A group of natural gas producers in North America are discovering the secret sauce to profits, and as a result many of them are outperforming their peers.

It’s called “wet gas” or “liquid rich gas” or “natural gas liquids” or “NGL”, but any way you spell it, you get better cash flow than just regular “dry” gas.  (Dry gas is methane.)

The market is now catching on to how much these NGLs improve cash flow, and they have been the first and biggest movers so far in the Canadian gas stocks.  Institutional investors are realizing they can buy big leverage to rising gas prices and still get good cash flow from current low prices, because of the added NGL content.

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“At a natural gas price of $ 4.50 per million cubic feet (mmcf), I think it is fair to say that 40 barrels of liquids per mmcf improves revenue to $ 7/mmcf plus” an executive at one junior producer told me in a recent interview.

“And at 20 barrels per million, it’s almost $6 gas equivalent.  On operating income that’s an improvement of 40% for 20 bbl/MMcf and close to a double for 40 bbl/MMcf.”

All these economics depends on the reservoir(s), and can vary play to play, but in my talks with several management teams operating in Western Canada, the answer was the same.  Revenue increases 50% to 100%, and profit increases 75%-100% or more with NGL credits.

Peters & Co., an oil and gas boutique brokerage firm in Calgary, Canada, said in a May 31 2010 report that the average half cycle (read: operating cash) cost of producing gas over 27 plays in western Canada was $5/mmcf.  But every 10 barrels of liquids for every million cubic feet of gas (bbl/mmcf) lowered that cost by 40 cents/mmcf.

Several producers are getting 25-40 bbl/mmcf in western Canada, which means they are lowering their cash cost by $1.60 per mmcf produced.  The most prolific liquid rich gas producer in Canada that I could find had one play that was over 50% NGLs, with well over 120 bbl/mmcf.   It was a recent addition to the OGIB subscriber portfolio.

For many gas producers at these gas prices – across the entire US as well as Canada – that liquid rich content is the difference between no net cash flow, and profits.

“Liquids can be two-thirds of the value of a well,” the junior producer told me.  “It’s fair to say that the value created from the liquids rich wells can be as good as or better than Cardium oil wells.”  Energy analysts in Canada often have Cardium oil wells ranked #2 or #3 in profitability of all the oil plays in Canada, behind the Bakken.

So what are these liquids that are worth so much they greatly increase cash flow for gas producers?  The industry names them C2, C3, C4 and C5.  C1 is regular dry gas, or methane.  The “liquid rich” gases are:

C2         Ethane

C3         Propane

C4         Butane

C5        Condensate

C5, or condensate is worth the most of the four liquids.  It is close to gasoline in quality and often gets a premium over the world oil price. In Canada, it is mostly sold to heavy oil operators where it’s used as a diluents; diluting the heavy oil.

Propane is sold as winter heating fuel, and has very seasonal pricing.  Butane is sold to Edmonton refineries and is used for blending.  Its price is a percentage of oil and follows oil.

The prices of C2-C4 can vary a lot, but as a general rule of thumb producers will get roughly 60%-65% of the oil price for their basket of NGLs.  When natural gas is 1/16^th the price of oil, that’s big money for these cash strapped gas producers.  A producer of just dry gas is likely having very low cash flow with these natural gas prices – in the US and Canada.

And the more condensate you have the more negotiating leverage you have with the gas plant to get better pricing on the C3-C4 which has weaker pricing. (The dance that producers have with pricing with gas plant operators and midstream gas carriers is a story unto itself.)

Not all plays have NGLs.  Most in Alberta and British Columbia are in what’s geologically called The Deep Basin.  If you drew a line from Calgary to Grande Prairie Alberta, most NGL plays would be just east of that line.  There are NGL plays up in the Peace River Arch area of north east British Columbia as well.

And the NGLs come from a certain group of organic matter, which was cooked at a certain temperature – not too hot, not too cold.

These NGL plays were recently made even more profitable as the Alberta government extended its new 5% royalty on these plays out for another year, and allowed the new lower royalties on drilling any deeper than 2000 metres – it used to 2500 metres.

While most NGLs are just below 2500 metres, this new announcement opens up the whole geological window for NGLs to lower royalties.  That’s another spice for the secret sauce.

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