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Research Update What is Changing in the Midstream Industry? Becca Followill Houston February 11, 2009 *Disclaimers on page 37 of this document. Energy Snapshot Where are we? (February 6, 2009) Current 2008 (% ) YTD ’09 (%) Majors (XOI) 975 - 37% 0%

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Becca Followill Houston February 11, 2009

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Research Update

What is Changing in the Midstream Industry?

Becca Followill

Houston

February 11, 2009

*Disclaimers on page 37 of this document.


Energy Snapshot

  • Where are we?

    • (February 6, 2009)

    • Current2008 (%)YTD ’09 (%)

    • Majors (XOI) 975-37% 0%

    • E&P (S&P 1500 Oil & Gas) 386 -38% +5%

    • Oil Service (OSX) 138 -60% +14%

    • MLPs (AMZ) 202 -41% +15%

    • S&P 500 869 -38% -4%

    • Crude Oil $40/bbl -54% -10%

    • Natural Gas $4.77/mcf -25% -15%

    • Gulf Coast Frac Spreads$1.79/mmbtu-98% 100+%

  • Opinion:

    • Oil price incredibly volatile but ultimately tied to global demand

    • Natural gas: supply problem and demand problem

    • Natural gas catalyst is on the way…rig count falling

  • Risks:

    • Oil – U.S./international demand weaken further

    • Gas – E&P companies don’t drop enough rigs

    • Gas – Demand stays weak (economy risk)

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    Energy Snapshot: The Bad News


    Crude Oil… Off 70+% from July Highs

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    U.S. Inventory Levels… Full!!!

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    Natural Gas… Off 60+% from July Highs

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    U.S. Gas Production… Still on the Rise

    Source: EIA/DOE


    Gas Storage… Filling!!!

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    Energy Snapshot: The Good News


    Frac Spreads… Coming off Recent Lows

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    Petrochemical Demand… Rebounding… A Little

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    Baltic Dry Index… Finding a Bottom

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    Rig Count… Market is Correcting

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    How Does Supply Correct?


    Onshore Supply Growth

    ~42% (400) rigs activity decline in 2001 impacted supply growth in 2002:

    2000 42.8 bcf/day

    2001 43.9 bcf/day

    2002 43.6 bcf/day

    6% onshore supply growth with ~flat rig count from early 2006 – early 2008.

    Recent decline is due to Gustav/Ike related impacts. Onshore supply growing 10% y/y in 2008.

    A

    B

    C

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    C

    A

    Source: Baker Hughes, EIA, TPH Estimates

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    Shale Plays Improving Mix

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    Implications for Rig Count

    Aug ’08

    1,543 rigs

    Current

    1,046 rigs

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    Rig Count Cuts on Way in Marginal U.S. Plays

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    Rig Count Changes by Well Path

    Source: RigData, Tudor Pickering Holt

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    Demand Issues


    Oil Demand is THE Cycle Killer

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    Industrial Demand Components

    • Uncertain economic outlook creates uncertainty when forecasting natural gas demand as industrial sector accounts for ~30% of total US gas consumed.

    • Weak automotive, chemical and steel outlook will likely result in lower industrial demand in 2009.

    • US industrial sector accounts for 20% of total electricity output. Weakness in the industrial sector will have spill-over impact into US power sector which will have an even greater natural gas demand impact.

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    Natural Gas – Power Generation

    US GDP and Total Power Generation Load

    US natural gas demand driven by electricity sector expansion and growth

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    Weak Electricity Demand

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    Midstream Issues

    • New administration – new rules, new agenda

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    Obama Land

    • Economy and jobs creation center stage

    • It’s a green, green world

    • Tougher labor and environmental regulations

    • Coal/Oil Out, Renewables In, Gas a necessary fossil fuel

    • CO2 legislation – 2nd half of term issue

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    Midstream Issues

    • New administration – new rules, new agenda

    • Heavily constrained capital markets = higher cost of capital

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    Challenging Capital Markets

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    Midstream Issues

    • New administration – new rules, new agenda

    • Heavily constrained capital markets = higher cost of capital

    • Working off the excess

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    Gas Processing Capacity

    • We see only modest gas processing capacity additions 2008-2010, increasing L-48 capacity by 7%.

    • However, this is in a market where ethane and other NGL demand is weak, so incremental capacity matters.

    Source: Oil and Gas Journal 2008, Company Press Releases, Tudor, Pickering, Holt


    Changing Dynamics: Ethylene & Propylene

    • Currently, the U.S. has the most ethylene and propylene processing capacity in the world, at 22% and 27%, respectively. China is second, with 8% of both ethylene and propylene capacity.

    • Prior to the financial meltdown, there was mounting concern that a massive amount of planned new international ethylene and propylene capacity would flood the market, eventually resulting in the U.S. becoming a net importer, thus backing off demand for domestic NGLs.

    • The vast majority of the adds are in the Middle East, where they’ll use cheap gas to make NGLs to feed the new petrochemical plants.

    • Given the economic slowdown, we are now assuming that only the plants currently under construction will be built. In total, these add 15% to existing capacity, or 3.5%/yr growth – not helpful in a weak economy, but not the onerous 39% addition if everything was built.

    Source: ICIS Plants & Projects Database, Company Press Releases, Tudor, Pickering, Holt


    10-17-08 Propylene prices hit 3-yr low

    10-18-08Naphtha prices in Asia drop by 50% since early August

    10-24-08India’s largest petrochem major to have halved PP run rates

    10-27-08 Weak demand compels Formosa to extend crack shutdown indefinitely

    11-3-08 Equistar Idles Olefin Plant in Texas

    11-11-08Ineos plans shutdown of 2 polypropylene units in Texas

    11-26-08UK’s BPI to Close Northeast England Facility

    11-28-08German Petrochem Sector to Face Difficult times Ahead

    12-6-08DuPont to Eliminate 2,500 Employees in Western Europe, US

    12-9-08Dow to Cut 11% of work force, Shutter 20 plants

    12-11-08Dow Set to Re-evaluate Scope of Proposed Oman Project

    12-12-08Japanese Ethylene production falls to 12-yr lows

    12-25-08China's largest ethylene producer expects to suffer major loss in 2008

    12-29-08Kuwait calls off Dow Chemical’s US $17.4B JV

    12-31-08Work on Qatar-based multi-billion petrochem complex stalled

    1-5-09LyondellBasell’s Chocolate Bayou C2-C3 facility shuttered indefinitely

    1-6-09Ethylene and propylene prices strengthen in Asia

    1-6-09Taiwan's Formosa puts 700,000 tpa cracker off stream due to demand

    1-8-09LyondellBasell’s US operations file Chapter 11

    1-14-09Sunoco to shutter polypropylene plant in Bayport

    1-16-09Equistar plans to restart La Porte olefin unit

    1-19-09Asian benzene plants hike run rates on demand recovery

    1-20-09 BASF cautions of potential cuts in production and jobs

    1-20-09 Rohm & Haas to shutter plants and cut 900 jobs

    1-21-09 Sunoco to permanently down the shutters at PP plant in Texas

    1-24-09 Huntsman to lay off 9% of total workforce; shut UK-based TiO2 plant

    1-29-09 LyondellBasell announces €100/ton increase in PE prices in Europe

    1-29-09 Equistar Chemicals plans restart of La Porte olefins unit by end of month

    1-31-09 INEOS NOVA announces up polystyrene prices in Europe

    Midstream – Diary of a Cycle

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    Midstream Issues

    • New administration – new rules, new agenda

    • Heavily constrained capital markets = higher cost of capital

    • Working off the excess

    • Declining cost structure

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    Declining Cost Structure

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    Midstream Issues

    • New administration – new rules, new agenda

    • Heavily constrained capital markets = higher cost of capital

    • Working off the excess

    • Declining cost structure

    • Changing ownership landscape

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    Changing Ownership Landscape

    • MLPs – traditional midstream players

    • But troubled:

      • 13% average MLP yield

      • 18% average Midstream MLP yield

    • 5 MLPs announced distribution cuts this quarter

    • 14 Midstream/Pipeline MLPs’ distributions will be flat

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    Disclaimer

    Tudor, Pickering, Holt & Co. does not provide accounting, tax or legal advice. In addition, we mutually agree that, subject to applicable law, you (and your employees, representatives and other agents) may disclose any aspects of any potential transaction or structure described herein that are necessary to support any U.S. federal income tax benefits, and all materials of any kind (including tax opinions and other tax analyses) related to those benefits, with no limitations imposed by Tudor, Pickering, Holt & Co.

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    Tudor, Pickering, Holt & Co., LLC is an integrated energy investment and merchant banking boutique, providing high quality advice and services to institutional and corporate clients. Through the company’s broker-dealer, Tudor, Pickering, Holt & Co. Securities, Inc., the company offers securities and investment banking services to the energy community. The firm, headquartered in Houston, Texas, was formed through the 2007 combination of Tudor Capital and Pickering Energy Partners, Inc. and today has approximately 70 employees. Pickering Energy Partners was founded in 2004 and has quickly grown to be one of the most highly regarded equity research, sales and trading firms covering the upstream, midstream and oilfield service sectors. This expertise was complemented by the addition of Tudor´s investment banking team, which provides focused advisory and financing services to its clients.

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