1. US Ethane Outlook: Implications for Processors and Ethylene Producers
Presented to the 84th Annual GPA Convention
March 15, 2005
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. Background Just 2 years ago, US gas processors faced many challenges,
especially for ethane.
Lingering effects of an economic recession
High gas prices relative to crude oil
Poor processing margins – considerable ethane rejection
A depressed petrochemical environment
Fears that US ethylene industry would pack up and leave
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. Currently Ethane is back!!! Economy is stronger
Petrochemicals have rebounded
Processing margins are strong
Ethane extraction is good
across all processing regions
But how long will it last?
What a difference a couple of years make.
Currently Ethane is back.
The economy is growing at a reasonable pace, the petrochemical sector has rebounded, processing margins are strong and ethane extraction is good across all processing regions.
The question is, how long will these good times last?

4. Topics to be covered today
Review the analysis from our NGL study completed in February ’04 which forecasted better times for ethane.
Examine fundamentals driving ethane supply/demand and frac spreads.
Present simple bench marks that help indicate whether ethane’s economic conditions will improve or worsen.
Share updated findings regarding the outlook for ethane and its implications.
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.

5. Why Focus on Ethane?
Major NGL component – constitutes 37% of the US NGL barrel.
Yields have fluctuated from 34% to 46% when processing economics dictated.
Ethane extraction mostly discretionary - sensitive to economic conditions.
Acts as the “canary in the mine shaft” - strong ethane frac spreads indicate a strong processing environment - especially for cryogenic plants.
Ethane has only one major end use - ethylene feedstock, competing with other NGL & petroleum feedstocks.
Ethylene industry needs ethane - constitutes 45% of their feedstock mix.
But ethane’s usage has swung from 38% to 51% of the mix depending on feedstock economics and ethylene plant utilization rates.
Overall, ethane supply/demand has demonstrated swings of 100 MBPD or more in a market averaging around 750 MBPD.
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. 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
680 89
Ethylene
751 98
Refining 84 11
Peak Shaving 13 2
Total
764
100
Key market drivers influencing ethane cracking and extraction:
Ethane Cracking
Ethylene business cycles
Cracker capacities &
feedstock capabilities
Competing feedstocks
Ethylene co-products
Derivative Imports/Exports
Ethane Extraction
Frac spreads
Processing contracts
Plant type
Plant location
Gas quantity & quality
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

7. Our analysis of ethane supply & demand focused on two primary drivers.
Rational
Influence
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 (as driven by GDP growth)
US ethylene industry consumes virtually all of the ethane extracted from natural gas.
The amount of ethane consumed should increase as ethylene production increases.
But, co-products can affect ethane cracking.
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.

8. 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

9. Source: Platts & En*Vantage
NGL frac spreads are inversely correlated to the gas to crude price ratio.....
Source: Platts & En*Vantage
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.

10. Source: DOE and En*Vantage
....and that inverse relationship is reflected in the amount of ethane extracted.
If ethane frac spreads have an inverse relationship with the gas to crude ratio then it stands to reason that as the gas to crude ratio falls ethane extraction should increase.
This scatter chart, which plots US quarterly ethane extraction volumes against their corresponding gas to crude price ratios, shows that ethane extraction does indeed increase when the gas to crude price ratio decreases.
What is interesting about this plot is its pattern where there is a wide range of ethane extraction volumes at very high gas to crude ratios and then it narrows as ethane extraction volumes increase at lower gas to crude price ratios.
The red circles are the latest quarterly data points for 2004 and they reinforce the inverse relationship to the gas to crude price ratio and fall within the pattern of the original quarterly data points studied from 1999 to 2003.
Next, we need to understand what affect the ethylene industry has on ethane extraction and how does that relate to the gas to crude ratio and the pattern we see in this chart.
Trough Conditions
Source: DOE and En*Vantage

11. 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.

12. The gas to crude price ratio can influence the cracking of ethane versus heavy feedstocks. But what is the relationship between ethylene production and ethane cracking?
This relationship between ethane cracking and the gas to crude ratio is further reaffirmed when we examine trends in ethane cracking versus the cracking of heavy feedstocks, such as naphthas and gas oils.
This chart shows that in 2001 and 2003 when the gas to crude price ratios spiked, the ethylene industry minimized ethane cracking in favor of maximizing the cracking of heavy feedstocks.
Also, notice that even in the worst conditions ethane cracking seldom goes below 525 MBPD on a quarterly basis and generally rebounds after one quarter.
What this chart cannot tell us is how the absolute level of ethylene production affects ethane cracking.
To answer that question we need to examine the relationship between ethylene production and ethane cracking.

13. 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
Trough conditions

14. The shift in US ethylene capacity, the past few years, is estimated to shift the ethane cracking range downwards by about 15 to 20 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.

15. Our analysis indicates the following implications for ethane demand at different levels of US ethylene production.
Putting the pattern of the scatter chart in tabular form including the revision we just mentioned, provides the range of ethane cracking volumes at different levels of ethylene production.
It is not a perfect tool in estimating the ethane cracking volumes for certain ethylene production levels, but it comes pretty close.
For example the Hodson numbers for January of this year showed that on annualized basis ethylene production was 57.8 billion lbs in January and that the implied amount of ethane cracked from processing was 711 MBPD. The trendline on our table would have estimated that ethane cracking for that level of ethylene production would have been about 720 MBPD or within 1.5% of the Hodson number.
So how can we measure the bottom line implications for processors by knowing how much ethane is needed by the ethylene industry?
Higher ethylene production requires greater ethane cracking and the flexibility to swing ethane volumes diminishes.
Gas to crude price ratios also influence ethane cracking levels, particularly when ethylene industry utilization rates are between 80% to 90%.
It appears that the US Ethylene Industry can not stay at minimum ethane cracking levels for more than 3 months without creating a surplus of ethylene co-products.

16. Source: Platts, En*Vantage and Hodson
To support greater ethane cracking levels, the ethane “frac” spread increases to encourage more ethane extraction.
What this next chart shows is that there is a parabolic relationship between ethane’s frac spread at Mt. Belvieu and the amount of ethane cracked from processing.
At ethane cracking levels less than 650 MBPD, ethane frac spreads can be under 5 cents per gallon, especially if the gas to crude ratios are above 90%. Under these conditions it is highly probable to see ethane rejection in regions where the effective cost of getting ethane to market exceeds 5 cents. This is exactly what happened in 2003.
However, if ethane extraction exceeds 675 MBPD, then ethane frac spreads at Mt. Belvieu can explode upward to encourage more ethane extraction across all processing regions.
When we presented our study over a year ago, we used this chart to illustrate that processing margins and ethane extraction could improve dramatically if only ethane cracking would pick up 50 MBPD from its current levels which was around 650 MBPD.
It took about 6 months, but as seen by the red stars which denote 2004 data, ethane frac spreads soared to almost record levels of 16 to 18 cents per gallon, well beyond our expectations.
Today ethane frac spreads at Belvieu are between 8 to 10 cents per gallon, still very good and they are consistent with the current ethane cracking levels of around 710 MBPD.
Source: Platts, En*Vantage and Hodson

17. So what does the future hold for ethane cracking and extraction?

18. Back in February 2004, we felt that economic conditions going forward would provide a better environment for ethane cracking.
Back in February 2004, we felt that economic conditions would provide a better environment for ethane cracking going forward and hence better times for the NGL midstream sector.
If ethylene production levels fall below 53 billion lbs then there is a high probability that we will see a great deal volatility in frac spreads, especially if the gas to crude price ratio goes back above 90%, and that ethane cracking could decline below 650 MBPD.
So what makes us so confident that conditions will be favorable going forward.

19. Entering a new era where crude oil supplies are constrained and high prices are the norm.
First, we feel that we are in new era of high crude oil prices based on the fact there is very little spare production capacity in the world.
This chart illustrates that point by plotting WTI prices versus OPEC’s spare production capacity, since OPEC is the world’s swing producer for crude oil.
The regression is quite good and helps explain parabolic nature of crude oil prices we have been witnessing for the past year.
Currently, OPEC’s spare production capacity is less than 1.5 million bpd and with world crude oil demand expected to grow another 2 million bpd this year it is highly probable we will see crude oil prices in the $40 to $50 range if not higher

20. A paradigm shift to tighter crude markets provides lower gas to crude price ratios and favorable conditions for ethane.
Source: En*Vantage, ICE, DOE
Second, the paradigm shift to tighter crude markets should provide lower gas to crude price ratios and favorable conditions for ethane.
So far in 2005, the gas to crude ratios are running on average about 75% and this at the bottom end of our expected range of about 75% to 85% for the year. As the chart shows 2005 ratios are running significantly lower that what was observed in 2003 and 2004 at this time of year.
The other factor to note is that at higher crude prices the gas price discount to crude oil is widening, making it easier to tolerate slightly higher gas to crude price ratios.
For example, year to date in gas to crude ratios were lower at 66% but the price discount of gas to crude was only $1.18/MM BTU compared today’s discount of over $2.00, with gas to crude ratios at 75%.
This is because crude prices in 2002 were $20 versus $50 today.

21. Assuming ethylene production tracks GDP growth rate at a 0
Assuming ethylene production tracks GDP growth rate at a 0.9 multiple, ethane cracking could reach 800 MBPD by 2010.
From 1985 thru1999 annual US ethylene demand tracked annual GDP growth rate at a 1.3 multiple.
This relationship broke down between 2000 and 2003 because of the recession, high gas prices relative to crude, and the loss of derivative exports.
In 2004 ethylene production grew at a pace 2.5 times the GDP growth rate which far exceeded everyone’s expectations.
If we just take a very conservative view of the economy going forward and assume that annual ethylene production or demand grows at a 0.9 multiple to GDP growth rate then US ethylene production could reach 63 billion lbs/year in 2010.
This is certainly possible given that there is currently 62 billion pounds of active capacity operating and another 1.5 billion lbs of capacity being mothballed.
If our projections are correct then the US ethylene industry would need a little over 800 MBPD of ethane from gas processing by 2010.
Is the processing industry capable of meeting that challenge?
Source: History- CMAI, En*Vantage and Hodson; Est & Forecast - En*Vantage

22. Data indicate that the processing industry can ramp up ethane extraction to near 780 MBPD, which supports 61 billion lb/yr of ethylene production.
We think it can.
Data indicate that the processing industry can currently ramp up ethane extraction to near 780 MBPD, which supports 61 billion lb/yr of ethylene production.
This conclusion is based on analyzing each of the major processing regions over the past 5 years and determining what is a reasonable maximum amount of ethane that it can currently extract.
Many of these regions have shown significant swings in ethane extraction over the past 5 years, but if ethylene production continues to increase as we expect, each region will have the incentive to maximize ethane extraction.
Now we realize that in some regions gas is declining and in other areas it is increasing, so we did a long range forecast to determine if the processing industry could supply the 800 MBPD of ethane needed by the ethylene industry.
Each processing region responds to economic signals to throttle up or down
ethane extraction to meet ethane demand.
Analysis of each region shows that the Rockies is not always the swing
producer. Upper MW, LA & TX GC often provide the swing.
Source: EIA & En*Vantage

23. La GC and Rockies will be the incremental producers of ethane in the ’05 to ’10 time period.
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

24. Feedstock Capabilities Regional Ethane Production
Our study demonstrated how ethylene production along with the gas to crude price ratio can estimate ethane supply & demand and the amount of swing that can be expected.
Demand Side Factors
Ethylene Demand
Ethylene Production
Feedstock Capabilities
Ethane Demand
Gas to Crude Price Ratio
Effective Operating Rate
Composition of Plants
GDP Growth
In Summary:
Our study demonstrated how ethylene production along with the gas to crude price ratio can determine ethane supply & demand and the amount of swing that can be expected.
It is truly demand pull mechanism for ethane rather a supply push mechanism.
Regional Ethane Production
Regional Extraction Economics
Ethane to Market
Ethane Frac Spread
Supply Side Factors

25. In Conclusion: Ethane is very much alive!!! --- barring a recession.
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.
This is not the time for processors to retreat from cryogenic plants.
A tighter crude market keeps gas to crude price ratios below 90%.
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 closely 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.