North American Natural Gas Fundamentals and Market Based Long-term Pricing Tommy Inglesby and Ankush Kumar McKinsey & Company, Inc. November 16, 2007 – Houston Baker Institute/CEE Energy Forum © 2007 McKinsey & Company, Inc. No part of this report may be circulated, quoted, or reproduced for distribution without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation, it is not a complete record of the discussion. The views expressed herein are based upon assumptions as to marketplace evolution and dynamics, and other factors which are inherently uncertain and are subject to change. There can be no assurance that all such assumptions will in fact be borne out, and, in fact, it can be anticipated that the assumptions will be subject to change over time.

1 PERSPECTIVES ON NATURAL GAS PRICES Gas price fundamentals: What you would need to believe to see a sustained gas price linkage to petroleum conversion capacity Questions Market based perspective on gas price: Estimating long-term gas price and probability distributions based on commodity and capital markets

2 NYMEX Henry Hub (natural gas) price $/MMBtu HH spot Historical forwards CONSENSUS ESTIMATES INDICATE A SHIFT IN LONG TERM GAS PRICE PROJECTIONS GII EEA SEER EIA HistoricalFuturesIndustry estimates for Current forward *EEA = Energy and Environmental Analysis, GII = Global Insight, Inc., SEER = Strategic Energy and Economic Research, EIA = Energy Information Administration Source:NYMEX, EIA, Team analysis Average market price $, MMBtu EIA 7.70EEA 6.68SEER 6.72GII Wide range of future gas price range Previous futures range

3 Asset value $ Billion LONG LIVED E&P ASSET VALUATIONS PROVIDE THE CAPITAL MARKETS PERSPECTIVE OF LONG TERM GAS PRICE – EXAMPLE DEAL Gas price assumptions Production profile Transaction value ($2.2 Billion) Long-term price Reserve risk factor Drilling profile Well production costs Development and operation costs estimates 040 Long-term price for 5+ years Forward curve for first 5 years Production profile Mmcf/d 0.6 tcf of proven reserves 1.4 tcf of unproven reserves Reserves Implies an embedded long tern gas price of $6.75/MMBTU Source:McKinsey Analysis

4 SIMILAR VALUATION OF OTHER LONG LIVED GAS EXPOSURES INDICATE LONG TERM GAS PRICE RANGE OF $ /MMBTU Long life E&P Transactions Implied long-term price $/MMBTU Deal 1 Deal 2 Deal 3 Implied long term price $/MMBTU Narrow range of long term implied gas prices Implies a long term gas price 6.50 to 7.50 $/MMbtu $ Millions E&P Company A E&P Company B E&P Company C E&P Company D Company Utility Asset value $ Millions 790 2, Enterprise value $ Millions 4,000 7,500 8,000 4,500 45, Source:McKinsey Analysis

5 MARKET OBSERVATIONS CAN BE COMBINED TO ESTIMATE GAS PRICE PROBABILITY DISTRIBUTION Expected Price – Near term : Forward prices – Mid- long term: Fundamentals combined with long term price embedded in E&P company valuation – Option implied volatilities combined with mean reversion from price history Price volatility Simulated natural gas price* distribution $ / MMBtu Stochastic simulations with market based inputs inputs <5% probability of gas price being below 3.50 $/MMbtu in 2018 <5% probability of gas price being above 13 $ /MMBTU in 2018 Source:McKinsey Analysis

6 PERSPECTIVES ON NATURAL GAS PRICES Gas price fundamentals: What you would need to believe to see a sustained gas price linkage to petroleum conversion capacity Questions Market based perspective on gas price: Estimating long-term gas price and probability distributions based on commodity and capital markets

7 US Gulf Coast gas and energy NYMEX prompt month prices* $/MMBtu Natural gas priced between resid and coal Refining margins were tight Natural gas priced between resid and distillate Refining margins were wide *Converted at EIA heat content of for No. 6 low sulfur and for No. 2. Coal prices shown as delivered spot prices to Northeast. Does not include estimate NOX and SOX costs Source:Bloomberg; McKinsey Analysis SINCE 2000, NATURAL GAS PRICES HAVE TRADED WITHIN THE BAND OF A RESID FLOOR AND A DISTILLATE CEILING #2 Distillate Natural gas #6 Resid Coal $10+ Crude linked Do gas prices stay linked to resid in a high crude price environment? $6-8 Gas on gas Do gas prices fall to gas or gas competition / or crude prices decline significant?

8 SIGNIFICANT GENERATION INVESTMENT WILL SOON BE REQUIRED; IF NUCLEAR AND COAL PLANTS CANNOT BE PERMITTED, CCGT BECOMES THE DEFAULT CHOICE Capacity to meet minimum U.S. power reserve margin of 15% GW Natural gas (CCGT) favored** Coal (SCPC) favored*** Nuclear favored By By 2015 *All plants use 9% WACC and 30-year life **CCGT at 7,000 Btu/kWh heat rate; $800/kW nominal greenfield Capex; 90% capacity factor; 3-year time to build ***Coal at 9,100 Btu/kWh heat rate; $2,100/kW nominal greenfield Capex; 92% capacity factor, 4-year time to build; $75/MMBtu coal Source:EIA; McKinsey Economic fuel choice* CO 2 price $/ton Natural gas price $/MMBtu

November 2005 to October 2006 EIA reported demand for US 2EIA estimate of 1.6% growth in US, 2.4% growth in Canada 3Assumes historical capacity creep for nuclear and coal capacity and utilization, with 30GW new coal build. Assumes renewable growth to 50 GW of capacity (7% of US power consumption). Remaining demand met by new CCGT at 7000 Btu/kWh Heat rate. Assumes 75% increase in gas-to-power demand growth met by capacity creep and new CCGT. 4Assumes accelerated growth as Oil Sands development to 6.6 MMBd of production by 2020, utilizing 13 cm per barrel of oil 5Assumes US achieves 20 BGY ethanol standard by 2015, growing to 30 BGY by 2020 – results in incremental 2 bcfd of natural gas demand by 2015 and 3 bcfd by Source:EIA Annual Energy Outlook (2006); National Energy Board of Canada; MMS Deepwater forecast; Renewable Fuels Association; BP Statistical report 2006; press clippings McKinsey analysis A SIGNIFICANT GROWTH IN GAS DEMAND CREATES A SIGNIFICANT SUPPLY GAP THAT MUST BE MET Traditional growth 2 Power 3 Oil sands 4 Ethanol demand 2006 production New demand drivers acting on top of traditional growth engines… Power Oil SandsEthanol High demand growth (1.8% per year) Difficult to permit new builds for nuclear and coal plants Growth in power demand met almost entirely by gas through higher utilization of existing CCGT gas plants and new gas fired plants Rapid increase in oil sands production (projections of 3-5 million bpd by 2020) Production requirement of 0.75 mcf per barrel of oil North American ethanol demand assumed to reach 15 billion gallons by 2015 and grow to 30 billion gallons by 2020 Production requirement of ~1 cm of gas per gallon of ethanol Demand Supply …increase demand growth, implying a potential supply gap of ~37.5 Bcfd by supply gap Bcfd

10 THE INCREASING SUPPLY GAP WILL DRIVE SIGNIFICANT E&P ACTIVITY AND REQUIRE ATTRACTING ADDITIONAL LNG VOLUMES FROM EUROPE NA Natural gas supply requirements Bcfd Gap to be filled by new resources and LNG Existing onshore** prod New prod from existing onshore fields Offshore*** Canada production *Yet To Find **Assumes hyperbolic decline from IHS 2006 survey ***Estimate from EIA/MMS Source:EIA Annual Energy Outlook (2006); Wood Mackenzie; MMS Deepwater forecast; McKinsey analysis 30, , % E&P activity will increase dramatically Number of new wells drilled per year Rigs Average rig count Within ten years, over 60% of the production will come from new wells in existing and YTF* fields as well as LNG … High US prices required to attract LNG: Limited LNG liquefaction capacity worldwide; NA plus Europe demand LNG regas capacity to exceed liquefaction capacity US gas prices will likely be above oil parity (Europe prices) to attract LNG cargos Net NA Natural gas demand, ~3% CAGR

11 LNG Imports (competitive) 2012 North American Natural gas supply and demand curve $/MMBtu Indigenous supply marginal lifting costs North American gas volumes Bcfd LNG Imports (fixed) Indigenous production Non- switching demand Distillate switching Power dispatch switching Resid switching Oil-linked pricing band ILLUSTRATIVE Source:McKinsey LNG PRICES IN A SHORT ENVIRONMENT RISE TO THE VALUE IN ALTERNATE MARKET – IN THIS CASE EUROPE If Demand stays robust and US supply not sufficient to push LNG back into the Atlantic, the marginal price setter for the US becomes LNG competing with Europe

12 PERSPECTIVES ON NATURAL GAS PRICES Gas price fundamentals: What you would need to believe to see a sustained gas price linkage to petroleum conversion capacity Questions Market based perspective on gas price: Estimating long-term gas price and probability distributions based on commodity and capital markets

13 UNUSED SLIDES

14 IN EUROPE, NATURAL GAS CONTRACTS INDEX PRICES TO LOW SULFUR FUEL OIL PRICES * Monthly prices. Gas prices average for Spain, Belgium, Netherlands, Germany, Italy, France & UK. 6-month lag compared to oil (Brent) and LSFO **Assumes MMBtu / Bbl for LSFO, FCC is marginal refining unit in Europe, and an average of narrow and wide light / heavy differentials (modeled) Source:Platts; World Gas Intelligence; EIA; McKinsey GGM; McKinsey refining equilibrium pricing model $ / MMBtu, Q3 40 $/bbl ($5.25/MMBtu)** 30 $/bbl ($3.90/MMBtu)** 20 $/bbl ($2.50/MMBtu)** Cost of Russian imports (full cost) Oil-linked gas border price* compared to Brent and LSFO prices Oil-linked gas prices reflect long- run marginal cost of Europe’s next alternative supply (Russia) Growing price gap to gas cost as oil prices increase and stay high 50 $/bbl ($6.65/MMBtu)** Brent Oil-linked gas price (WGI)* Low Sulfur Fuel Oil (LSFO)

15 LIQUEFACTION ACROSS THE ATLANTIC IS CONSTRAINED AND WILL NOT BE SUFFICIENT TO FILL US REGAS CAPACITY Natural gas delivered into Europe currently prices at a residual fuel oil linked contract price If the US prices below resid, then more majority of excess LNG should divert to Europe If US is pricing at a premium to resid – it becomes the advantaged market * Assuming end-of-year in-service dates. Regas projects shown only in operation and under construction Bcfd facilities approved by FERC. Liquefaction assumes projects operating, under construction and in development. Includes Middle Eastern projects with expected delievries to Atlantic Basin based on investing partners or signed contracts Source: LNG Asian demand – Dr. Fesharaki, FACTS Inc., September 2005; McKinsey Energy Practice; McKinsey analysis Europe North America Atlantic basin liquefaction Atlantic Basin Liquefaction and regas capacity* Bcfd