins which resulted in considerable ethane
rejection.
A depressed petrochemical environment
And a real fear that the US ethylene industry would pack up and
leave as we witnessed Dow permanently shut down 2 ethylene
plants that cracked primarily ethane and E/P mix.

4. What Was Our Conclusions Two Years Ago?
Conditions should remain favorable for ethane cracking and
extraction, even with moderate ethylene production growth:
Ethane frac spreads should remain strong to encourage extraction in all processing regions.
A tighter crude market keeps gas to crude price ratios below 90%.
This is not the time for processors to retreat from cryogenic plants.
As ethylene production grows, ethane cracking increases and the flexibility to switch off ethane diminishes.
By 2010, ethane production should reach and sustain the 800 MBPD level, with the Rockies and La Gulf Coast contributing a larger share.
Ethylene producers need to track the regional shift in ethane supplies.
Reviewing our findings:
Ethane is very much alive!!! --- barring a recession
The 2 key points from this slide that I would like to leave with you are:
Ethane frac spreads should remain strong to encourage extraction in all regions.
This is not the time for processors to retreat from cryogenic plants.
Thank you very much.

5. Why Focus on Ethane Again?
In 2006, midstream players announced $2 billion in projects betting on the long-term viability of ethane.
Over 3 bcfd of cryogenic processing capacity, capable of extracting 150 MBPD of NGLs
450 bpd of new NGL pipeline capacity
215 bpd of additional fractionation capacity
Major NGL component – constitutes 39% of the US NGL barrel.
In some processing regions, ethane is 50% of the NGL barrel .
Ethane extraction mostly discretionary - sensitive to economic conditions.
Ethane has only one end use as an ethylene feedstock.
US Ethylene industry needs ethane - constitutes 40% of their feedstock mix, but the ethylene industry has a wide range of feedstock flexibility.
Ethane supply/demand has demonstrated swings of 150 MBPD or more in a market averaging around 660 MBPD for ethane from processing.
So why focus on ethane?
When we started our study early last year it became apparent that ethane was extremely important to the health of the gas processing and petrochemical industries.
On average, 37% of the US NGL barrel extracted by gas processors is ethane, so ethane is a major NGL component.
However ethane extraction yields have varied from 34% to 46% of the NGL barrel when processing economics dictated.
This is because ethane extraction is mostly discretionary and very sensitive to economic conditions.
Strong ethane extraction margins indicate a healthy processing environment - especially for cryogenic plants.
What makes ethane vulnerable is that it has only one major end-use and that is as a feedstock for ethylene production where it competes with other NGL & petroleum feedstocks.
Although it appears one sided, ethane, on average constitutes, 45% of the US ethylene feedstock mix, so it is a major feedstock for ethylene producers.
However, ethane cracking has been known to vary from 38% to 51% of the mix depending on feedstock economics and ethylene plant utilization rates.
Overall, when you sum all these factors together, ethane supply/demand has demonstrated swings of 100 MBPD or more in a market averaging around 750 MBPD. So ethane supply and demand can be quite volatile.

6. What are the Major Questions Today?
Will new ethane volumes from gas processing flood the market?
What is the long-term viability of the US Ethylene Industry and the outlook for ethane feedstock consumption?
What will be the regional distribution of ethane supplies and which processing regions will have the economic advantage of extracting ethane?
Which segments of the midstream value chain are taking the most risk in betting on ethane and how can this risk be mitigated?
So why focus on ethane?
When we started our study early last year it became apparent that ethane was extremely important to the health of the gas processing and petrochemical industries.
On average, 37% of the US NGL barrel extracted by gas processors is ethane, so ethane is a major NGL component.
However ethane extraction yields have varied from 34% to 46% of the NGL barrel when processing economics dictated.
This is because ethane extraction is mostly discretionary and very sensitive to economic conditions.
Strong ethane extraction margins indicate a healthy processing environment - especially for cryogenic plants.
What makes ethane vulnerable is that it has only one major end-use and that is as a feedstock for ethylene production where it competes with other NGL & petroleum feedstocks.
Although it appears one sided, ethane, on average constitutes, 45% of the US ethylene feedstock mix, so it is a major feedstock for ethylene producers.
However, ethane cracking has been known to vary from 38% to 51% of the mix depending on feedstock economics and ethylene plant utilization rates.
Overall, when you sum all these factors together, ethane supply/demand has demonstrated swings of 100 MBPD or more in a market averaging around 750 MBPD. So ethane supply and demand can be quite volatile.

7. Topics to be covered today
Overview of ethane supply/demand and simple benchmarks to follow.
Examine fundamentals driving ethane cracking.
Look at ethane extraction trends and outlook for the future.
Implications for midstream players
To answer this question we have to go back to a study we did early last year before the rebound occurred for ethane. We were commissioned to study ethane market conditions and determine when they would improve and why?
So today, I would like to review the analysis performed in that study that was completed in February of 2004 which did forecast better times for ethane.
Specifically, we will examine the fundamentals driving ethane supply/demand and frac spreads.
Present simple benchmarks that we developed that can be used to indicate whether ethane’s economic conditions will improve or worsen;
And along the way we will share updated findings regarding the outlook for ethane and its implications.

8. US Ethane Supply & Demand
Ethane supply & demand fundamentals appear simple, but they are complex and volatile.
US Ethane Supply & Demand
5-Year Average
( )
Supply
Demand
Source
MBPD %
End Use
Processing
667 89
Ethylene
734 98
Refining 83 11
Peak Shaving 16 2
Total
750
100
Key market drivers for ethane extraction and cracking:
Ethane Extraction
Frac spreads
Processing contracts
Plant type
Plant location
Gas quantity & quality
Ethane Cracking
Ethylene business cycles
Cracker capacities &
feedstock capabilities
Competing feedstocks
Ethylene co-products
Derivative Imports/Exports
On the surface, ethane supply/demand fundamentals appear simple, but they are complex which causes the wide volume swings that are associated with ethane.
Taking a look at a 5 year average balance for ethane we see that::
On the supply side the major source of ethane is gas processing which contributes 89% of all ethane supplies or about 680 MBPD.
Refiners also contribute the equivalent of 11% or 84 MBPD of ethane supplies in the form of an ethane/ethylene mix that is recovered and sent to an adjacent ethylene plants.
The demand side as we mentioned is dominated by the ethylene industry consuming 98% of ethane supplies and whatever is left over usually goes to utilities for peak shaving.
The fundamentals are complex when you consider that the demand for ethane can be influenced by ethylene business cycles, cracker capacities and feedstock capabilities. Also competing feedstock economics and co-product prices, and even ethylene derivative imports and exports can influence the amount of ethane used in the production of ethylene.
Factors that influence ethane extraction are not that simple either. Frac spreads, processing contracts, plant type and location, the quantity and quality of gas can all influence how much ethane reaches the market.
Source: DOE, En*Vantage, Hodson

9. Primary Drivers Rational Influences
Our analysis of ethane supply & demand focuses on three primary drivers.
Primary Drivers
Rational
Influences
Natural Gas to Crude Price Ratio
(Henry Hub Gas/Cushing WTI on a BTU basis)
Gas sets price floor for ethane and petroleum derived feedstocks set the market price.
Processing
Margins
Feedstock
Economics
US Ethylene Production
Sole market for ethane extracted from natural gas.
Ethane consumption versus competing feedstocks
Natural Gas Production & Quality
Pretty Straightforward
Volume of ethane that can be extracted given processing plant capacities and types
Both being inversely related to the gas to crude price ratio
To simplify and try to encapsulate all the various fundament drivers influencing ethane supply and demand, we focused our study on 2 primary drivers:
The Gas to Crude Price Ratio and US Ethylene Production as driven by GDP growth rate.
US ethylene production is an obvious choice since it is ethane’s only market. So, as ethylene production increases the amount ethane cracked should also increase. The key was getting a better handle on how GDP growth rate influences ethylene production.
The gas to crude ratio was chosen because ethane’s cost basis or price floor is set by natural gas prices and ethane’s market price prices is set by petroleum derived feedstock values.
Consequently, we felt that the gas to crude price ratio would be a good inverse indicator in determining the direction of processing margins and ethane’s attractiveness as an ethylene feedstock.
The gas to crude ratio in this presentation is expressed as % of the BTU value of natural gas at Henry Hub to the BTU value of WTI crude.

10. Source: Platts, DOE and En*Vantage
Relative value of gas to crude can affect U.S. NGL supply/demand, particularly for ethane.
Charting the gas to crude ratio for the past 14 years shows that the value of gas has steadily increased relative to crude oil from the early 1990’s through 2003.
As the gas bubble dissipated by the mid to late 1990’s, the market experienced major price shocks in the winter of 2000/2001 and then again in the winter and spring in 2003 as measured by the spikes in the gas to crude price ratio.
Our study examined the period between 1999 and 2003 to get a better understanding of how these gas price shocks affected the processing and ethylene industries, specifically with regards for ethane.
Any of you who were in the processing business during these 2 episodes, know these periods were especially painful. The first spike that occurred in 2001 was sharp and dramatic as the gas to crude ratio soared to 180% but it only lasted for a couple of months, In 2003, the second spike did not reach the levels of the 2001 spike but the gas to crude ratios were well over a 100% for a period of 6 months.
Since mid 2003, gas prices relative to crude have been trending downward and we will address why this has been happening and whether the long term has been broken later on in the presentation.
Source: Platts, DOE and En*Vantage

11. Source: Platts & En*Vantage
Ethane (NGL) frac spreads are inversely correlated to the gas to crude price ratio.....
As would be expected NGL frac spreads are inversely correlated to the gas to crude price ratio.
This chart shows frac spreads for ethane, propane and butane plus for each quarter between 1999 and 2004 overlaying the gas to crude ratio throughout this period.
During the winter and spring of 2003 the industry experienced some of the lowest NGL frac spreads, particularly for ethane. It was during this time that many market observers were becoming concerned whether ethane would ever bounce back and questioned if ethane extraction was worth it.
As can be seen in the chart, ethane margins did bounce back in the second half of 2004 coinciding with the drop in the gas to crude ratio and we will provide further explanations why this happened.
Source: Platts & En*Vantage

12. Ethane extraction closely tracks ethane cracking, influenced by the gas to crude price ratio.
This next chart shows that ethane extraction tracks very closely to ethane cracking with up and down movements inversely influenced by the rise and fall of the gas to crude ratio. (Note that the ethane cracking volumes shown in this chart excludes that amount of equivalent ethane sourced from refineries, so it is a fair representation of the amount of ethane required from gas processing.)
When we first made this plot it confirmed our intuition that ethane extraction does not take place independently from ethane cracking. That is ethane extraction exist because the ethylene industry needs the ethane.
When the gas to crude ratio is overlaid on the plot it shows that ethane cracking is also inversely influenced by the gas to crude ratio. The gas price spikes of 2001 and 2003 are also reflected in the downturn of ethane cracking.
This is important because it demonstrates that there is a relationship between the gas to crude price ratio and the ethylene industry’s usage of ethane.

13. A couple of concerning long-term trends
For the past several years, ethane cracking does not seem to be increasing.
Ethane extraction seems to be trending down even at times when extraction economics are extremely good.
This raises the questions of how much influence one trend is
having on the other and are there specific demand and supply
factors influencing the long-term trends for ethane cracking
and extraction, respectively.
To answer this question we have to go back to a study we did early last year before the rebound occurred for ethane. We were commissioned to study ethane market conditions and determine when they would improve and why?
So today, I would like to review the analysis performed in that study that was completed in February of 2004 which did forecast better times for ethane.
Specifically, we will examine the fundamentals driving ethane supply/demand and frac spreads.
Present simple benchmarks that we developed that can be used to indicate whether ethane’s economic conditions will improve or worsen;
And along the way we will share updated findings regarding the outlook for ethane and its implications.

14. Let’s take a closer look at what drives ethane cracking

15. Ethane cracking, as compared to alternative ethylene feedstocks, is definitely trending downward.

16. As ethylene production increases, ethane cracking increases and the flexibility to swing ethane usage diminishes.
Taking ethane cracking data and plotting it against ethylene production data was the key to explaining the real dynamics of ethane cracking.
Again, this is a scatter chart that shows the same pattern that was seen in the previous scatter chart, but it provides a clearer picture why this pattern exists. First, the major trend that is obvious is that as ethylene production increases the need for ethane also increases.
Second, the flexibility to swing ethane volumes is greatest when the ethylene industry is operating at low production levels below 53 billion lbs/yr.
As ethylene production increases its flexibility to swing ethane usage diminishes. When the industry needs that next incremental pound of ethylene it cracks more ethane because it provides the highest ethylene yield than any other feedstock.
Also, at high ethylene production levels the gas to crude ratio becomes less of a factor determining the amount of ethane cracked, whereas at lower ethylene production levels high gas to crude ratios have a greater influence in minimizing ethane cracking.
However, chronologically connecting the data shows the ethylene industry can only minimize ethane cracking for 1 quarter at most - when ethylene producers maximize heavy feedstocks they over produce co-products such as pyrolysis gasoline and gas oils.
Also, notice that the quarterly ethane cracking data for 2004 denoted by the red triangles falls pretty much within the historical pattern and re-confirms that as ethylene production increases so does ethane cracking.
To fully understand the profile of ethane cranking and how it can change over time we need to briefly discuss the types of US ethylene plants and their ability to swing feedstocks

17. The shift in US ethylene capacity is estimated to shift the ethane cracking range downwards by about 40 to 55 MBPD.
The composition of the US ethylene plants is the fundamental reason why the trends just discussed for ethane cracking exist.
There are basically 4 types of ethylene plants.
The plants that have the greatest amount of feedstock switching capability are the flexi crackers that can crack a wide range of feedstocks from ethane through naphthas and gas oils. The heavy crackers have little, if any, feedstock flexibility to crack ethane.
The purity and E/P cracker are basically stuck with cracking purity ethane and E/P mix and that is why there is a minimum amount of ethane that must be cracked by the industry.
As you can see the effective capacity of the ethylene industry has increased by 2 billion lbs/yr from about 60 billion pounds in 2000 to about 62 billion pounds as of the end 2004.
The capacity increase has shifted the mix of plants more to the flexi and heavy cracker categories as new plants in this category have come on line and as older purity and E/P crackers have been mothballed or permanently shutdown.
Based on this shift, we adjusted the ethane cracking range that is implied in the previous scatter chart downward by 15 to 20 MBPD.
But this revision may be temporary as there is talk that ChevronPhillips is seriously looking at restarting their 650 million lb/yr E/P cracker in Sweeny and there has been some noise out of Lyondell that they are studying whether to bring their 850 million lb/yr E/P cracker in Lake Charles out mothball status.

18. Growth in US ethylene production and capacity has stagnated over the past 5 years and the forecast is not that optimistic.

19. In the future, the stability of ethane demand continues to be uncertain with a wide range possible.

20. So what does the future hold for ethane extraction?

21. US NGL extraction is declining 2. 5%/yr since peaking in 2001
US NGL extraction is declining 2.5%/yr since peaking in Declining gas production is the primary factor for lower volumes.

22. But we are also seeing signs that the liquid content in US proven gas reserves is also declining. That is, gas is getting leaner.

23. The processors along the TX and LA Gulf Coast have shown the greatest declines in NGL extraction volumes.

24. Ethane extraction is declining
Ethane extraction is declining. If trend continues, ethane extraction volumes will be down 12% by 2011.

25. However, there is a number of new cryogenic plants under construction in the 3 of the hottest gas producing basins.
What is the ethane extraction capability of these new plants assuming 95% utilization?
What is the growth potential for these growing gas producing basins?
What are the prospects for additional ethane extraction in these growing basins?
How much does this potential incremental ethane extraction add to total ethane supplies from gas processing?

26. Major new cryogenic processing capacity will be installed in the Rockies and Barnett Shale in 2007 and 2008
What that analysis showed is that processing industry has the capability to extract 800 MBPD of ethane by 2010.
The incremental ethane production will come from the Louisiana Gulf Coast and the Rockies.
Although we did not factor LNG as a source of ethane, it is probable that after 2010 LNG could be a source for as much as 50 to 100 MBPD of ethane if the LNG comes in “hot”.
Source: DOE, En*Vantage

27. These new processing plants increase the industry’s maximum ethane extraction capability by an additional 65 to 70 MBPD
What that analysis showed is that processing industry has the capability to extract 800 MBPD of ethane by 2010.
The incremental ethane production will come from the Louisiana Gulf Coast and the Rockies.
Although we did not factor LNG as a source of ethane, it is probable that after 2010 LNG could be a source for as much as 50 to 100 MBPD of ethane if the LNG comes in “hot”.
Source: DOE, En*Vantage

28. In addition to ethane from announced processing plants, at least one US LNG terminal will be recovering NGLs by 2009.
Trunkline is building a BCFD NGL extraction plant at its Lake Charles LNG Terminal.
Depending on the quality of LNG being imported, we estimate that anywhere between 18 MBPD to 48 MBPD could be extracted.
Most likely, the Trunkline LNG terminal will process Nigerian LNG which has as an average BTU content of /- 25.
That would imply an ethane recovery rate of ~32 MBPD.
To be conservative we are assuming Trunkline will extract at least 30 MBPD. This ethane will not be economically sensitive because it needs to be recovered to make the LNG pipeline quality.

29. If no additional cryo plants are built, ethane balances should be reasonable, unless “low ethane demand case” occurs. But…..
What that analysis showed is that processing industry has the capability to extract 800 MBPD of ethane by 2010.
The incremental ethane production will come from the Louisiana Gulf Coast and the Rockies.
Although we did not factor LNG as a source of ethane, it is probable that after 2010 LNG could be a source for as much as 50 to 100 MBPD of ethane if the LNG comes in “hot”.
Source: DOE, En*Vantage

30. Incremental gas production should come from Barnett Shale, Rockies, Anadarko, and Arklatex regions based on reserve growth.
What that analysis showed is that processing industry has the capability to extract 800 MBPD of ethane by 2010.
The incremental ethane production will come from the Louisiana Gulf Coast and the Rockies.
Although we did not factor LNG as a source of ethane, it is probable that after 2010 LNG could be a source for as much as 50 to 100 MBPD of ethane if the LNG comes in “hot”.

31. By 2011, there could be an additional 2
By 2011, there could be an additional 2.8 BCFD of gas production that could be processed. Should cryo plants be built?
What that analysis showed is that processing industry has the capability to extract 800 MBPD of ethane by 2010.
The incremental ethane production will come from the Louisiana Gulf Coast and the Rockies.
Although we did not factor LNG as a source of ethane, it is probable that after 2010 LNG could be a source for as much as 50 to 100 MBPD of ethane if the LNG comes in “hot”.

32. Processors have to consider the consequences of adding more cryo capacity as there could be a large ethane supply overhang.
What that analysis showed is that processing industry has the capability to extract 800 MBPD of ethane by 2010.
The incremental ethane production will come from the Louisiana Gulf Coast and the Rockies.
Although we did not factor LNG as a source of ethane, it is probable that after 2010 LNG could be a source for as much as 50 to 100 MBPD of ethane if the LNG comes in “hot”.
Source: DOE, En*Vantage

33. In the future, more ethane will be extracted from the inland growth basins.
What that analysis showed is that processing industry has the capability to extract 800 MBPD of ethane by 2010.
The incremental ethane production will come from the Louisiana Gulf Coast and the Rockies.
Although we did not factor LNG as a source of ethane, it is probable that after 2010 LNG could be a source for as much as 50 to 100 MBPD of ethane if the LNG comes in “hot”.
Source: DOE, En*Vantage

34. There are several implications for midstream players if a large ethane overhang causes ethane on ethane competition:
Independent gas processors with “keep whole” contracts have the highest exposure to economic risks.
Processors in the Rockies should experience narrower gas basis in the future as new gas pipeline takeaway capacity comes on-line.
Processors with POP contracts or fee based contracts could prolong oversupplied ethane conditions.
Integrated midstream players should have less economic risks as they can distribute those risks across their NGL value chain.
Logistic assets (pipelines, fractionation, storage) to be built or expanded to service NGLs from new processing capacity will also have exposure to ethane rich NGL streams.

35. Let’s Review the Trends and the Analysis
Demand Side:
US ethylene capacity not expected to increase. Contraction possible.
US ethylene producers will have greater feedstock flexibility.
Low ethane demand case: 600 to 620 MBPD.
High ethane demand case: 700 to 725 MBPD.
Supply Side
US NGL (ethane) extraction is in decline, but announced plants plus ethane recovered from LNG will offset this decline.
Any “New” cryogenic capacity could create a large ethane extraction overhang. Processing contracts can prolong oversupplied conditions.
Regional shifts to the Rockies and N. Texas will spur new “logistics” that will be heavily dependent on ethane.
More ethane demand
variability
Reviewing our findings:
Ethane is very much alive!!! --- barring a recession
The 2 key points from this slide that I would like to leave with you are:
Ethane frac spreads should remain strong to encourage extraction in all regions.
This is not the time for processors to retreat from cryogenic plants.
Thank you very much.

36. In Conclusion
The US Midstream Sector can no longer take for granted that the US Petrochemical Industry will always be there for ethane.
Any processor considering to add more cryo capacity must:
Carefully follow and evaluate the state of the US petrochemical industry.
Examine economic position versus competition that may be more integrated across the NGL value chain.
Have the ability to reject ethane, because ethane market conditions will be more volatile.
Structure processing deals to minimize economic damage when a downturn occurs.
Logistic players will need to recognize and manage the risks of having projects that handle high ethane content NGL streams .
Reviewing our findings:
Ethane is very much alive!!! --- barring a recession
The 2 key points from this slide that I would like to leave with you are:
Ethane frac spreads should remain strong to encourage extraction in all regions.
This is not the time for processors to retreat from cryogenic plants.
Thank you very much.