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YPE Executive Leadership Reception

YPE Executive Leadership Reception. “EVOLUTION OF THE U.S. NATURAL GAS INDUSTRY – WHERE ARE WE AND WHERE ARE WE GOING?”. October 26, 2010. DISCUSSION TOPICS. THE TECHNOLOGY REVOLUTION AND THE SHALE GAS EXPLOSION IS IT A SHALE GAS TSUNAMI? IF SO, HOW DOES AN E&P COMPANY SURVIVE?

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YPE Executive Leadership Reception

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  1. YPE Executive Leadership Reception “EVOLUTION OF THE U.S. NATURAL GAS INDUSTRY – WHERE ARE WE AND WHERE ARE WE GOING?” October 26, 2010

  2. DISCUSSION TOPICS • THE TECHNOLOGY REVOLUTION AND THE SHALE GAS EXPLOSION • IS IT A SHALE GAS TSUNAMI? • IF SO, HOW DOES AN E&P COMPANY SURVIVE? • WHAT IS THE IMPACT OF THE SHALE GAS EXPLOSION? • WHAT ARE THE EFFECTS OF THE SHALE GAS EXPLOSION ON: • E&P BEHAVIOR • U.S. AND WORLD MARKETS • POLITICS • THE ENVIRONMENT • AMERICAN’S WAY OF LIFE • FUTURE INDUSTRY EMPLOYMENT

  3. U.S. NATURAL GAS • WHERE HAVE WE BEEN?

  4. HISTORY OF NATURAL GAS MARKETS 1938 − “Natural Gas Act” (NGA) • Involved the federal government in rates charged by interstate gas pipelines • Federal Power Commission (FPC) given jurisdiction over regulation of interstate gas sales • FPC instituted a tradition of “cost of service” plus a “fair profit” in setting rates / prices for natural gas transported through interstate pipelines 1978 – “Natural Gas Policy Act” (NGPA) • Maintained price controls on some gas, decontrolled prices for newly defined classifications of gas (“Deep Gas” >15,000 feet; “Tight Sand Gas”) • Set a maximum price producers could receive based on each well’s date, depth, geology and proximity to other wells • Allowed for an increase in “blended” prices for natural gas • Higher prices stimulated exploration and production (“supply”) • Higher prices and increased supply resulted in reduced demand 1978 – “Fuel Use Act” • Restricted construction of power plants using natural gas as a primary fuel • The Result? A “15 – year gas bubble / glut” (Prices fell as low as $0.80 per Mcfe in the late 1980’s)

  5. THE END OF GOVERNMENT REGULATION • 1987 − Repeal of Fuel Use Act • Removed all federal price controls on natural gas • Power generation markets re-opened to natural gas • Cheap, abundant gas caused demand to reverse course and increase dramatically (demand for natural gas up > 50% since 1990) • 1989 − Natural Gas Wellhead Decontrol Act (NGWDA) • Removed the federal government from control over natural gas prices • Market forces (supply and demand) set prices for gas

  6. HISTORICAL U.S. NATURAL GAS CONSUMPTION Passage of Natural Gas Policy Act and Fuel Use Act Repeal of Fuel Use Act Source: Energy Information Administration.

  7. U.S. NATURAL GAS • WHERE ARE WE NOW?

  8. U.S. NATURAL GAS DEMAND VS. CITY GATE PRICES 3Q’08: Worldwide Economic Crisis Est. 65.2 Bcf/day 3Q’05: Hurricanes Katrina and Rita Source: Energy Information Administration & Bloomberg.

  9. U.S. DRY GAS PRODUCTION VS. AVERAGE NYMEX PRICES Est. 61.3 Bcf/day 3Q’05: Hurricanes Katrina and Rita Source: Energy Information Administration & Bloomberg.

  10. LNG IMPORTS TO U.S. 1.3 Source: Energy Information Administration.

  11. CANADIAN IMPORTS TO U.S. 9.0 Source: Energy Information Administration.

  12. U.S. NATURAL GAS WHERE ARE WE HEADING?

  13. “CONVENTIONAL” VS. “UNCONVENTIONAL” DEFINITIONS Conventional Reservoirs • Reservoirs with generally high quality rock properties (porosity and permeability), do not need artificial stimulation (fracturing) to achieve commercial production rates, wells typically drain hundreds/thousands of acres, typically geologically driven plays with higher risk. Unconventional Reservoirs • Tight sands, limestones and shales (low porosity and permeability) which must be fracture stimulated to achieve commercial rates of production, typically highly gas saturated reservoirs deposited over a broad geographic area, typical wells only drain a very small geographic area (10-40 acres), horizontal wells generally improve the economics of development and most wells decline 70% − 80% in initial year of production.

  14. DOMESTIC U.S. SUPPLY GROWTH Source: Energy Information Administration.

  15. EVOLUTION OF DOMESTIC E&P INDUSTRY • Higher prices open up new plays and technologies (“unconventional reservoirs”) • Unconventional plays have reversed domestic production declines and resulted in net production growth (August 12, 2008 WSJ – “US Natural Gas Production Is Up 8% This Year and Growing Faster Than Demand”) • Unconventional plays becoming a greater percentage of both domestic drilling and production (“More than 25 Bcf Per Day of Domestic Production Coming From Unconventional Plays or 48% of Total Production, Up From 14 Bcf Per Day or 27% in 1998 alone”) • The industry is trading “geologic risk” for “lower margins” and increased “capital demands” • Natural gas supply growth from unconventional reservoirs (average well typically declines 75% - 85% in year one) has created a much tighter correlation between natural gas supply, natural gas pricing and capital expenditures • The result? A more direct correlation between capital budgets and supply and generally compressed natural gas price cycles(i.e. “no more 15-year gas bubbles!”)

  16. U.S. NATURAL GAS THE ROLE OF THE BIG SHALE GAS PLAYS

  17. RECENT SHALE GAS QUOTES March 2008 - “The Haynesville Shale likely covers 3 million acres, contains 250 Tcf of recoverable reserves, over 700 Tcf of gas-in-place or roughly five times the size of the Barnett Shale. The Haynesville Shale is likely to become America’s largest gas field and perhaps the fourth largest in the world.” −Aubrey McClendon, Chief Executive Officer, Chesapeake Energy June 2008 - “If recent discoveries prove as successful as companies expect, the industry will need to promote natural gas for both power generation and transportation. Its going to change the dynamics of the gas markets.” −Mark Papa, Chief Executive Officer, EOG Resources October 2010 - The Pennsylvania gubernatorial candidates agree, “The Marcellus Shale is the biggest issue in the Northeast, if not the entire state. Its impact on jobs and the economy will be overwhelming.”

  18. NATURAL GAS DIRECTED RIG COUNT

  19. U.S. NATURAL GAS DIRECTED AND HORIZONTAL RIG COUNT

  20. NORTHWEST LOUISIANA / EAST TEXAS (HAYNESVILLE) HORIZONTAL RIG COUNT

  21. BARNETT SHALE HORIZONTAL RIG COUNT

  22. NORTHEAST (MARCELLUS) HORIZONTAL RIG COUNT

  23. EIA NATURAL GAS PRODUCTION DATA

  24. LOUISIANA NATURAL GAS PRODUCTION

  25. MARCELLUS NATURAL GAS PRODUCTION

  26. THE “DARK SIDE” OF THE SHALE GAS PLAYS • SHALE GAS RESERVES AND PIPELINE SUPPLY ARE NOT THE SAME THING • THE “BIG TWO” SHALE GAS PLAYS (HAYNESVILLE & MARCELLUS) HAVE ADDED ~ 5.0 BCF/DAY (8%) TO U.S. SUPPLY IN TWO YEARS • PRODUCTION ADDS HAVE COME FROM “ROBUST INCREASES IN HORIZONTAL GAS DIRECTED ACTIVITY” • SHALE GAS PRODUCTION ONLY GROWS WITH: • INCREASING LEVELS OF ACTIVITY • LONGER LATERAL LENGTH WELLS • MORE EFFECTIVE COMPLETION TECHNIQUES • INDIVIDUAL WELLS DECLINE IN PRODUCTION 75% – 85% WITHIN FIRST 12 MONTHS OF PRODUCTION • ANY REDUCTION IN RIG COUNT WILL LEAD TO SUPPLY VOLUMES ROLLING OVER

  27. “U.S. Natural Gas Reserves May Have Doubled,” Secretary Chu Says (April, 2010)

  28. CONVENTIONAL RESERVOIRS?

  29. UNCONVENTIONAL RESERVOIRS!

  30. HORIZONTAL WELL DESIGN

  31. HAYNESVILLE TYPE CURVE

  32. ENVIRONMENTAL SAFETY AND POLITICS OF HYDROLIC FRACKURING • 70 YEARS OF CASE HISTORIES • AN “UNSTIMULATED” UNCONVENTIONAL RESERVOIR PRODUCES ZERO GAS • THE UNCONVENTIONAL RESERVOIRS ARE 1-2 MILES BELOW THE FRESH WATER TABLE • STATES ALREADY GOVERN AND REGULATE HYDROLIC FRACTURING • FEDERAL OVERSITE UNNECESSARY BUT INDUSTRY COULD HANDLE • A PROHIBITION IMMEDIATELY REVERSES U.S. SUPPLY GROWTH

  33. WHY HAS NATURAL GAS DIRECTED CAPEX REMAINED SO ROBUST? • STRONG HEDGE POSITIONS • ~52% OF NORTH AMERICAN PRODUCTION HEDGED FOR 2010 AT > $6.25/MMBTU • ~30% HEDGED AT > $6.10/MMBTU FOR 2011 • THE FORWARD NATURAL GAS STRIP HAS REMAINED IN STEEP CONTANGO UNITL RECENTLY • WALL STREET HAS BEEN FUNDING THE SHALE PLAYS • DRILLING TO CAPTURE LEASEHOLD INVESTMENTS • SHALE GAS JOINT VENTURES HAVE ENHANCED ECONOMICS FOR THOSE IN CONTROL

  34. CAL 2011 NATURAL GAS STRIP PRICES

  35. AVERAGE FORWARD 5-YEAR NYMEX NATURAL GAS STRIP

  36. EXAMPLE COST STRUCTURE AND MARGIN COMPRESSION $6.80 $5.45 $4.25

  37. E&P CAPITAL RAISING ACTIVITY $28.8 $26.7 $25.4 $23.8 Source: Credit Suisse equity research.

  38. WHAT CHANGES THE NEAR TERM NATURAL GAS DYNAMIC? • CAPITAL BEHAVIOR! • THE RECENT FLATTENING OF THE FORWARD STRIP • LOWER E&P UNIVERSE HEDGE PERCENTAGES • RE-ALLOCATION TO GROWING CRUDE OIL AND LIQUIDS RICH PLAYS (EAGLE FORD, BAKKEN, GRANITE WASH) • MODERATING OF THE HAYNESVILLE / BOSSIER “LAND RETENTION STRATEGY” • 2011 BUDGET PROCESS

  39. RIGS TARGETING HAYNESVILLE SHALE 179 177 149 25 34 14 86 8 15 134 68 120 134

  40. THE CRUDE OIL / LIQUIDS ADVANTAGE $36,000 per day $12,000 per day ExampleDry Gas Well Average GDPEFS Well @ $75/Bbl = $34k per day Crude Oil450 Bbls/d @ $4/Mcf = $12k per day Dry Gas3.0 MMcfe/d @ $4/Mcf = $1.2k per day Dry Gas300 Mcfe/d

  41. WHAT CHANGES THE LONGER TERM NATURAL GAS DYNAMIC? • 1) INDUSTRIAL DEMAND IMPROVEMENT • 2) POWER GENERATION MARKET SHARE GROWTH • 3) CNG COMMERCIAL BUS FLEET AND 18-WHEELER CONVERSION • 4) CNG CONSUMER VEHICLE OPTIONS • 5) LNG EXPORTATION

  42. COMPONENTS OF NATURAL GAS DEMAND (2007) Source: Energy Information Administration.

  43. INDUSTRIAL CONSUMPTION Source: Energy Information Administration.

  44. ELECTRIC POWER CONSUMPTION Source: Energy Information Administration & equity research.

  45. CAN COAL MAINTAIN 50% MARKET SHARE?

  46. U.S. COAL PLANT FLEET Source: Credit Suisse equity research.

  47. A CNG-POWERED BUS FLEET

  48. KITIMAT! Canadian Gas Going the Other Way in 2014?

  49. WHAT IS KITIMAT? • Apache Corporation's 51% owned liquefied natural gas (LNG) export terminal in British Columbia • The Kitimat LNG Terminal will receive natural gas supplies via pipeline from the Western Canadian Sedimentary Basin • Planned initial capacity of about 700 MMcf of natural gas per day • First LNG shipments to Asia are projected for 2014 • "The growing supply of natural gas in the United States and Canada is transforming North American energy markets, and this increased resource has significant potential for global impact," said G. Steven Farris, Apache's Chairman and Chief Executive Officer."

  50. IMPACT OF THE SHALE GAS PLAYS • E&P PROSPECT INVENTORIES (“RAGS-TO-RICHES”) • CAPITAL BUDGETS (“WALL STREET ACCESS”) • WOKE UP THE GIANTS (“MAJORS MOVING BACK IN?”) • LNG MARKETS (“SEND IT THE OTHER WAY?”) • HEDGING STRATEGIES (“NOW A NECESSITY”) • REDUCING THE MARGINAL COST OF GAS • UTILITIES MORE CONFIDENT IN SUPPLY (“MORE GAS-FIRED POWER GENERATION?”) • POLITICS (PENNSYLVANIA, WEST VIRGINIA AND WASHINGTON, D.C. CAN NOW SAY “NATURAL” AND “GAS” IN THE SAME SENTENCE) • U.S. TRANSPORTATION (“18-WHEELERS ROLLING?”) • A REAL SHOT AT REDUCING OIL IMPORTS AND U.S. ENERGY INDEPENDENCE

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