1. Bureau of Economic Geology, The University of Texas at Austin Market Trends for Natural Gas SPE Unconventional, June 15, 2011

2. ©CEE-UT, 2 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT When we think about the world of energy… …do we understand the present? Our energy present is a function of our demographic and economic past –Fundamental shifts are taking place For the foreseeable future, oil will remain critical to US and global energy supply –Natural gas will continue to gain market share contingent on development of internal markets and global trade New fuels and/or fuel technologies could increase in importance –Pace depends on cost and timing; incumbent infrastructure is dominant – the challenge of energy density Materials and nonfuel minerals may be more important We deal in political rather than economic trade offs –Much of what we perceive in energy, economy, environment is a function of beliefs rather than evidence; perception is reality

3. ©CEE-UT, 3 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Oil Price Bounds Down? At the global level, clear intent from OPEC to sustain worldwide economic recover –Iraq and OPEC quotas; China U.S. production turnaround? Access, technology gains Impact of climate policies and inter-fuel competition Up? Global recovery will stimulate demand, especially in BRICs Belief governments will not alter product subsidies Noncommercial demand for commodity derivatives U.S. macro policy and the dollar USEIA (left); IEA

4. ©CEE-UT, 4 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT NG Price Bounds Down? Sustained success with shales and other plays LNG shaves peaks Access, technology gains Inter-fuel competition displaces gas Up? Worldwide economic recovery, demand growth, dash to gas no regrets policy on climate Production growth slows LNG demand prevents peak shaving effects USEIA (left); IEA

5. ©CEE-UT, 5 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT How Does Unconventional Gas Fit In? The Story… Its a factory business… Have I got a shale deal to sell you… We can make money at $4… …and the Back Story Unknown unknowns in technology Shifting upstream business models Impact of oil directed drilling –Is natural gas price volatility dead? Private lands event driven by historical price marker

6. ©CEE-UT, 6 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT How Does Unconventional Gas Fit In? The Story… Its a factory business… Have I got a shale deal to sell you… We can make money at $4… …and the Back Story Unknown unknowns in technology Shifting upstream business models Impact of oil directed drilling –Is natural gas price volatility dead? Private lands event driven by historical price marker

7. ©CEE-UT, 7 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT How Does Unconventional Gas Fit In? The Story… Its a factory business… Have I got a shale deal to sell you… We can make money at $4… …and the Back Story Unknown unknowns in technology Shifting upstream business models Impact of oil directed drilling –Is natural gas price volatility dead? Private lands event driven by historical price marker

8. ©CEE-UT, 8 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT [U.S. LNG market potential] is much more limited than typically realized… There is plenty of room for new spikes in Henry Hub price. But what about the possibility of a Henry Hub basis collapse? This could come about in two ways. One is the formation of a new gas bubble if new domestic [unconventional] supplies are more rapidly proved up than demand warrants. A second possibility exists with LNG. -Michot Foss, OIES NG 18, Feb 07 2010: The 2003 NPC Study Was Prescient…

9. ©CEE-UT, 9 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Compiled by CEE based on industry data

10. ©CEE-UT, 10 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Production Phases

11. ©CEE-UT, 11 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Glubbausage! CEE based on U.S. EIA Searching for the bottom…

12. ©CEE-UT, 12 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT What drives oil and gas prices? An Experiment With FD Cost Marginal barrel, MCF sets price We can estimate price using 3x rule –If you want to make any money in this business, you need to sell oil for 3x your drilling costs: 1/3 for the well, 1/3 for the tax collector, and 1/3 for yourself. (DB Commodities Research, 16 July 2007) For oil, strong, sustained correlation between full, BE FD cost and market price Implications for natural gas FD cost, price interactions are persistent

13. ©CEE-UT, 13 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Guitar, Man Peak Oil Explained! Unknown source; posted on The Oil Drum

14. ©CEE-UT, 14 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT

15. ©CEE-UT, 15 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT CEE analysis based on U.S. EIA FRS

16. ©CEE-UT, 16 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT A Tough Business, Anyway

17. ©CEE-UT, 17 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Cost reductions are real… …but gainers, losers Impact of Wall Street technology

18. ©CEE-UT, 18 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Used with permission Break Even Gas Price Top 30% Wells With Land Cost

19. ©CEE-UT, 19 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Kepes, et al, OGJ 4/4/11, Fiscal Regimes Currently, the relationship between costs and prices is unfavorable for dry gas wells. Assuming a Henry Hub price of $5/MMBTU and a negative gas price differential of 30¢/MMBTU, the available margin for the base case dry gas well is only $1.80/MCF. In the majority of the jurisdictions in North America most of this margin is used to pay royalties (often $1/MCF or more), severance taxes, property taxes, and corporate tax.

20. ©CEE-UT, 20 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Living with negative margins… In the past few years, a glut of natural gas has driven down the price to half the 2008 averagea level where it costs a U.S. consumer $2.75 a day to meet a home's natural-gas needs, according to the American Gas Association. That's good news for consumers, but a recent study by consultancy Wood Mackenzie found that 40% of U.S. natural gas produced last year didn't meet break-even prices for producers. - Daniel Gilbert, WSJ, May 23, 2011

21. ©CEE-UT, 21 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Canadian and U.S. natural gas producers are responding to the U.S. oversupply by shifting away from drilling activity that focuses solely on natural gas. Instead, companies are targeting oil and natural gas containing…NGLs…to capitalize on the rise in oil prices. NEB-Canada May 2011 …means shifting strategies

22. ©CEE-UT, 22 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Compiled by CEE using EIA Relatively small changes in supply, demand swing price Price Change & Volatility Matter What are the demand side drivers?

23. ©CEE-UT, 23 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Compiled by CEE; U.S. EIA Change in shares of net generation, 1996-2010 (total net generation, 2010), all %: 10 (23)1 (20)2 (4)0 (0) -8 (44)-1 (1)-3 (7)

24. ©CEE-UT, 24 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT ERCOT Peak Day by Fuel Type Electric Reliability Council of Texas (ERCOT)

25. ©CEE-UT, 25 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Does Renewable Energy Create Volatility? Negative price intervals (15 min) 2006 76 2007 338 2008 4,894 2009 3,069 2010 4,445 (Nov) April 26, 2009 Compiled by CEE using ERCOT data

26. ©CEE-UT, 26 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Bros/SG, used with permission, May 30, 2011 Note – precedes Germany announcement

27. ©CEE-UT, 27 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Environment Discontents Cleanest burning fossil fuel Hydraulic fracturing –Water use, disposal, contamination (chemicals and methane) –Seismicity Air emissions –Drilling operations –Fugitive methane Fugitive emissions from value chain Is natural gas just too cheap?

28. ©CEE-UT, 28 Dr. Michelle Michot Foss, CEE/BEG/JSG/UT Carpe Diem