US Ethane Outlook:Implications for US Processors and Ethylene Producers

Presented to PFAA’s Eleventh Annual Conference

Barton Creek

Austin, Texas

November 3rd – 5th, 2004

Peter Fasullo

En*Vantage, Inc

pfasullo@envantageinc.com

2

Background:

Last December ‘03, Enterprise commissioned En*Vantage to:1. Determine the sensitivity of the NGL midstream environment to the business

cycles of the US ethylene industry.

2. Assess how the GulfTerra merger changes Enterpise’s sensitivity to ethylene business cycles and to different price decks for crude and natural gas.

Study completed in February ‘04 and was presented to rating agencies, bankers and security analysts, made public at security analyst meeting on May 26, 2004.

Challenge was to develop simple bench marks to gauge whether the NGL business environment would improve or worsen.

Part 1 of the study primarily centered on the fundamentals driving ethane supply/demand and frac spreads.

Today: Walk through methodology and share updated findings regarding the outlook for ethane and its implications.

3

Why Ethane? --- It is the one NGL component that has frustrated processors and ethylene producers the most.

On average, ethane constitutes 37% of the US NGL barrel extracted, but yields have varied from 34% to 46% when processing economics dictated. Ethane extraction is mostly discretionary and very sensitive to economic conditions,

frac margins and location of the processing facility. When extraction economics are good for ethane, they are good for the entire

processing operation, and the opposite is true - especially for cryogenic plants.

Unlike other NGLs with multiple end uses, virtually all ethane is used in ethylene production, competing with other NGL and petroleum feedstocks. On average, ethane constitutes 45% of the US ethylene feedstock mix and it provides

the highest ethylene yield of all the feedstocks.

But, history indicates that ethane cracking can swing quickly from 38% to 51% of the mix when feedstock economics dictate or cracker utilization rates change.

Overall, ethane supply and demand can easily swing 100 MBPD or more in a market that has averaged around 750 MBPD.

4

Ethane is extremely dependent on gas processing and ethylene production. Supply & Demand fundamentals may appear simplistic, but they are complex and volatile.

Key market drivers influencing ethane cracking and extraction:

Ethane Cracking

Ethylene business cycle

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

US Ethane Supply & Demand5-Year Average

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

900.0

Ethane Supply Ethane Demand

Etha

ne M

BPD Gas Processing

680 MBPD

Petrochemicals(Primarily Ethylene)

751 MBPD89%

84 MBPD

Crude Oil Refining

764 MBPD 764 MBPD

Peak Shaving13 MBPD

98%

Source: DOE, En*Vantage, Hodson

5

Our analysis of ethane supply & demand focused on two primary drivers.

Primary Driver Rational Influence

Natural Gas to Crude Price Ratio(Henry Hub Gas/Cushing WTI on a BTU basis)

Gas sets price floor for NGLs (ethane) and petroleum derived feedstocks and products set the market price.

Processing Margins

Feedstock Economics

US Ethylene Production as driven by GDP growth

US ethylene industry consumes 54% of total NGLs supplied and virtually all of the ethane extracted from natural gas.

The amount of ethane consumed should increase as ethylene production increases.

Need to determine how co-products can affect ethane cracking.

Both being inversely related to the gas to crude price ratio

6

The relative value of gas to crude plays an important role in driving U.S. NGL supply/demand, particularly for ethane.

Source: Platts, DOE and En*Vantage

Gas to Crude Price Ratio*(Henry Hub Gas to WTI on a BTU Basis)

1/91 thru 10/04

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

Jan-

91

Jul-9

1

Jan-

92

Jul-9

2

Jan-

93

Jul-9

3

Jan-

94

Jul-9

4

Jan-

95

Jul-9

5

Jan-

96

Jul-9

6

Jan-

97

Jul-9

7

Jan-

98

Jul-9

8

Jan-

99

Jul-9

9

Jan-

00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

’91-’94: 56%’95-’98: 70%’99-’02: 78% ’03: 103%’04 YTD: 86%

Winter ‘00/’01

Winter/Spring ’03

"Gas Bubble" Mid '80s to Early '90s

End of "Gas Bubble" Late '90s to Now

"The Emergence of Gas Fired Power Plants"

Time period where we focused our study

* Based on 5.8 MM BTU/Bbl

7

NGL frac spreads are inversely correlated to the gas to crude price ratio.....

NGL Frac Spreads (Mt Belvieu minus Henry Gas)

(15.00)

(10.00)

(5.00)

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

45.00

NG

L F

rac

Sp

read

cp

g

40%

60%

80%

100%

120%

140%

160%

180%

Gas

to

Cru

de

Rat

io %

Ethane Frac Spread

Gas to Crude Ratio Propane Frac Spread

Butane+ Frac Spread

Study Completed

Source: Platts & En*Vantage

8

....and that inverse relationship is reflected in the amount of NGLs extracted versus the gas to crude price ratio. But what causes this particular pattern and variability?

U.S. Gas Processing NGL Production vs Gas to Crude Price Ratio

1500

1600

1700

1800

1900

2000

2100

40.0%50.0%60.0%70.0%80.0%90.0%100.0%110.0%120.0%130.0%140.0%

Gas to Crude Price Ratio

NG

L E

xtra

ctio

n (M

BP

D)

Q2 '03

Q3 '03

Q4 '03Q1 '03

Q1 '01

Q2 '01 Q3 '01

Q4 '01

Q4 '00

Q1 '00

Q2 '00Q3 '00

Q4 '99

Q1 '99

Q2 '99

Q3 '99Q4 '02 Q1 '02

Q3 '02Q2 '02

Trough Conditions

R2 = 0.63

Source: DOE and En*Vantage

9

The pattern and variability seen in NGL extraction versus the gas to crude price ratio is mostly due to the fundamentals driving ethane extraction. Needs further investigation.

Trough Conditions

Source: DOE and En*Vantage

10

Ethane Cracking & Ethane Extraction vs Gas to Crude Ratio

350

400

450

500

550

600

650

700

750

800

Q1'99

Q2'99

Q3'99

Q4'99

Q1'00

Q2'00

Q3'00

Q4'00

Q1'01

Q2'01

Q3'01

Q4'01

Q1'02

Q2'02

Q3'02

Q4'02

Q1'03

Q2'03

Q3'03

Q4'03

Q1'04

Q2'04

Eth

an

e E

xtra

ctio

n o

r C

rack

ing

(M

BP

D)

40%

50%

60%

70%

80%

90%

100%

110%

120%

130%

Ga

s to

Cru

de

Ra

tio (

He

nry

Hu

b/W

TI)

Ethane Cracking (excluding

refinery ethane)Gas to Crude Ratio

Ethane Extraction

Source: Hodson, EIA, En*Vantage

Ethane extraction closely tracks ethane cracking, influenced by the gas to crude price ratio. But, how do competing feedstocks & ethylene business cycles affect the amount of ethane cracked?

11

The gas to crude price ratio appears to influence the cracking of ethane versus heavy feedstocks. So, how does the absolute level of ethylene production affect ethane cracking?

U.S. Ethylene Feedstock Consumption(Q1 '99 to Q3 '04)

0

100

200

300

400

500

600

700

800

Q1'99

Q2'99

Q3'99

Q4'99

Q1'00

Q2'00

Q3'00

Q4'00

Q1'01

Q2'01

Q3'01

Q4'01

Q1'02

Q2'02

Q3'02

Q4'02

Q1'03

Q2'03

Q3'03

Q4'03

Q1'04

Q2'04

Q3'04

Fee

dst

ock

s C

rack

ed M

BP

D

0%

20%

40%

60%

80%

100%

120%

140%

160%

Gas

to

Cru

de

Pri

ce R

atio

Source: Hodson, En*Vantage

Ethane (excl. refinery ethane)

Heavy Feeds(naphthas & gas oils)

Gas to Crude Ratio

Propane

N-Butane

Study Completion

12

For the past 5 years, U.S. ethylene production varied anywhere between 48 and 58 billion lbs/yr rates and it is currently rebounding from the mid-year 2003 trough.

US Ethylene Quarterly Ethylene Production on an Annualized Basis Versus Industry Operating Rates

30

35

40

45

50

55

60

65

Q1'99 Q3'99 Q1'00 Q3'00 Q1'01 Q3'01 Q1'02 Q3'02 Q1'03 Q3'03 Q1'04 Q3'04

Eth

yle

ne P

rodu

ctio

n B

illio

n Lb

/Yr

70

75

80

85

90

95

100

105

Ope

ratin

g R

ate

%

Ethylene Production Effective Operating Rate Nameplate Operating Rate

Source: NPRA, CMAI, Hodson and En*Vantage Estimate based on preliminary 3rd Quater '04 production

Trough Conditions

13

As ethylene production increases, ethane cracking increases and the flexibility to swing ethane volumes diminishes.

E th a n e C ra c k in g v e rsu s

E th yle n e P ro d u c tio n

(E xc lu d in g R e fin e ry

E th a n e )

4 5 05 0 0

5 5 06 0 0

6 5 07 0 0

7 5 08 0 0

4 7 .

0

4 8 .

0

4 9 .

0

5 0 .05 1 .

0

5 2 .

0

5 3 .

0

5 4 .

0

5 5 .

0

5 6 .

0

5 7 .

0

5 8 .

0

5 9 .

0

E th yle n e P ro d u c tio n

(b illio n lb /yr)

Ethane Cracking versus Ethylene Production(Excluding Refinery Ethane)

450

500

550

600

650

700

750

800

47.0 48.0 49.0 50.0 51.0 52.0 53.0 54.0 55.0 56.0 57.0 58.0 59.0

Ethylene Production (billion lb/yr)

Eth

ane

Cra

ckin

g M

BP

D

Effective Op Rate: 79.0% 80.7% 82.3% 83.9% 85.5% 87.1 % 88.7% 90.3% 91.9% 93.5%

Qrtly Ethane Cracking Volumes: Hodson: Q1'99 thru Q4'03 Annualized Qtrly Ethylene Production: Hodson & CMAI

Max. Cracking Level

Min.Cracking Level

Q1

Q2 ’04

Q3

Q1 & Q2 ‘03

14

Minimum ethane cracking levels are not sustained more than 1 quarter without creating a surplus of ethylene co-products.

E th a n e C ra c k in g v e rsu s

E th yle n e P ro d u c tio n

(E xc lu d in g R e fin e ry

E th a n e )

4 5 05 0 0

5 5 06 0 0

6 5 07 0 0

7 5 08 0 0

4 7 .

0

4 8 .

0

4 9 .

0

5 0 .05 1 .

0

5 2 .

0

5 3 .

0

5 4 .

0

5 5 .

0

5 6 .

0

5 7 .

0

5 8 .

0

5 9 .

0

E th yle n e P ro d u c tio n

(b illio n lb /yr)

Ethane Cracking versus Ethylene Production(Excluding Refinery Ethane)

450

500

550

600

650

700

750

800

47.0 48.0 49.0 50.0 51.0 52.0 53.0 54.0 55.0 56.0 57.0 58.0 59.0

Ethylene Production (billion lb/yr)

Eth

ane

Cra

ckin

g M

BP

D

Effective Op Rate: 80.3% 82.0% 83.6% 85.2% 86.9% 88.5 % 90.2% 91.8% 93.4% 95.1%

Qrtly Ethane Cracking Volumes: Hodson: Q1'99 thru Q4'03 Annualized Qtrly Ethylene Production: Hodson & CMAI

Q2’03; 108%

Q3’03; 96%

Q4’03; 94%

Q1’02; 63%

Q1’01; 143%

Q2’01; 97%

Q1’00; 51% Q4’99; 61%

Q3’99; 69%

Quarter; Gas to Crude R atio

Q1’03; 112% Q2’02;

75%

Q4’02; 82%Q3’02; 65%

Q1’99; 77%

Q2’99; 71%Q2’00; 69%

Q3’00; 78%

Q4’00;96%

Q1 ’04; 92%

Q2 ’04; 93%

Q3 ’04; 73%

Effective Op Rate: 79.0% 80.7% 82.3% 83.9% 85.5% 87.1 % 88.7% 90.3% 91.9% 93.5%

15

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.

Shift in US Ethylene Plants

Basic Types of Ethylene Plants

Effective Capacity1

2004 2000

B Lb/Yr % B Lb/Yr %

Purity Ethane Crackers 6.1 9.8 6.6 11.0

E/P Crackers 20.2 32.6 23.2 38.6

Flexi Crackers 29.3 47.3 27.1 45.1

Heavy Feed Crackers 6.4 10.3 3.2 5.3

Total Effective Capacity 62.0 100.0 60.1 100.0

1 Capacity numbers exclude ethylene plants that are mothballed. Source: Hodson and En*Vantage

16

Our analysis indicates the following implications for ethane demand at different levels of US ethylene production.

Ethylene Production

Effective Utilization

Ethane Cracking Levels1 (MBPD)

(B Lb/Yr) (%) Min. Max. Flex. Range Trendline

49515355575961

79.082.285.588.791.995.298.4

495545595645695735775

655675695710725745775

1601301006530100

575610645675710740775

1 Excludes Refinery Ethane

1. Higher ethylene production requires greater ethane cracking (min and max) and the industry’s flexibility to swing ethane volumes diminishes.

2. The gas to crude price ratio also influences ethane cracking levels, particularly when ethylene industry utilization rates are between 80% to 90%. Gas to crude price ratios above 90% increase the probability of minimizing ethane cracking.

3. However, 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.

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

18

Back in February 2004, we felt that conditions in 2004 should provide a better environment for ethane cracking.

Ethane Cracking Swings Between 500 -700 MBPD Are Possible with a Bias to Maximize Ethane Cracking

High Probability of Ethane Cracking Swings Between 500 -700 MBPD with a Bias to Minimize Ethane Cracking as long as Co-Product Production is Not an Inhibitor

At 53-55 B Lb/yr, Moderate to Good Probability of Ethane Cracking at or above 650 MBPD. Gas to Crude Ratio Less of a Factor at Production Rates above 55 B Lb/yr

Gas

to

Cru

de P

rice

Rat

io

Bel

ow 9

0%A

bove

90%

Ethylene ProductionBelow 53 B LB/YR Above 53 B LB/YR

High Probability of Sustainable Ethane Cracking at or Above 650 MBPD

19

To support greater ethane cracking levels, the ethane “frac” spread increases to encourage more ethane extraction.

Mt. Belvieu Ethane Frac Spread vs Ethane Cracking

0

2

4

6

8

10

12

14

16

18

20

22

24

500 525 550 575 600 625 650 675 700 725 750 775 800

Ethane Cracking MBPD

Fra

c S

pre

ad c

pg

When cracking levels exceed 675 MBPD, ethane fracs have a greater probability to expand rapidly, particularily when gas to crude ratios are below 90%

129%

113%94%

81%

75%

94%

120%69%

107%

89%

68%65%

92%60%

73%

68%

73%

82%

59%

52%

73%

93%

92%

Q1 '99 thru Q4 '03

Q1 '04 thru Q3 '04

Gas to Crude Ratio

Q3 ‘04

Q1 ‘04

Q2 ‘04

Source: Platts, En*Vantage and Hodson

20

A paradigm shift to tighter crude markets should provide reasonable gas to crude price ratios (90% or below) and favorable conditions for ethane cracking and extraction.

Gas to Crude Price RatioHenry Hub Gas to WTI (BTU Basis)*

50%

60%

70%

80%

90%

100%

110%

120%

130%

140%

150%

160%

170%

2003

2004

2002

Expected Range of '05 Gas to Crude Ratio

* 5.8 MM BTU/Bbl

Study Completion

2004

2002

2003 Period WTI Prices WTI Prices Natural Gas Prices Gas to Crude Ratio Gas Premium to Crude$/Bbl $/MM Btu $/MM Btu % $/MM Btu

1st 10 mos '03 $31.03 $5.35 $5.51 103% $0.161st 10 mos '04 $40.04 $6.90 $5.77 84% ($1.14)Delta '04 -'03 $9.01 $1.55 $0.26 -19% ($1.29)

Source: En*Vantage, ICE, DOE

21

Assuming ethylene production tracks GDP growth rate at a 0.9 multiple, ethane cracking could reach 800 MBPD by 2010.

Forecast of Ethylene Production and Ethane CrackingPeriod US GDP

AGRUS Ethylene

AGRUS Ethylene Production

US Ethane Cracking2

Billion Lbs/Year MBPD

Q1 ’85 – Q4 ’99

2000

2001

2002

2003

3.0%

3.7%

0.2%

2.1%

3.1%

4.0%

-0.8%

-9.2%

3.4%

-1.0%

55.81

55.4

50.3

52.1

51.2

688

722

642

673

613

2004(e) 4.0% 9.2% 55.9 680

2005

2006

2007

2008

2009

2010

3.2%

2.5%

2.0%

2.0%

2.0%

2.0%

2.9%

2.2%

1.8%

1.8%

1.8%

1.8%

57.5

58.7

59.7

60.8

61.9

63.0

715

735

755

770

790

8051 1999 Production 2 Excludes Ref. Ethane

Source: History- CMAI, En*Vantage and Hodson; Est & Forecast - En*Vantage

22

US ethane extraction is distributed across the major processing regions. Regional costs of getting ethane to market is determined by T&F fees and gas basis.

80 12%

Rocky Mtn.Mid-Continent

Texas Inland

Texas Gulf Coast

Louisiana Gulf CoastNew Mexico

Upper Midwest

Other

5-Year Average Ethane Regional Production from Processing

(MBPD )

85 12%

222 33%

58 9%

111 16%

97 14%

203%

9 1%

% of US Ethane Production

• US Processing NGLs: 1843 MBPD• US Processing Ethane: 682 MBPD• US Ethane/US NGLs: 37%• Rockies Ethane/NGLs: 40%• NM Ethane/NGLs: 47%• Tex Inland Ethane/NGLs: 39%• Tex GC Ethane/NGLs: 42%• La GC Ethane/NGLs: 35%• Mid-Cont Ethane/NGLs: 36%

• 80% of US Gas Production is Processed

• 590 processing plants - 72 BCFD capacity

• 56% of plant capacity is cryogenic

• 70 fractionators - 2.0 million BPD capacity

• 85 % of Frac capacity at market centers

Source: EIA and En*Vantage

23

• Each processing region responds to economic signals to throttle up or down

ethane extraction to meet ethane demand. • Analysis of each region’s cost of getting ethane to market shows that the Rockies is not always the swing producer. “East LA” often provides the swing.

Source: EIA & En*Vantage

Monthly Min-Max Range of Regional Ethane Production from Processing(MBPD)

1999 2000 2001 2002 2003Region Avg Min Max Avg Min Max Avg Min Max Avg Min Max Avg Min Max

Texas Inland 227 211 238 233 192 242 219 163 240 225 209 237 204 169 228

Texas G.C. 60 49 67 68 59 72 56 15 67 58 50 64 44 34 56

LA. G.C. 116 77 150 128 72 146 109 45 143 115 91 133 84 64 111

New Mexico 93 78 103 97 89 104 100 83 110 97 88 104 99 90 106

Rocky Mountain 59 29 81 85 70 94 86 64 93 87 72 99 83 60 108

Mid Continent 99 86 106 92 52 107 84 55 96 78 64 91 71 63 86

Upper Midwest 4 4 4 3 0 4 28 3 38 32 17 43 36 22 45

Other 10 3 12 10 7 13 9 8 10 6 4 9 4 1 9

Total Ethane 668 537 761 716 541 782 691 435 797 699 594 779 625 503 749

Data indicate that the processing industry can ramp up ethane extraction to near 800 MBPD, which supports 62 to 63 billion lb/yr of ethylene production.

24

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

Source: DOE, En*Vantage

U.S. Regional Ethane Production Outlook(MBPD)

130 111 117 82 115 136217

98 100 9799

106109

102

302274 281

245

257

258

8585 87

89

99106

127113 110

101

103101

94

251

270

0

100

200

300

400

500

600

700

800

2000 2001 2002 2003 2004 2005 2010

MB

PD

La Gulf Coast New Mexico Texas Rockies Mid Cont. Other

18%

14%

42%

12%

13%

13%

16%

40%

15%

16%

27%

13%

32%

16%

12%720

618

805

Forecast

680715692 699

25

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.

Ethylene Demand

Ethylene Production

Feedstock Capabilities

Ethane Demand

GDP GrowthEffective

Operating RateComposition

of Plants

Gas to Crude Price Ratio

Ethane Frac Spread

Regional Extraction Economics

Regional Ethane

Production

Ethane to Market

Demand Side Factors

Supply Side Factors

26

In Conclusion: Ethane is very much alive!!! --- barring a recession.

As ethylene production grows, ethane cracking must increase and the flexibility to switch off ethane diminishes.

Paradigm shift to a tighter crude market will keep ethane competitive with heavier feedstocks.

Ethane frac spreads should remain strong to encourage extraction in all regions.

This is not the time for processors to retreat from cryogenic plants. Current infrastructure is in place to support ethane extraction in the 750

to 800 MBPD range, which can support ethylene production levels of 60 to 62 billion lbs/year as the economy moderately grows.

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.