Nine months ago, natural gas liquids (NGLs) seemed like a sure thing for producers.

To boost profits, the oil and gas industry spent the past few years going through a shale-gas makeover as hydraulic-fracturing techniques advanced. Part of that transformation was a shift to liquids-rich gas and away from dry natural gas.

The bounty has been good; maybe a bit too good.

A mounting supply of NGLs has created a steep discount this year, weakening the profitability of a key driver of U.S. shale development, according to an Oct. 22 Ernst & Young Oil & Gas Center quarterly analysis.

Supply has outpaced demand, particularly from chemical plants that use NGLs as feedstock for plastics. The market for NGLs appears to be leveling out, the analysis says.

While not as robust, NGLs are still “more attractive” than producing dry natural gas.

“Companies still have plenty of incentive to produce NGLs,” said Marcela Donadio, Americas
Oil and Gas Leader, Ernst & Young. “Prices remain significantly higher than natural gas. But we’re seeing a marked shift in demand.”

Nonetheless, a new report by IHS Global Insight (NYSE: IHS) sees prospects for natural gas beyond the domestic market and says increasing NGL production will be a boon to the petrochemical industry.

“The greater availability of NGLs can be expected to support the expansion of U.S. petrochemical manufacturing, which uses NGLs as feedstock,” according to the report, America’s New Energy Future: The Unconventional Oil and Gas Revolution and the U.S. Economy.

In a broader sense, an abundant supply of natural gas and its impact on market prices is prompting a national discussion about wider markets, and the question may well be, “not how much the U.S. imports, but rather how much it should export,” according to the report. It was sponsored by the American Petroleum Institute, the American Chemistry Council and other associations.

NGL production from shale-gas and tight-gas plays and other sources could potentially reach 4.8 million barrels of oil equivalent per day (MMBOE/d) by 2035 from 1.8 MMBOE/d this year, IHS reported.

Since 2008, overall NGL production in the U.S. has grown more than 500,000 barrels per day (bbl/d), a 29% increase largely tied to unconventional sources, IHS reported. Production of NGLs from unconventional activity is anticipated to more than double to 3.8 million barrels per day (MMb/d) by 2020 from 1.8 MMb/d this year.

Gas processing plants extract NGLs such as ethane, propane, butane, isobutene and pentane for sale in their respective markets.

Overall, domestic natural gas production has increased 20.5% since 2008, when hydraulic fracturing and other technology opened up shale resources, Mark J. Perry, an economics professor at the University of Michigan and American Enterprise Institute scholar, recently noted.

Shale production has created bargain prices for U.S. consumers, who save more than $100 billion per year from lower natural gas costs, Perry said.

But market prices are falling for NGLs, too.

The frac spread, which calculates the margin between NGL prices and the cost of natural gas used to extract NGLs, is shrinking, according to Ernst & Young.

Natural gas prices, on the other hand, are being driven up by slowing production growth, increasing demand, and reductions in the massive storage overhang. For instance, year-to-date gas consumption is up 30% in the power sector.

Spot natural gas prices have climbed to more than $3.25 per million Btu (MMBtu). While about 50% higher than in the second quarter, the price is still low by historical standards, the analysis said.

Domestic natural gas storage levels are nearing more average ranges, a good sign for natural gas producers since prices could be strengthened by a cold, early winter and lower storage levels.

NGL composite spot prices, on the other hand, began the year at $13.81 per MMBtu, a slight increase from last year. By July, prices had plunged 30% to $9.66 per MMBtu, according to statistics from the Energy Information Administration. In July 2011, NGL composite spot prices commanded $15.79 per MMBtu. Composite spot prices are based on NGLs weighted by gas processing plant production volumes.

But another shale resource isn’t feeling the pressure from increased production. Crude oil is expected to produce 6.9 MMb/d next year, the highest level of production since 1993. No supply shortages or excesses are on the horizon, Ernst & Young reported.

Oil has managed to resist the supply and demand tug of war, as prices remain high with U.K. Brent crude trading at more than $110 a barrel and West Texas Intermediate (WTI) crude trading over $90 per barrel, the analysis said.

Shale drilling continues to fuel growth but, “infrastructure bottlenecks remain a serious issue,” according to the Ernst & Young.
However, the number of rigs drilling in the Gulf of Mexico is steadily increasing.