# Presentation: 438688

## The Impact of Prices on Production Volumes: Propane and Natural GasKara Norman

## This is a working document prepared by the Energy Information Administration (EIA) in order to solicit advice and comment on statistical matters from the American Statistical Association Committee on Energy Statistics. This topic will be discussed at EIA's fall 2007 meeting with the Committee to be held October 18 and 19, 2007.

**Notes:**
Here’s the disclaimer.  This is a work in progress, especially in my case!

## Outline

- Objective
- Background
- Research
- Analysis
- Questions to the Committee

## Objective

- Research Goal
- analyze the impact of propane and natural gas prices on produced volumes of propane and dry natural gas

**Notes:**
Our research goal is to analyze the impact of propane and natural gas prices on the produced volumes of propane and dry natural gas.

In other words, “Does propane drive the natural gas market?”

## Natural Gas Composition

**Notes:**
Unprocessed natural gas contains, on average:

71% methane
12% ethane
8% propane
5% butane
4% contaminants

(Processed natural gas is approximately 90% methane.)

## Natural Gas Processing

**Notes:**
As you can see, there are many steps to processing natural gas.  The last step is fractionation, which is optional depending on the source and type of gas stream.  

For our analysis, we also assume that the potential profitability of the extracted propane affects whether or not fractionation occurs.

EIA Definition of Fractionation: The process by which saturated hydrocarbons are removed from natural gas and separated into distinct products, or "fractions," such as propane, butane, and ethane. 

## Background

- Fractionation
- separate ethane, propane, and butane from natural gas stream
- focus on propane
- When to take propane *from* stream?
- When to leave propane *in *stream?

**Notes:**
Through the fractionation process natural gas processing plants can separate propane, ethane, and butane from the natural gas stream, all of which are marketable.  We focus on propane, mainly because there are more data available for propane.

I want to know: At which point would the owner of that natural gas decide to extract more propane from the natural gas they have purchased?  When would the owner opt to leave propane in the natural gas stream?

My hypothesis is that this depends on the prices of the natural gas supplied to the process, as well as the natural gas and propane sold after the process.

For example if the selling price of natural gas is high, it would be in the gas owner’s best interest to leave as much propane, ethane, and butane in the natural gas stream as possible (provided they still meet any regulations on the quality of that natural gas).  In that case, the volume of the natural gas the owner sells will be larger, they will not need to spend time or money extracting other gases, and thus their overall profit would increase.

## Research

- Model
- 15 observations from 1996 to 2006
- Least Squares Regression Method
- Dependent Variable
- Propane Spot Prices
- Belvieu
- MidCon
- Independent Variables
- Crude Oil Spot Price
- Natural Gas Wellhead Price
- Coefficient estimates similar for both models

**Notes:**
During my research, I came across two models for natural gas processing plants using the Least Squares Method.  There were 15 observations from 1996 to 2006.  The two models only differ with regards to the dependent variables.  The first uses a propane spot price from Belvieu, the second uses a propane spot price from MidCon, but basically the models are the same, and the coefficient estimates were quite similar for both models.

However, I questioned the use of the first independent variable, Crude Oil Spot Price.  If this is a natural gas phenomenon, why involve crude oil?  I understand there are many interdependencies between oil and gas, but this didn’t seem like a good case for relying on those relationships.

Data may not even be “international”, and why did they use Crude Oil for a NATURAL GAS phenomenon??? – FOLLOW UP ON THIS!!! Model used for ___???

## Input/Output Diagram

**Notes:**
However, one thing I liked about that model was its simplicity and I’m looking to keep my analysis simple and straightforward.

Ideally, what I want are the input prices and volumes, as well as the output prices and volumes from this simple diagram.  

Basically, wet natural gas is sent through fractionators, and propane and dry natural gas are the end products.

## Analysis:Price Variables

| Input Prices |
| --- |
| U.S. Natural Gas Wellhead Price Converted (¢/GGE) |
| Output Prices |
| U.S. Natural Gas Weighted Average Price (¢/GGE) |
| U.S. Propane Simple Average Price (¢/GGE) |

**Notes:**
So, I went looking for data to fill this model.  This was actually the most time consuming part of the process.  I would find data, I would analyze it, I would share my results with colleagues, I would discover problems, many times requiring me to redefine the concept, which meant I had to start the process all over again.  This went on for months before I finally sifted out the following variables.

Sort Variable
date		Date

Input Price
usngwpc		U.S. Natural Gas Wellhead Price Converted (Cents per Gasoline Gallon Equivalent)

Output Prices
usngap		U.S. Natural Gas Weighted Average Price (Cents per Gasoline Gallon Equivalent) – Weighted Average of Residential, Commercial, Industrial, and Electric Power Prices
uspap		U.S. Propane Simple Average Price (Cents per Gallon) – Simple Average of Residential, Commercial, and Industrial Prices (volumes unavailable for a weighted average)

## Analysis:Volumetric Variables

| Input Volumes |
| --- |
| U.S. Natural Gas Gross Withdrawals Converted (MCF) |
| U.S. Total Volume of Natural Gas Received from Fractionators, Gas Processing Plants, and Natural Gas Plants (MCF) |

**Notes:**
Input Volumes
usnggwc		U.S. Natural Gas Gross Withdrawals Converted (Thousand Cubic Feet)
ngr			U.S. Total Volume of Natural Gas Received from Fractionators, Gas Processing Plants, and Natural Gas Plants (Thousand Cubic Feet)

NOTE:  “ngr” is not published and it is only a good volumetric input if we focus our analysis solely on the fractionators, gas processing plants, and natural gas plants, furthermore this data was only collected briefly and is no longer collected.

## Analysis:Volumetric Variables

| Output Volumes |
| --- |
| U.S. Natural Gas Marketed Production Converted (MCF) |
| U.S. Dry Natural Gas Production Converted (MCF) |
| U.S. Total Volume of Natural Gas Shipped from Fractionators, Gas Processing Plants, and Natural Gas Plants (MCF) |
| U.S. Total Propane Production from Fractionators, Gas Processing Plants, and Natural Gas Plants Converted (MCF) |

**Notes:**
Output Volumes
usngmpc		U.S. Natural Gas Marketed Production Converted (Thousand Cubic Feet)
usdngpc		U.S. Dry Natural Gas Production Converted (Thousand Cubic Feet)
ngs		U.S. Total Volume of Natural Gas Shipped from Fractionators, Gas Processing Plants, and Natural Gas Plants (Thousand Cubic Feet)
propanec	U.S. Total Propane Production from Fractionators, Gas Processing Plants, and Natural Gas Plants Converted (Thousand Cubic Feet)

NOTE:  “ngs” is not published and it is only a good volumetric input if we focus our analysis solely on the fractionators, gas processing plants, and natural gas plants, furthermore this data was only collected briefly and is no longer collected.

## Analysis:Fractionator Correlations

|  | date | ngwp | ngap | pap | ngr | ngs | prop |
| --- | --- | --- | --- | --- | --- | --- | --- |
| date | 1 | + | + | + | + | + |  |
| ngwp | + | 1 | + | + | + |  | - |
| ngap | + | + | 1 | + | + |  | - |
| pap | + | + | + | 1 | + | + | - |
| ngr | + | + | + | + | 1 | + |  |
| ngs | + |  |  | + | + | 1 | + |
| prop |  | - | - | - |  | + | 1 |

**Notes:**
This is a simplified correlation matrix for date, natural gas wellhead price, natural gas average price, propane average price, natural gas received by and shipped from fractionators/gas processing plants/natural gas plants, as well as the associated propane production for those facilities.

There’s a strong positive correlation between natural gas wellhead price and the other price variables, there’s also a positive correlation between natural gas wellhead price and natural gas received, but there’s a negative correlation between wellhead price and propane production.
There’s a positive correlation between natural gas average price and propane price, there’s a positive correlation between natural gas average price and natural gas received, but again there’s a negative correlation with propane production.
There’s a positive correlation between propane average price and natural gas received, as well as natural gas shipped, but again, there’s that counterintuitive negative correlation between propane price and propane production.

So,for high natural gas wellhead prices, propane production is low, and the same phenomenon occurs for high end-user prices of natural gas, which is what we want to see for our analysis, BUT, for high propane prices, propane production is low, which contradicts my hypothesis.

The only other interesting point to note is that for high values of propane average price, there’s an increase in natural gas received and shipped, almost as if that increased price causes gas owners to send more natural gas for processing, which again, is what we would expect, but with the negative correlation between propane price and propane production, the picture seems a little fuzzy.

## Analysis:National Correlations

|  | date | nggw | ngmp | prop | ngwp | ngap | pap |
| --- | --- | --- | --- | --- | --- | --- | --- |
| date | 1 | - | - | - | + | + | + |
| nggw | - | 1 | + | + | - | - | - |
| ngmp | - | + | 1 | + | - | - | - |
| prop | - | + | + | 1 | - | - | - |
| ngwp | + | - | - | - | 1 | + | + |
| ngap | + | - | - | - | + | 1 | + |
| pap | + | - | - | - | + | + | 1 |

**Notes:**
So here is a simplified correlation matrix for date, natural gas gross withdrawals, natural gas marketed production, propane produced by fractionators/gas processing plants/natural gas plants.
natural gas wellhead price, natural gas average price, and propane average price.

Basically, we zoomed out a bit, and rather than focus on the natural gas received by and shipped from fractionators, gas processing plants, and natural gas plants, we’re looking at the national volumes of natural gas.  However, I still use propane production from those plants because it is the best volumetric value I could find (all others included propane from refineries and that’s not really what we’re after with this analysis).

There’s a strong positive correlation between natural gas gross withdrawals and the other two volumetric variables, but a negative correlation between natural gas gross withdrawals and all three price variables (makes sense: production increases, prices decrease).
There’s a positive correlation between marketed production and propane production, but there’s a negative correlation between marketed production and all three price variables (again production increases, prices decrease).
There is a negative correlation between propane production and all three price variables (prices decrease for natural gas and propane, and MORE propane is produced? Or for high production of propane, prices decrease?)

So, for high natural gas wellhead prices, propane production is low, and the same phenomenon occurs for high prices of natural gas to end-users.  Both of these phenomena is what we want to see for our hypothesis, BUT, for high propane prices, propane production is STILL low, which seems to contradict my hypothesis.

## Analysis:Price Plot

**Notes:**
Here is an overlaid plot of natural gas wellhead price, natural gas average price, and propane average price.  You can see that they share very similar patterns.  If one increases, the others increase and vice versa.

## Analysis:Marketed Production and Price Plot

**Notes:**
Here’s an overlaid, double-axis plot.  On the left vertical axis, we see natural gas marketed production volumes (the black squares).  The right vertical axis is for our three price variables (wellhead price, natural gas average price, and propane average price).

What we want to see is an increase in marketed production whenever there’s an increase in natural gas average price and a decrease in production whenever there’s an increase in propane price.  

However, even though there are obvious spikes in the price series, marketed production doesn’t seem to respond accordingly.  In fact, at a point when prices sky-rocket in 2006, marketed production plummets?  Did production cease because gas owners could thrive on the profits from selling the gas they had ALREADY produced?

## Analysis:Propane Production and Price Plot

**Notes:**
Here’s an overlaid, double-axis plot.  On the left vertical axis, we see propane volumes (the black squares).  The right vertical axis is for our three price variables (wellhead price, natural gas average price, and propane average price).

What we want to see is an increase in propane production whenever there’s an increase in propane price and a decrease in production whenever there’s an increase in natural gas price.  However, as we just showed, the price data share very similar patterns, so when natural gas prices spike in 2006, sure, propane production is low, BUT propane prices ALSO spiked at the same time and furthermore propane prices are always higher than natural gas prices, so we should have expected propane production to increase.  

There must be some logical explanation.  Even though propane prices can climb very high, propane volumes, even with the best fractionation technology are still going to be very low compared to natural gas volumes.  Gas owners must weigh their decision based on their optimal expected profit.  They probably conclude that selling large volumes of natural gas at a moderately inflated price produces a higher profit than selling small volumes of propane at an extremely inflated price.

NOTE: change colors to parallel first plot.

## Analysis:prop = ngr + pap

**Notes:**
Based on the analysis, I tried a simple model of these fractionators regressing propane production on natural gas received and propane price to end users.

The model is basically a flop.  Although the model is statistically significant, as are all of its variables, the plot of predicted values (not included here) is not at all close to the original values for propane production.  And the R-Square and Adjusted R-Square values aren’t even greater than 0.50.

NOTE: Add plots of predicted values?

## Analysis:prop = pap

**Notes:**
So, I tried an even simpler model, regressing propane production on propane price to end users.

Again, the model is statistically significant, as is its one independent variable, but the plot of predicted values is even worse and the R-Square and Adjusted R-Square values fall below 0.20 this time.  

## Questions to the Committee

- Are there other data worth exploring to better understand this phenomenon?
- Are there other methods of analyzing the data on this subject, especially ways that would better integrate the price and volume analysis?
- Supply Demand Models?

**Notes:**
Supply: function of natural gas production, price of propane, and price of dry natural gas 
Demand: function of price of propane, as well as natural (weather?) and/or economic activities???

## Questions/Comments

- Kara Norman
- _[kara.norman@eia.doe.gov](mailto:kara.norman@eia.doe.gov)_