2 Stocks to Profit From Falling Ethane Prices

by Aaron Levitt | October 9, 2013 10:24 am

2 Stocks to Profit From Falling Ethane Prices

It seems that the advanced drilling techniques sweeping across the nation may be a little too advanced. As the E&P industry has applied hydraulic fracturing to numerous shale plays and older legacy fields, a surge of energy has been released. That has created the age old problem of too much supply and not enough demand.

And as with all good commodities, when this issue occurs we get a steep drop in prices[1].

While the historic plunge in dry natural gas has been well-documented by the financial media, the producers of wet gas are also see issues with prices for the various natural gas liquids associated with their production. Prices for a key NGL — ethane — have plunged over the last two years and now sit at decade lows. That has crimped for profits producers that rely heavily on wet gas for their earnings.

However, the price plunge doesn’t have to be a total loss for investors. There are plenty of opportunities in the firms that are drinking up these low NGL prices.

Lowest Since 2002

Natural gas liquids are essentially a group of hydrocarbons — which include ethane, propane[2], and butane — that are often found alongside traditional dry natural gas or methane. And just like dry gas and shale oil, these hydrocarbons can be stimulated upwards via fracking quite efficiently.

Which is part of the problem.

As fracking has taking hold, supplies of ethane — the most prominent NGL — have surged. The Energy Information Administration’s latest Short-Term Energy Outlook estimates that the U.S. will see a 3.4% increase in average daily NGL production this year. This will push production up to a record 2.48 million barrels per day.

End users simply can’t handle that much production and currently “reject” about 200,000 barrels of ethane per day back into the gas supply. However, that has its limits as well. And with no real ways to take up the excess supply, prices for ethane have plunged about 70% over the last two years. That has dropped prices down to lows not seen since 2002.

Given the falling NGL prices, the luster is certainly starting to fade for wet gas producers like Range Resources (RRC[3]) or Linn Energy (LINE[4]). Yet, for those firms that rely on ethane for feedstocks, the shine is getting all the brighter.

Ethane can be “cracked” in a refining process to create one of the basic commodity chemicals, ethylene. From there, it can be used to make everything from plastic bottles to baby diapers. And given the low prices for ethane, margins at several chemical manufacturers are now at huge historic highs.

For investors, adding a dose of the chemical producers could be exactly what their portfolio needs. Here are two of the best.

Westlake Chemical

Low ethane prices have been a boon for Westlake Chemical (WLK[5]). That’s because the firm solely operates in the commodity chemicals business — with ethylene and its derivatives as its main products. Those low feedstock prices, along with strong margins have helped Westlake’s profits pop nearly 26% year-over-year during the last reported quarter. The company has also managed to provide positive earnings surprises for the past four quarters by beating analyst expectation by an average of 18.5%.

Investors in Westlake have been benefiting as well.

Aside from the fact that WLK stock is up about 30% year-to-date, the company recently decided to spread some of its good fortunes back to investors via a big bump in its quarterly dividend. The firm recently upped its dividend by 20%, even after 2012’s huge 150% increase to its dividend.

With plenty of new ethylene projects underway and margins continuing to be quite juicy, investors in Westlake can expect similar dividend increases down the road. WLK shares currently trade for a forward P/E of less than 12.

LyondellBasell

Like Westlake, LyondellBasell (LYB[6]) is making a killing from cheap U.S. natural gas. The chemical firm produces ethylene at a cost of around 10 cents per pound. That helps provide some of the largest margins in the business. European and Asian rivals make the commodity chemical for around 50 cents per pound. Given that huge spread, LyondellBasell expects profits will jump about 17% next year.

However, the company isn’t just a one-trick pony with regards to growing production due to fracking.

LYB is also taking advantage of low natural gas prices with the production of methanol. The firm’s Channelview Plant in Texas has been idled for more than decade as natural gas prices previously surged. The restarted plant will produce around 260 million gallons of methanol every year and contribute about $250 million to Lyondell’s earnings.

Shares of the firm are up about 32% this year, and LYB continues to reaffirm and raise its dividend[7]. The stock currently yields 2.5% and can be had for a forward P/E of just 10.

The bottom line: Both Westlake and LyondellBasell can be your ticket to sustained lower NGL and natural gas prices for the next few years.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

Endnotes:
  1. steep drop in prices: http://investorplace.com/2013/08/riding-the-roller-coaster-in-agriculture/
  2. propane: http://investorplace.com/2013/05/power-your-portfolio-with-2-propane-plays/
  3. RRC: http://studio-5.financialcontent.com/investplace/quote?Symbol=RRC
  4. LINE: http://studio-5.financialcontent.com/investplace/quote?Symbol=LINE
  5. WLK: http://studio-5.financialcontent.com/investplace/quote?Symbol=WLK
  6. LYB: http://studio-5.financialcontent.com/investplace/quote?Symbol=LYB
  7. raise its dividend: http://investorplace.com/ipo-playbook/new-mlp-ipos-hot-out-of-the-oven/

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