The second half of the recent decade was transformative for the U.S. natural gas business. Midstream companies have been in the thick of this transformation.

Historically, upstream companies built and owned gas-gathering, processing and storage infrastructure to support local exploration, production and marketing activities. Starting in the late 1980s, particularly in the U.S., producers began to move away from ownership of processing and related infrastructure and became increasingly accepting of third-party owner/operators.

Backing off the midstream investment freed up capital to invest more heavily in upstream activities, the core business viewed as having potential to create higher returns. A strong, independent midstream segment developed, which is now turning heads for its ability to capture the value of natural gas liquids (NGLs).

Once a troublesome afterthought of the natural gas business, NGLs have become an important part of the natural gas and petroleum value chains. The extraction of NGLs from gas, through processing, has become increasingly commercially attractive.

In the past five years, driven by very different supply-and-demand fundamentals, a dramatic shift in the relative values of oil and natural gas has occurred. With the prices of various NGL fractions or products (e.g., ethane, pentanes, butanes and propane) largely tied to crude oil prices, the value of these NGLs has become far greater when extracted and sold separately than when left as components in the natural gas stream.

The traditional relationship between oil and natural gas prices has been trending upward. While the nominal Btu parity level of 6 to 1 seemed to hold true, on average, before 2005, as oil prices escalated, the average equivalence shifted upward, averaging 10 to 1 from 2006 to 2008. When the price collapsed in late 2008, the relationship reverted briefly back to the nominal parity level, but as crude prices recovered and gas prices languished, the market equivalence has more recently reached unprecedented levels in excess of 20 to 1.

The shift in relative prices, and the corresponding high equivalence, implies a distinct competitive advantage for the more oil-weighted producers and has resulted in a dramatic shift in gas-processing and NGL-extraction economics.

While very volatile, extraction economics (represented by the trend line in the frac spread) have increased sharply in recent years. This trend has incentivized deeper extraction cuts (i.e., taking more liquids out of the gas stream), as well as shifts by gas producers to liquids-rich gas plays. These opportunities have made the gas-processing segment an attractive investment target once again and spurred a considerable flow of funds into the pipeline master limited partnership (MLP) segment.

Today, MLP owners control much of the country’s processing capacity, and companies in the Alerian MLP index saw their collective market capitalization more than double since early 2009.

Going forward, at least for the medium term, strong midstream economics should continue as fundamental supply-and-demand pressures (i.e., relatively strong global oil demand growth in the face of less strong and more expensive supply growth) keep oil prices relatively high, while in contrast, very different fundamentals (i.e., strong supply growth and only modest demand growth) keep natural gas prices relatively low.