1. The Houston Economy, O&G Activity and the Implications for Commercial Real Estate Harold Hunt, PhD Real Estate Center at Texas A&M College Station, Texas hhunt@tamu.edu

2. A Brief Economic Overview

3. Texas Job Growth Texas U.S. Texas versus the U.S. 3.4% 1.8%

4. Texas Job Growth still capturing market share Texas still capturing market share in private-sector jobs. 14.1%8% 347,200 / 2,470,000 = 14.1% of private job growth 25 mil. / 300 mil. = 8% of pop.

5. Texas Employment Growth by Industry Mining (O&G) Mining (O&G) again the leader (by %).

6. Texas Employment Growth by Industry Prof. & Bus. Services Prof. & Bus. Services the absolute leader.

7. Source: Texas Workforce Commission Ending August, 2014 Job Growth Past 12 Months Ending August, 2014

8. Source: Texas Workforce Commission

9. Ending August, 2014 Job Growth Past 12 Months Ending August, 2014 Source: Texas Workforce Commission

10. ( August, 2014) Houston MSA Employment and Annual Employment Growth by Category ( August, 2014) Source: Texas Workforce Commission Biggest absolute increase in jobs Biggest % increase in jobs

11. How Large is the Energy Industry in Houston? Recent estimates by the Bureau of Economic Analysis (BEA) say: Mining & Logging (O&G) 19.8% The Mining & Logging (O&G) sector in Houston accounted for 19.8% of the region’s GDP. chemicals, refining, and oilfield equipment manufacturing32.0% When you add in chemicals, refining, and oilfield equipment manufacturing, energy accounts for 32.0% of the region’s GDP. fabricated metal products, P/L transportation, and engineering services38.1% When you add in fabricated metal products, P/L transportation, and engineering services, energy accounts for 38.1% of the region’s GDP. Source: GHP: The Economy at a Glance Oct. 2014

12. So Where is the Energy Sector Headed? The most critical question for real estate professionals still seems to be: How long will the drilling activity in Texas last?

13. First, a Quick Overview

14. Active Drilling Rigs in Texas (As of October 17 th, 2014) Source: Baker Hughes

15. October 17 th, 2014 October 18 th, 2013 Rig Counts (Land Rigs: October 17 th, 2014 vs October 18 th, 2013)

16. Two Definitions Porosity Porosity - the percentage of void space in a material. Permeability Permeability – The property of a porous material to permit a liquid or gas to pass through it.

17. Permeability of Shale Source: SPE International Shales Mid-East Reservoirs

18. Conventional vs Unconventional Drilling Source: U.S. Energy Information Administration 5,000 ft. or more Source rock Low Permeability

19. Equipment to Fracture a Well

20. My Early Prediction of the Length of Eagle Ford Drilling Activity Dallas Federal Reserve 5 mil. The Dallas Federal Reserve reported that 5 mil. acres of the Eagle Ford are under lease. So I assumed: 20020k total wells – 4 mil. acres/200 acres drained per well = 20k total wells 51,250 wells per yr. – 250 rigs x 5 wells drilled per yr. = 1,250 wells per yr. 16 years to drill – 20k wells needed/1,250 wells per yr. = 16 years to drill

21. Completed Wells in the Eagle Ford Source: Texas Railroad Commission 263 Producing Oil Wells 263 Producing Oil Wells 394 Producing Gas Wells 394 Producing Gas Wells As of Aug, 2011:

22. Completed Wells in the Eagle Ford Source: Texas Railroad Commission 1,690 Producing Oil Wells 710 Producing Gas Wells 710 Producing Gas Wells As of July, 2012: An Increase of: 1,427 Producing Oil Wells 316 Producing Gas Wells 316 Producing Gas Wells Total Increase: 1,743 wells 11 Months Later…

23. Completed Wells in the Eagle Ford Source: Texas Railroad Commission 3,868 Producing Oil Wells 1,681 Producing Gas Wells As of July, 2013: An Increase of: 2,178 Producing Oil Wells 971 Producing Gas Wells 971 Producing Gas Wells Total Increase: 3,149 wells 12 Months Later…

24. Completed Wells in the Eagle Ford Source: Texas Railroad Commission 6,414 Producing Oil Wells 3,214 Producing Gas Wells As of July, 2014: An Increase of: 2,546 Producing Oil Wells 1,533 Producing Gas Wells 1,533 Producing Gas Wells Total Increase: 4,079 wells 12 Months Later…

25. Several Factors Affect the Speed and Number of Wells that Get Drilled “hold a field by production” giving way to “pad drilling” 1)Drilling one well to “hold a field by production” giving way to “pad drilling” where multiple wells are drilled from one drillsite, saving time and money. rigs that “walk” or move along rails 2)Drilling rigs that “walk” or move along rails will significantly reduce the downtime between drilling a well. well spacing 3)The well spacing continues to tighten, leading to more producing wells on a given amount of acreage. other pay zones 4)Tapping other pay zones will extend the drilling activity in fields.

26. 1) Evolution to Pad Drilling

27. Pad Drilling Example

28. Karnes Co. Drilling Pads

29. Gonzales Co. Drilling Pads

30. 2 Wells On One Pad in Gonzales Co.

31. 3 Wells On One Pad in Gonzales Co.

32. 4 Wells Just Drilled by EOG in Gonzales Co. (using FracFocus.org)

33. 22 Wells On One Pad

34. 2) Moving the Rigs Gets Faster

35. Walking Rigs

36. Rigs Moving on Rails

38. Piping Moves With Rig Movement

39. Increasing Efficiency Begins to Show Up Source: Baker Hughes Quarterly Well Count Report Started 1 well every 24 days Started 1 well every 16 days 2012 Q1 2014 Q3

40. $14 mil. $6 mil. Well Costs Dropped from $14 mil. to $6 mil. Source: UTSA Economic Impact of the Eagle Ford Shale Study Sept. 2010 Sept. 2013

41. 3) Well Spacing Gets Tighter

42. Rosetta Resources Map of Its Well Spacing Plan Source: Rosetta Resources

43. EOG Pushed Downspacing, Dramatically Increasing the Well Count

44. Factors to Consider With Increased Downspacing rob production 1)When laterals get close enough, they start to rob production from each other. Marathon test two wells on 40-acre spacing one well on 80-acre spacing 2)A Marathon test showed two wells on 40-acre spacing each had about 80% of the recovery as one well on 80-acre spacing. Ex.(Total = 1,000 bbls) Ex. 1 well @ 80 acres produces 1,000 bbls of oil (Total = 1,000 bbls) vs (Total = 1,600 bbls) 2 wells @ 40 acres produce 800 bbls of oil each (Total = 1,600 bbls) increased production increased well cost 3)So increased production from downspacing must be weighed against increased well cost.

45. 4) Tapping Other Pay Zones in the Future

46. Multiple Payzones Could Extend the Drilling Activity in a Play Eagle Ford Austin Chalk Pearsall Buda

47. Pearsall 13 Payzones identified so far by Pioneer The Permian Multiple Payzones Could Extend the Drilling Activity in a Play

48. Vertical Wells versus Horizontal Wells Using Pad Drilling

49. Horizontal Wells Using Pad Drilling in Multiple Stacked Plays

50. “Stacked Lateral” Also Experimenting With “Stacked Lateral” Development

51. Stacked Laterals Being Tested by Rosetta Resources in the Gates Ranch Field Source: SeekingAlpha Article Nov. 18, 2013

52. Stacked Laterals Being Tested by Rosetta Resources in the Gates Ranch Field Source: SeekingAlpha Article Nov. 18, 2013

53. “secondary recovery” (ex. re-fracking) Finally, there may also be “secondary recovery” (ex. re-fracking) activity on early wells now in decline

54. My Revised Guess of Future Eagle Ford Drilling Activity Dallas Federal Reserve 5 mil. The Dallas Federal Reserve reported that 5 mil. acres of the Eagle Ford are under lease. So my latest guess is: 8050k total wells – 4 mil. acres/80 acres drained per well = 50k total wells 200204,000 wells per yr. – 200 rigs x 20 wells drilled per yr. = 4,000 wells per yr. 12.5 years to drill – 50k wells needed/4,000 wells per yr. = 12.5 years to drill * 1) multiple payzones or 2) secondary recovery. * Without considering: 1) multiple payzones or 2) secondary recovery.

55. What Could Derail This O&G “Boom” A major breakthrough in renewables (wind, solar, etc.) Water availability or contamination endangering aquifers or surface

56. Surface Reservoir Conditions in Texas (As of October 1 st, 2014 are 63.8% full Statewide) Source: www.waterdatafortexas.org

57. Top 32 Highest Water Use Counties for Hydraulic Fracking Operations in the U.S. Source: www.ceres.org Texas had 16 of top 32 U.S. counties from Jan. 2011 to May 2013 Can include water sourced outside the county. May be non-fresh water as well. 4 bil. Gallons in Dimmit Co.

58. “Freshwater” “Freshwater” Use for Fracking is a Significant % in a Few Texas Counties Source: TWDB and Bureau of Economic Geology McMullen Co: 55% San Augustine Co: 39% Karnes Co: 31% Dimmit Co: 24% Montague Co: 34%

59. What Could Derail This O&G “Boom” A major breakthrough in renewables (wind, solar, etc.) Water availability or contamination endangering aquifers or surface Govt. involvement becomes too onerous EPA – (ex. EPA severely regulates: water disposal, air quality, frack fluids U.S. Fish & Wildlife Dunes Sagebrush Lizard Spot-tailed Earless Lizard – (ex. 2. U.S. Fish & Wildlife: finds endangered species in area, such as the Dunes Sagebrush Lizard or the Spot-tailed Earless Lizard) The big one: A severe drop in price

60. Estimates of Breakeven Prices

61. Shale Gas U.S. Shale Gas Resources by Breakeven Cost $4.00/mcf

62. Red Dots Show Active Gas Rigs (As of October 17 th, 2014) Source: Baker Hughes

63. Tight Oil U.S. Tight Oil Resources by Breakeven Cost $50/bbl$80/bbl 80% of resources breakeven w/i $50 to $80

64. Blue Dots Show Active Oil Rigs (As of October 17 th, 2014) Source: Baker Hughes

65. Unknowns that Could Affect Price technology 1)How fast will technology improve? o Miscellaneous Possible Gamechangers o Miscellaneous Possible Gamechangers (Glori Energy: microbes in conventional wells; Siluria: dry natural gas to diesel/gasoline) o Drilling costs o Drilling costs (faster drilling times, cheaper completion techniques, etc.) o Recovery rates of O&G in place o Recovery rates of O&G in place improve o Well decline rates o Well decline rates improve

66. Gas Pct. Of U.S. Unconventional Gas Wells Grow Over Time Increasing % of faster-declining gas wells

67. Oil Pct. Of U.S. Unconventional Oil Wells Grow Over Time Increasing % of faster-declining oil wells

68. Conventional Unconventional vs Conventional O&G Well Lifetime Production Curves Years Production Rate Unconventional

69. Companies are Increasing “Initial” Production Source: SeekingAlpha EOG’s Eagle Ford Wells EOG had a 20% improvement in initial production rates over just 2 quarters.

70. Conventional Unconventional But What About Production Over the Total Life of a Well? Years Production Rate The long-term scenario that turns out to be correct will have a major impact. #1 #3 #2 Increase in I.P.

71. Eagle Ford Numbers Show Increased Initial Production Source: Energy Information Administration Increased production from: 25 BPD in ‘09 about 25 BPD in ‘09 to 375 BPD in ‘14 about 375 BPD in ‘14

72. Numbers Also Show Increased Decline Rates Source: Energy Information Administration Increased production from: 25 BPD in ‘09 about 25 BPD in ‘09 to 375 BPD in ‘14 about 375 BPD in ‘14

73. Unknowns that Could Affect Price exporting crude 2)Will restrictions on exporting crude be lifted? RefinersProducers o Pits (midsize) Refiners against (independent) Producers crude exports would actually benefit U.S. economy (ex. lower the price of gasoline) o Recent reports say crude exports would actually benefit U.S. economy (ex. lower the price of gasoline) political fear o Federal political fear may override economic considerations  (gasoline price for Congress and environmentalists for Obama)

74. Diesel Exports U.S. Diesel Exports Have Increased Dramatically

75. Gasoline Exports The Same With U.S. Gasoline Exports

76. Brent/WTI Spread Widened With Cushing Bottleneck in 2011 Source: Energy Information Administration Sept. 2011: $27 WTI Discount Brent Price: $112/bbl WTI Price: $ 85/bbl

77. New Pipelines Pushed the Crude Glut South to the Gulf Coast

78. Inventories Now Gulf Coast Light Crude Inventories are Much Higher than Average Source: RBN Energy Blog 2014

79. Conventional Some Predicting: Some Predicting: Lower Domestic Prices Will Lead to Increased Crude Imports Again ) (But Could Rapid Unconventional Well Decline Rates Make A Difference?) Years Production Rate Unconventional

80. Unknowns that Could Affect Price massive amounts of light crude 3)Will refiners retool to handle massive amounts of light crude? The short answer is: NO (political risk)

81. Unknowns that Could Affect Price LNG 4)How much LNG will be exported from the US? Petrochems, Manufacturing, Elect. power Producers o Pits Petrochems, Manufacturing, Elect. power against Producers Petrochems o Some Petrochems showing more flexibility lately (dry gas vs NGLs) Feds the market o Discussion over whether the Feds should control export levels thru permitting process or let the market do it.

82. 9.5 BCF/day DOE Has Approved LNG Export Terminals Totaling 9.5 BCF/day in Export Capacity Source: SeekingAlpha and Veresen

83. Proposed Another 16 BCF/day Other Proposed LNG Export Terminals Could Add Another 16 BCF/day in Exports

84. Unknowns that Could Affect Price other countries 5)Will shale O&G from other countries take off and flood the global market?

85. Infrastructure Lack of O&G Infrastructure Technology & Equipment Lack of O&G Technology & Equipment Qualified Labor Lack of Qualified Labor Water Lack of sufficient Water Tax Regimes, Legal Environment Uncertain Tax Regimes, Legal Environment Regulatory Expertise Lack of Regulatory Expertise Security Worker Security Private Mineral Ownership Anti-drilling Activism by Citizens Lack of Private Mineral Ownership increases the odds of Anti-drilling Activism by Citizens Hurdles Affecting Production of Shale Resources in Other Countries

86. Finally, How is this O&G boom different from the 80’s?

87. Saudis Cut Production in Early 1980’s, Then Increased It in 1985 Source: Haver Analytics 10 mil./bpd 2 mil./bpd 6 mil./bpd

88. Saudis Now Think “Developing” Countries Will Drive Future Oil Consumption Source: Oil & Gas Investor Magazine Developing Countries U.S. EU Other Developed

89. But Most OPEC Countries Now Rely on Oil for Their Budgets (a lot)

90. Russia Also Needs High Oil Price for Budgets Saudi Arabia Russia Iran China Kuwait Mexico $101.70 Breakeven Oil Price Source: April 11, 2014 Bloomberg article: “Venezuela Needs 2014 Brent Oil Price of $121”

91. RussiaOPEC Russia and most OPEC countries besides the Saudis can’t. Saudis Saudis think the U.S. and Canada can be made to cut before they do. “global stabilizer” o (Shale production should be the “global stabilizer” against high or low prices.) U.S. producers U.S. producers think Saudis will cut first. recession o (Does it benefit the Saudis if we get thrown into recession?) Saudis Saudis seem to be in the “driver’s seat.” o Have staying power; They can drive the price lower o Are they bluffing to get other OPEC members to cut as well? If price drops significantly, If price drops significantly, we will see what actual “breakeven” is for various producers. (Investors will be important) The Big Question is : Who Cuts Production First? (and how will that affect us?)

92. http://recenter.tamu.edu REAL ESTATE CENTER at TEXAS A&M UNIVERSITY Mays School of Business