1. David E. Dismukes, Ph.D. Center for Energy Studies Louisiana State University November 9, 2015 Emerging Issues in Fuel Procurement: Opportunities & Challenges in Natural Gas Reserves Investment National Association of State Utility Consumer Advocates Annual Meeting, Austin, Texas

2. Overview 2 © LSU Center for Energy Studies

3. Overview Rationale for New Thinking on Supply Procurement New Natural Gas End Uses & Fuel Diversity Concerns 3 Large base of relatively low-cost natural gas resources from relatively diverse set of domestic basins. Currently, there is a meaningful opportunity for utilities to lock down some fixed level of future natural gas supplies at relatively low prices. In order for this to occur, utilities could enter into longer-term forward agreements with natural gas marketers for future natural gas supplies. However, there is also a unique opportunity by contracting directly for the natural gas reserves (inventory) held by the producers and effectively eliminating the “middle-man” (i.e., marketers). © LSU Center for Energy Studies

4. Overview Potential Contracting Benefits New Natural Gas End Uses & Fuel Diversity Concerns 4 © LSU Center for Energy Studies Utilities directly contracting with producers for reserves could result in several positive outcomes between parties: Ratepayers get secure source of cost-based (not market based) natural gas supplies. Producers get capital infusion to continue drilling and leverage that to other in-field opportunities. Utilities will get new earnings opportunities.

5. Reserves Contracting 5 © LSU Center for Energy Studies

6. Reserves Contracting How Does Reserves Contracting Work? New Natural Gas End Uses & Fuel Diversity Concerns 6 Likely multiple ways an agreement can be configured. A simple example is for a utility to secure a non-operating (mineral) interest in a natural gas field and its associated reserves. The utility is effectively purchasing a partnership share in the field that gives it a claim to the minerals developed from that field (or the revenues associated with the sale of those minerals). Why do this? Only makes sense if a utility could secure a purchase price for the reserves lower than what could be attained under a forward (physical) market. © LSU Center for Energy Studies

7. Reserves Contracting How Does this Differ from Traditional Utility Fuel Procurement? New Natural Gas End Uses & Fuel Diversity Concerns 7 This is just another form of long-term agreement, right? No, since: (1)Utilities become partners in the fuel production process rather than buyers. (2)Utilities tie part of their fuel procurement to a specific asset (field contingent). (3)While some incremental costs will go through the PGA/FAC, a large share will likely be capitalized and rate based. (4)Utilities will not have the opportunity to earn a rate of return on their asset – however, it can expose them (and ratepayers) to an entirely new level and type of risk that has to be firmly appreciated and understood. © LSU Center for Energy Studies

8. Reserves Contracting States allowing longer term reserve purchases New Natural Gas End Uses & Fuel Diversity Concerns 8 Longer term physical arrangements allowed in about 16 states. © LSU Center for Energy Studies Source: Barbara Summers, Securing Long-Term Physical Gas Supplies. Western Regulators Meeting, Jun. 1-4, 2014... LA Water & Power NW Natural Gas Northwestern Gas Black Hills Energy Quester Gas Legislative Enabler FPL Public Gas Partners

9. Reserves Contracting Potential Risks Associated with Utility Reserve Partnerships New Natural Gas End Uses & Fuel Diversity Concerns 9 (1)Regulatory risk: most commissions have very little experience or knowledge about the upstream part of the business and the vagaries of mineral law. (2)Resource base risk: uncertainties about the future reliability and affordability of unconventional oil and gas development. (3)Partnership risk: uncertainties associated with the specific producer and the basin in which that producer operates. © LSU Center for Energy Studies

10. Regulatory Risk 10 © LSU Center for Energy Studies

11. Regulatory Risk New Challenges for the Regulatory Process New Natural Gas End Uses & Fuel Diversity Concerns 11 © LSU Center for Energy Studies Evaluating proposals: proposals likely bilateral in nature, with potentially complicated terms and conditions. Likely that these will be similar to a unit-contingent/resource contingent contract. Contract development/terms: need to under stand the relative rights and responsibilities between producers and utilities. Ratemaking treatment: need to understand the ratemaking treatment and implications of the proposal if accepted. Allowed returns Affiliate relationships Gains on sale Impacts on overall risk/rate of return Opportunity cost: are the potential rewards of a proposal of this nature better than simple longer-term forward contracting.

12. Resource Base Risk 12 © LSU Center for Energy Studies

13. Resource Base Estimates of U.S. Recoverable Natural Gas Resources New Natural Gas End Uses & Fuel Diversity Concerns 13 Resource base, at this point, is relatively secure. © LSU Center for Energy Studies CERA, MIT NPC, INGAA ICF Potential Gas Committee EIA ‘00 ‘02 ‘04 ‘06 ‘08 ’10 ’12 ‘14’08 ‘09 ‘10 ‘11 ’12 ’13 ‘14‘10 ‘11 ‘09 ’12 ’13 ‘15 Proved Reserves Potential Shale Gas Resources Total Resource (Uncategorized) Non-shale Gas Resources Source: ANGA and multiple sources..

14. Resource Base Estimated North American Supply Curve (ICF Consulting) 14 Conventional wisdom is that this resource base will be reasonably-priced even as that base grows. © LSU Center for Energy Studies Source: ANGA..

15. Partnership Risks 15 © LSU Center for Energy Studies

16. Partnership Risk Basin Risk: Haynesville initial production rates by completion year (MMCFD). 16 © LSU Center for Energy Studies A clear “learning-by-doing” trend that has arisen in most unconventional basins.

17. Partnership Risk Basin Risk: Haynesville initial production rates by parish (MMCFD). New Natural Gas End Uses & Fuel Diversity Concerns 17 © LSU Center for Energy Studies Not all locations in the basin are created equal.

18. Partnership Risk Company Risk: Top and Bottom Producers (Haynesville Shale) New Natural Gas End Uses & Fuel Diversity Concerns 18 © LSU Center for Energy Studies Not all companies are created equal.

19. 19 © LSU Center for Energy Studies Conclusions

20. Factors that contribute to successful resource purchase evaluation New Natural Gas End Uses & Fuel Diversity Concerns 20 Consensus on goal: hedging instrument not opportunity to use ratepayer resources to “play the market.” Consensus on need/commitment: dependent upon past gas supply plans and future outlook including physical constraints. Utility due diligence is very important. Transparency: open process recognizing that some information will inherently be competitively sensitive. Market test: using the market to test offers helps to provide confidence in the evaluation process. This test is not restricted to use RFPs alone. Flexibility: the ultimate outcome will likely be the result of bi- lateral negotiations. Will be difficult to generalize. © LSU Center for Energy Studies

21. Questions, Comments and Discussion www.enrg.lsu.edu dismukes@lsu.edu