There has been growing optimism in my hometown of Pittsburgh, Pa., that Royal Dutch Shell (NYSE:RDS-A) will choose a proposed site in nearby Monaca, Pa., for a world-class cracker facility. The proposed plant would convert ethane found in the natural gas pumped from the Marcellus Shale and Utica Shale into over 1 million metric tons of ethylene each year, which would then be processed into higher-value chemicals for everyday products. Shell would use its own gas reserves, as well as gas from regional suppliers such as Enerplus Corporation (NYSE:ERF), as feedstock -- creating a massive opportunity for multiple players and reducing "ethane rejection" that heavily weighs on margins.
The Appalachia cracker, as Royal Dutch Shell calls it, is just one of three megagrowth projects originally considered by the energy giant, which include a now terminated $20 billion gas-to-liquids, or GTL, plant in Louisiana and a halted liquefied natural gas, or LNG, facility in Canada. While Pittsburgh residents are becoming increasingly more excited, Chief Financial Officer Simon Henry put it bluntly on the company's third-quarter conference call, saying "We can't do all of these." Indeed, the company may not choose any of the three projects.
However, if you consider recent developments related to each project and local events on the ground in Pittsburgh, then Royal Dutch Shell could be leaning toward building the multi-billion dollar Appalachia cracker facility after all. What has happened to grease the wheels? What opportunities would it create for Enerplus Corporation and others in the Marcellus Shale? And why might the project not happen at all?
Progress builds optimism
The Appalachia cracker got its name because, initially, Royal Dutch Shell was considering sites in Pennsylvania, West Virginia, and Ohio. Pennsylvania Gov. Tom Corbett offered the sweetest tax deal, including a $2.10 credit for each gallon of ethane purchased from state-based natural gas drillers (the single largest tax break in state history), and the energy giant purchased an 80-year-old zinc plant and its accompanying 300-acre site in Monaca in March 2012. Native Pittsburghers simply call it "The Cracker." It's a pretty big deal for a region that, despite a growing base of young workers, is struggling to add jobs and continues to suffer from population declines.
Fast-forward to 2014, and Royal Dutch Shell has remained connected to the local community. It recently extended its land option agreement for the site for the third time, bought an industrial warehouse across the road from the site, paid the zinc processor to demolish part of its site, and completed plans for moving and expanding Route 18 (which it will also pay for). Locals are waiting for the company to file for an air permit with the Pennsylvania Department of Environmental Protection in the second half of 2014, which is largely considered as a major indicator to proceed with building the facility.
The events unfolding here in Pittsburgh aren't the only reason for contagious optimism. The company recently decided to toss out the proposed GTL project in Louisiana and halt the construction of liquefaction trains at the Canadian export facility. Things may look good for Pittsburgh now, but there are many exits available for Royal Dutch Shell going forward. "The Cracker" could still be terminated for economic or environmental reasons, or even due to community opposition, although that doesn't appear to be a hurdle at this point in time.
But a "go" decision would mean more than 10,000 construction jobs and hundreds of permanent family wage salaries in the Pittsburgh area. The city has lost 42% of its population since 1970 -- and the losses haven't stopped just because the economy is now more dependent on health care and education than steel. A major airline recently pulled its hub out of the local airport, the city's pension system is roughly 38% short of meeting its obligations, and much of the infrastructure depended on everyday dates back to Andrew Carnegie. "The Cracker" could help Pittsburgh grow for years to come. (Helping to reverse the flow of rush hour traffic wouldn't hurt, either, since Monaca is northwest of the city.)
Big opportunities in Marcellus Shale ethane
Pennsylvania is poised for some spectacular growth thanks to the Marcellus Shale, which has grown from just 2% of domestic gas supply in 2007 to nearly 20% at the end of 2013. Without the play, domestic production would have likely peaked in 2011 or 2012. In fact, production is expected to keep growing at least through 2015, despite the fact that wells experience an average 65% decline in volume over any three-year period. That helped Pennsylvania become the only state in the top five of proven wet natural gas reserves to see a positive increase in 2012, which helped it jump from fifth to second in the rankings, albeit a distant second.
The proven reserves aren't discovered and confirmed by charities, either. Enerplus Corporation is one company pouring money into the region, which has helped it secure 57,500 acres with an estimated 1.3 trillion cubic feet of natural gas. The company's 2012 proven reserves represented roughly 4% of the region's total at the time. However, with the portfolio's proven reserves increasing 181% last year, it's safe to say the share has grown considerably since.
Production from the Marcellus Shale will represent approximately 40% of Enerplus Corporation's total production this year. While that's good news for investors, it's important to note that natural gas is not a single chemical with a single value. One of the most valuable components is ethane, which can be sold as a chemical feedstock at a higher price than natural gas that is burned for fuel. Unfortunately, there is a severe lack of industrial capacity for all of the ethane being produced from American energy plays, which results in "ethane rejection," or ethane being sold as natural gas at fuel prices.
For producers such as Enerplus Corporation, ethane rejection is literally the act of lighting money on fire. The problem is pandemic. Consider that natural gas liquids and pipeline companies are currently struggling with an estimated 300,000 barrels a day of excess ethane. While some are looking to export the glut of ethane, most energy projections call for margins to shrink in the coming years when liquefaction and transportation costs are accounted for. Thus, there are major economic incentives for keeping American ethane on our shores. Royal Dutch Shell could benefit mightily if those scenarios turn out -- and it decides to build "The Cracker."
Don't hold your breath
That everything seemingly points to Royal Dutch Shell's building "The Cracker" could be nothing more than late-stage planning. A company that raked in $451 billion in revenue in 2013 would probably not think twice about writing off a few tens of millions of dollars preparing a proposed construction site if the long-term numbers didn't work out. Additionally, the fact that Royal Dutch Shell has remained attached to the Monaca site for over two years means little. As Anya Litvak of the Pittsburgh Post-Gazette recently penned:
Time is not an indication of Shell's intent, as evidenced by the company's 31 years of research in oil shale extraction at its Mahogany exploration project in Colorado, which came to a close with a no-go decision last year.
Shell spent decades and millions of dollars in Colorado building pipelines, a $2 million office building and a $30 million freeze wall to hold shale oil when it's heated. In September 2013, the company decided it wouldn't fund the actual extraction and disbanded the nearly 1,000-person team.
Given the economic importance of the Marcellus Shale, losing 10,000 construction jobs and hundreds of permanent family wage salaries in the Pittsburgh area wouldn't be the only consequence. Companies such as Enerplus Corporation looking to diversify downstream revenue opportunities for their natural gas and ethane production would lose out on an important opportunity, too. The absence of "The Cracker" probably wouldn't jeopardize the play's anticipated growth in production in the short-term, but sending the region's natural gas hundreds or thousands of miles away via pipeline would certainly jeopardize the economic potential of the region in the long-term.
So, will Royal Dutch Shell build "The Cracker"? No one can say for sure at this time. It could create billions of dollars in revenue for the company once completed, boost margins for regional producers by reducing ethane rejection, and help revitalize the Pittsburgh region. While it's too early for investors to get excited about potential growth opportunities, diligent investors will want to keep an eye on major developments for the project.