An 8.23% Yield With This Chemical Company

David Fessler By David Fessler, Energy and Infrastructure Strategist, The Oxford Club

Oil & Gas

Next to methane, the largest chemical compound found in natural gas is ethane, or C2H6. Until the 1960s, producers left it in the gas stream and burned it right along with methane.

Nowadays, however, ethane is the raw material used to produce ethylene. Ethylene is widely used in the chemical industry to produce polyethylene, a popular plastic.

Over the last five years, the demand for plastic has grown an average of 5% annually. And that’s expected to continue. The demand for its raw material, ethylene, has also grown, and that’s creating a big opportunity for investors.

Let’s look at today’s ethane market. With the abundance of natural gas production from U.S. shale formations, the U.S. has seen a sharp rise in the production of natural gas liquids (NGLs).

NGLs contain ethane and other chemicals. Cracking plants separate them from the natural gas stream. Manufacturers use them for industrial and commercial purposes.

The oversupply of NGLs sent their prices plummeting. As a result, natural gas suppliers were “rejecting” ethane.

That means instead of separating it out, they were just leaving it in the natural gas stream. That increases the energy content of the natural gas and allows producers to get higher prices. And why not? They might as well get higher prices in a down market.

A $164 Billion Expense

However, last year, given the oversupply of natural gas and low prices, the top 40 U.S. producers of natural gas cut capital expenditures by 50% or more. That means less natural gas and, consequently, less ethane.

Yet demand is ramping up. The chemical industry is making huge investments based on available ethane capacity from U.S. shales.

And why wouldn’t they? With U.S. natural gas prices the lowest on the planet, the chemical companies can make ethylene cheaper here than anywhere else.

Approximately $164 billion in new capital will be spent on U.S. ethylene plant construction.

As you can see, ethane crackers (chemical processing plants built to extract and purify ethylene) are under construction along the Gulf Coast and in Western Pennsylvania.

Much of the added cracking (production) capacity is for export markets. Given the low input costs, exported ethylene is very competitive on the global market.

This certainly improves the U.S. balance of trade. Royal Dutch Shell (NYSE: RDS.A) is building one of the largest ethylene plants in the U.S.

The plant is northwest of Pittsburgh. The 780-acre site is existing industrial land located on the Ohio River.

Shell plans to complete the plant sometime in 2020. When fully operational, the plant would convert ethane into ethylene and then into 1.6 million tons of polyethylene annually. Polyethylene has many uses, including trash bags, food packaging, diapers, housewares, toys, drums, crates and bottles.

Why did Shell decide to build the $6 billion plant 30 miles northwest of Pittsburgh? Simple.

The Marcellus and Utica shales provide nearly 25% of the natural gas supply in the U.S. So there is an ample supply of ethane to feed a huge chemical plant like the Shell plant.

In fact, there is so much natural gas and ethane in Appalachia, there are two more companies planning similarly sized plants. The first one will be in Ohio and the second will be in West Virginia.

The Shell plant will be of similar size to ethane cracking plants located in the Gulf Coast region and in other parts of the world. The plant is so large, it will require its own power-generating station, which will also run on natural gas.

An 8.23% Yield

Once again, I’m a pick-and-shovel guy. This plant and the power plant that feeds it are going to need a lot of natural gas.

So I would focus my efforts on natural gas pipeline companies that operate in the Marcellus region. Many are master limited partnerships (MLPs).

DCP Midstream L.P. (NYSE: DCP) is one such MLP. It primarily focuses on natural gas and NGLs. Over the last year, its unit price has increased more than 68%.

Even better, it currently pays a handsome 8.23% distribution yield. It doesn’t get much better than that.

The bottom line is ethane is big business and getting bigger. And cheap natural gas makes it even more profitable.

In my opinion, natural gas pipeline MLPs are the best way to play this booming sector.

Good investing,

Dave