By Robert Campbell
NEW YORK, May 7 (Reuters) - U.S. natural gas drillers, stung by decade-low gas prices, have flooded into so-called liquids-rich plays, but the surge in natural gas liquids (NGLs) output that was meant to salvage profitability is leading to a new glut.
Big shale gas drillers, including Chesapeake Energy and EnCana, have pivoted away from "dry" shale gas plays like the Haynesville Shale in Louisiana, in favor of shales that hold liquids as well as natural gas, such as Texas' Eagle Ford Shale.
Proponents of liquids-rich drilling point out that NGLs command prices similar to those of crude oil instead of natural gas. However, the movement of the herd into liquids-rich drilling is undermining that idea.
Prices for the main NGLs -- ethane, propane and natural gasoline -- have plummeted in recent weeks as surging supplies run up against the limits to North American demand.
Propane at the Mont Belvieu, Texas market hub has sunk to an unprecedented discount to Brent crude oil of more than $70 a barrel.
A similar, but less dramatic, fall in natural gasoline prices can also be seen. Natural gasoline, a term that encompasses the heaviest natural gas liquids, now trades more than $20 a barrel below Brent crude.
Production of NGLs at U.S. natural gas treatment plants has jumped by nearly 40 percent since January 2009 to hit 2.388 million barrels per day in February this year, the most recent government data shows.
The bulk of this increase is coming in the hardest-hit parts of the NGL complex: lighter products such as ethane and propane.
The main problem NGL producers face is a slow-growing domestic market and limited opportunities to export production.
Although U.S. petrochemicals firms and other industrial users are retooling to replace crude-oil-derived inputs in favor of NGLs, this is a process that takes years.
Similarly, terminals where NGLs are chilled or compressed for loading onto special tankers are being expanded to boost exports, but capacity growth here too is slow.
Certainly, such bottlenecks present major business opportunities for nimble firms.
But overproduction means many of the economic gains will likely end up being captured by midstream and downstream firms and those companies that are big enough, and rich enough, to take on the cost of moving cheap, liquids-rich gas to market.
For instance, petrochemicals producers such as Dow Chemical and Royal Dutch Shell are banking on cheap NGLs to support the business cases for a swath of new ethylene cracking capacity.
A significant rise in the cost of ethane would probably result only in the cancellation of some crackers' construction, undermining the case for higher ethane prices.
Similarly, moves to expand NGL export capacity are likely to benefit the main infrastructure holders.
Enterprise Products Partners and Targa Resources are increasing export capacity from Texas but what they add will probably fall short of demand and likely be controlled by contract shippers.
So in that sense, the market at Mont Belvieu understates, in many ways, the extent of the problem for NGL producers.
In the field, many gas producers are struggling to get liquids-rich streams onto pipelines to move their output to major fractionation centers.
Once there, fractionation space is limited, forcing producers to accept lower prices to gain access to capacity.
Such tumbling prices have huge implications for the North American natural gas industry. In many ways, liquids-rich shales are both a blessing and a curse for natural gas.
On the one hand, NGLs are rescuing hard-hit gas drillers by rebuilding revenue streams shattered by plunging natural gas prices.
But on the other hand, NGLs are perpetuating the natural gas glut. Due to the higher prices received for NGLs, producers have been able to ignore low natural gas prices.
In essence, when NGL volumes determine the profitability of a well, the natural gas produced is effectively "free", making drillers indifferent to low natural gas prices.
That, of course, is one reason why U.S. natural gas output has not slowed as fast as some companies might have liked.
But the NGL glut is showing the limits to this strategy. By oversupplying the relatively small and inflexible NGL market, producers are cutting themselves off at the knees.
Gas bulls should welcome this. Ultimately, cheap NGLs will force drillers to do what they don't want to do: idle rigs on gas-prone plays.
The shakeout is likely to be painful as pricy leases are relinquished and rigs shifted further to searching for crude oil. But if so, that will bring about the long-awaited slowdown in natural gas production growth.
A bottom in the propane market could well mark a bottom in the natural gas market.