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THE SHALE GALE MARKET UPDATE & TRENDS IN MIDSTREAM INFRASTRUCTURE Beaver Creek Energy Conference February 2013. Natural Gas Market Update. Review of Natural Gas Markets: The Slow Grind Higher. 3. 2013 is shaping up to be better than 2012

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THE SHALE GALE

MARKET UPDATE

&

TRENDS IN MIDSTREAM INFRASTRUCTURE

Beaver Creek Energy Conference

February 2013



Review of natural gas markets the slow grind higher
Review of Natural Gas Markets: The Slow Grind Higher

3

  • 2013 is shaping up to be better than 2012

    • Moderating supply growth, strengthening industrial demand

  • However, the threat of oversupply lingers

    • Storage is likely to end heating season above 2.1 Tcf

  • We are holding on to our 2013 forecast of $4.00/Mcf for now

    • There is potential for an H2 rebound

  • We expect a slow rise over the next few years to $5.00/Mcf

Domestic natural gas inventories

Source: EIA, Credit Agricole Securities (USA)


Robust supply
Robust Supply

  • Supply continues to grow despite a sharp drop in the natural gas rig count

    • Driven by shale gas production – 25% increase in 2012 (EIA)

    • Gulf of Mexico in terminal decline

Adjusted US onshore natural gas rig count

Domestic natural gas production: Form EIA-914 data

Source: Baker Hughes, Credit Agricole Securities (USA)

Source: EIA


Demand creeps higher
Demand Creeps Higher

Cheap gas spurred demand growth from power generation in 2012

Price rise to lower power burn in 2013  7% decline projected

Solid industrial growth  chemicals, refining lead

There is actually a winter this year

Y-o-Y change in demand

Monthly industrial demand for natural gas

Source: EIA, Credit Agricole Securities (USA)


Long term points of interest
Long Term Points of Interest

  • LNG exports

    • May become a pawn in the political battle over the approval of the Keystone pipeline

  • Use as a transportation fuel

    • It’s happening, slowly

  • GTL proposal(s)

    • Not. Gonna. Happen.

  • The 2nd American Industrial Revolution

    • So far, it’s just talk



Ii midstream infrastructure
II. Midstream Infrastructure



Technology has changed the game
Technology has Changed the Game

With the advent of multi-stage hydraulic fracturing, horizontal drilling and other technological innovations many unconventional reservoirs in the U.S. are now highly economical to produce at current commodity prices.


Shale gas production growth
Shale Gas Production Growth

Since 2005, shale gas production has grown at a 42% compounded annual growth rate


Shale gas is here to stay
Shale Gas is Here to Stay

  • As of September 2012, U.S. shale gas production contributed about 35% of total U.S. dry production.

  • This share is projected to grow to 50% by 2040


Marcellus Shale

  • Between 2009 and 2011, Pennsylvania's natural gas production more than quadrupled due to expanded horizontal drilling combined with hydraulic fracturing

  • Drilling programs in the Marcellus have recently migrated to more liquids-rich areas due to the price premium of crude oil and natural gas liquids


Bakken the major source of shale oil
Bakken: The Major Source of Shale Oil

Since 2005, oil production in the Bakken has grown at a 35%annual growth rate since 2005, driven by fracking and robust commodity pricing

North Dakota is now the fourth largest oil-producing state—trailing only Texas, Alaska, and California


Bakken gas a stranded asset
Bakken Gas: a Stranded Asset?

Associated natural gas production from oil production in North Dakota has more than doubled since 2005, largely due to associated natural gas from the growing Bakken oil production

However, due to insufficient natural gas processing / pipeline capacity, over 35% of North Dakota's natural gas production (vs. a national average of less than 1%) in 2011 was flared or otherwise not marketed.


Midstream infrastructure critical in getting gas to market
Midstream Infrastructure: Critical in Getting Gas to Market

  • Gathering / Compression : Systems that are directly connected to wellheads and draw natural gas to a central location (aided by compression) for processing / treating

  • Processing: Most wellhead gas does not meet the quality standards required by interstate pipelines, so it must be processed to remove contaminants and the heavier NGL components

  • Pipeline / Interconnections: Laterals to deliver marketable gas to interstate pipelines (or into storage)

  • Interstate Pipelines: Delivery to power plants and commercial / residential customers

  • Storage: Allows for accumulation / drawing of inventories to match seasonal demand


Critical to extracting value added products from wet gas
Critical to Extracting Value-Added Products from “Wet Gas”

17

Source: Tudor, Pickering, Holt & Co


A typical barrel of ngl looks like this
A typical “Barrel” of NGL Looks Like This: Gas”

18

  • Propanes and heavier components (propanes+), make up ~60% of the NGL stream, and pipeline specs mandate it has to be removed from the wet gas produced at the wellhead.

  • Ethane is “discretionary” meaning producers/ processors can opt to keep it in the stream or remove it, depending on economics.

  • Leaving ethane in the dry gas stream is called “ethane rejection”(think of this from the processors’ standpoint). The amount of Btus is always the same - it’s just whether liquid or gaseous that’s different.

Source: Tudor, Pickering, Holt & Co



The market for processing is self correcting
The Market for Processing is Self-Correcting Gas”

20

Source: Tudor, Pickering, Holt & Co



Investment trends
Investment Trends Gas”

  • Producer owns exploration / drilling rights for a certain area but wants to preserve capital for exploration / drilling

  • Third parties, including private equity, are becoming the primary investors in infrastructure platforms

  • Many platforms are joint ventures between the producer and a third party


Midstream investment criteria
Midstream Investment Criteria Gas”

First and foremost is needed a predictable stream of production. This requires:

Good Well Economics:

A handy Rule-of-Thumb: The breakeven price = (2 x Capex) / EUR

Low to Moderate Technical Risk

Geology and technology needs to be well understood to insure continued investment.

Additionally there needs to be a significant upside potential from both a geologic and a technical standpoint.

Reasonable development schedule

A predictable production profile and reasonable schedule of capital invested has a direct correlation to the midstream provider’s rate of return.


Rule of thumb to approximate a required breakeven price
Rule-of-Thumb to approximate a Required Breakeven Price Gas”

Not Perfect, but a reasonable

“Quick & Dirty” approximation.

A real life example:


Midstream investment criteria1
Midstream Investment Criteria Gas”

First and foremost is needed a predictable stream of production. This requires:

Good Well Economics:

A handy Rule-of-Thumb: The breakeven price = (2 x Capex) / EUR

Low to Moderate Technical Risk

Geology and technology needs to be well understood to insure continued investment.

Additionally there needs to be a significant upside potential from both a geologic and a technical standpoint.

Reasonable development schedule

A predictable production profile and reasonable schedule of capital invested has a direct correlation to the midstream provider’s rate of return.


Commercial arrangements
Commercial Arrangements Gas”

Midstream business provides steady, generally predictable cash flows

Producer and Gatherer will enter into a contract, where producer is required to build out gathering / processing / pipeline delivery infrastructure in return for contract for gas throughput.

For dry gas gathering / processing, contract features vary, but generally are characterized by fee-based arrangements, with fixed fee paid per unit of natural gas gathered and additional fees paid for other services (treating, processing).

Additional features may include:

Dedicated Acreage requirements,

Minimum volume / take or pay requirements

Contract tenors vary, typically in the 8-10 year range

For wet gas processing, contract features may include product or revenue sharing arrangements, generally a Percent of Proceeds from the NGL products, and processor’s discretion with respect to “ethane rejection”


Risk characteristics summary
Risk Characteristics Summary Gas”

  • Construction Risk – building on time to accommodate production activity – contracts may include penalty clauses

  • Indirect Commodity Price Risk – what are breakeven costs for producer?

  • Capital Availability for Growth

  • Dependabilty of Reserve Base

  • Offtaker Risk

  • Management / Operational Risk

  • Regulatory / Political Risk – will vary by location


Midstream players
Midstream Players Gas”

  • Traditional Large / Publicly Traded Players – Integrated Diversified Players with Midstream Operations

    • Kinder Morgan

    • Williams Companies / Williams Partners

    • El Paso Pipeline partners

    • Targa Resources Partners

    • Enterprise Products Parnters (natural gas liquids)

    • Rose Rock Midstream

    • Western Gas Partners

    • Dominion / Caiman Joint Venture

    • Spectra Energy Corporation

  • Private Equity

    • Active investors in the sector. Buying midstream assets from integrated players who are divesting to allow capital to be re-invested in E&P growth

    • Includes large diversified Private Equity Players as well energy-specific funds

    • Includes platforms established as strategic joint ventures between a private equity firm and a producer with targets to grow their

    • Spin-outs / divestitures of larger / integrated players


Private equity firms active in midstream acquisitions
Private Equity Firms Active in Midstream Acquisitions Gas”

Large - Diversified

KKR

Texas Pacific

Blackstone

Kelso

Warburg Pincus

Energy Industry Focused

ArcLight Capital Partners

Tenaska Capital Partners

Global Infrastructure Partners

Denham Capital Partners

First Reserve Corporation

Haddington Ventures

Riverstone / Kaiser (Sage)

Macquarie

Highstar Capital

Encap Flatrock

Kayne Anderson

NGP Energy Capital Management

Energy Spectrum Capital




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