1 dynamics of north american natural gas supply prepared for: opening plenary: the dynamic energy...

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Dynamics of North American Natural Gas Supply

| JAF2015_101.PPT | October 23, 2015 | www.adv-res.com

Prepared for:

Opening Plenary: The Dynamic Energy Landscape: Natural Gas in the U.S.

33rd Annual USAEE/IAEE North American Conference

Prepared By:

Vello Kuuskraa, PresidentAdvanced Resources International, Inc.Arlington, VA USA

October 25-28, 2015Pittsburgh, PA


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Advanced Resources International


Some of Our Highly Valued ClientsOur History and Services

Our History. Formed in 1970, with Over 30 Years of Focus on Unconventional Resources and Enhanced Oil Recovery.

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Geology, reservoir engineering and economics

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1. Background and Context

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“Transformation” of the Domestic Natural Gas Industry

From “fears of scarcity” less than a decade ago, we moved to “expectations of plenty” and now to a “supply glut” with market prices below industry “break-even” costs.*

LNG terminals, initially built to receive imports, are being converted to handle natural gas exports.

Domestic natural gas prices, once linked to oil prices at a ratio of about 10 to 1, have decoupled, with today’s ratio at 18 to 1 ($45 to $50/B oil price and $2.50 to $2.75/Mcf natural gas price.)

No energy commodity in modern history has witnessed changes more dramatic than North American natural gas supply:

These changes have been so swift that many still question the economic viability of future natural gas supplies, particularly from the large, still emerging shale gas resource base.*”Break-even” costs include 15% ROR (before tax).

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National Petroleum Council’s2007 Report

Expected Global LNG Trade Set Forth in NPC’s

“Hard Truths” Report

LNG Flow Paths

Source: NPC, 2007

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2007 2015

(Bcfd) (Bcfd)

Unconventional Gas

▪ Shale Gas 4 39

▪ Tight Gas 16 15

▪ CBM 5 3

Total 25 57

Conventional Gas 28 17

Total 53 74

SupplySource

Annual DryGas Production

J AF2015_046.XLS

Growth of U.S. Natural Gas Production:How Much, How Quickly?

Driven by the massive Marcellus/Utica shales and associated gas from shale / “tight” oil, U.S. natural gas production has reached 74 Bcfd, up by 21 Bcfd since the start of the “shale revolution.”


U.S. Natural Gas Production (Dry)U.S. Natural Gas Production (Dry)

*Includes L-48 onshore, offshore and Alaska. Source: EIA; Advanced Resources Int. Shale Gas Database, 2014.

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A Year of Living Irrationally


From a “rational” economic supply modeling perspective, given the low current oil and natural gas prices, only limited new activity is justified and supply should be declining:

In our view, the recent ten months of activity by the oil and gas industry represent one of the longest periods of “irrational” oil and gas industry behavior and destruction of shareholder value.

The first half of 2015 financial statements for essentially all of the E&P companies (once hedges are removed) show losses, with costs of production (F&D plus operating costs) in excess of current market prices.

While active rigs are down by 60% from their year 2014 peak, over 800 oil and gas rigs are still active.

Even with active rigs and capital outlays down, natural gas production continues to grow.

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Some of Industry’s “Sky Hooks”


1. Massive Number of Already Drilled but Uncompleted Wells. The active rig fleet in 2014 created a massive backlog of drilled but uncompleted wells that are only now being placed on production.

Even with rig counts two-thirds lower, the number of wells placed on production (first half of 2015) is essentially the same as in the first half of 2014 for the Bakken “tight oil” play and the Marcellus gas play.

2. Improved Well Performance and Lower Well Costs. Companies are using improved well completion technology and targeting their higher productivity acreage. For example, “high-density” completions show substantially higher IPs (and EURs) for the Eagle Ford shale play. However, improving well performance along with declines in well costs, while important, have not been able to fully counter lower “realized” oil and natural gas prices.

3. “Beggar Thy Neighbor”. Each company is trying to maximize top line revenues, hoping someone else cuts production.

Three reasons, among others, help explain the lack of supply response to lower prices and fewer rigs during the first half of 2015.

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Impact of Drilled But Uncompleted Wells


Considerable delay occurs between the time a well is spud (proxy for active rigs) and the time the well comes on production (proxy for productive capacity), helping explain the time lag between a reduction in active rigs and the reduction in natural gas (or oil) production.

The great bulk (80%) of the wells spud in a given year come on-line one to four years after spud.

Assuming only 500 new well spuds in the Marcellus (PA) in Year 2015, 930 new wells will come on-line, similar to the 1,117 wells that came on-line last year.

To illustrate this, we have tabulated the well spuds in the Marcellus Shale (PA) for the past five years and tracked when these wells come on-line:

Marcellus Shale (PA) Well Spuds and Completions

Expected

2011 2012 2013 2014 2015

Wells Spud and Drilled to Depth 1,816 1,230 1,111 1,186 500

Well Completions From:

Spuds in Same Yr 241 208 248 238 100

Spuds 1 Year Prior 688 853 668 649 590

Spuds 2 Years Prior 70 214 325 133 160

Spuds 3 Years Prior 2 30 71 76 60

Spuds 4 or More Years Prior 4 2 9 21 20

Total Well Completions 1,005 1,307 1,321 1,117 930

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2. Status and Outlook for North American Natural Gas Supply

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The Stacked Plays of the Appalachian Basin


The Appalachian Basin, the new “powerhouse” of natural gas production contains three major shale plays, in descending order:

Together, these shale three plays hold a vast volume of technically recoverable shale resources (dry), as well as significant volumes of NGLs.

Additional Appalachian Basin natural gas resources include the legacy Huron (Ohio) Shale, tight gas in the Berea, Oriskany, etc., and coalbed methane in Virginia.

Upper Devonian

Marcellus

Utica/Point Pleasant

Source: Range Resources.

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The North East PA Marcellus Shale Play


The North East Marcellus Shale play has changed the dynamics of U.S. natural gas supply and infrastructure.

This play area accounted for 8 Bcfd of the Marcellus’s total of 13 Bcfd of dry gas production in 2014.

Operators have steadily improved well performance and reduced well costs, making this portion of the Marcellus Shale the lowest cost dry shale gas play in the country.

Source: Range Resources, 2015.

Source: Southwestern Resources, 2015

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Utica Shale/ Point Pleasant “Sweet Spot”


The Utica is poised to become the next source of significant gains in natural gas production.

The plays high productivity “sweet spot” extends from western Pennsylvania into West Virginia. With an additional play area emerging in Tioga Co. in eastern Pennsylvania

The Utica has provided multiple high IP wells, including EQT’s recently completed Scotts Run at 73 MMcfd.

Source: Southwest Energy, 2015

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After Years of decline, Canadian natural gas production now has three consecutive years of growth . Similar to the U.S., Canada’s unconventional gas is driving the growth, countering the decline in conventional gas production.

With the discovery and development of the Montney Resource Play, its northern B.C. shale gas resources, and its associated gas from “tight oil” plays, Canada is no longer resource limited for natural gas.


Oh Canada!

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Canada’s “Mighty Montney”

The Montney is the “Marcellus of Canada.” We use 12 partitions to capture the geologically distinct settings and hydrocarbon resource types of this play.

1

2

3

4

56

7

8

910

11

12

The Montney’s stack of productive formations provides massive but still mostly undeveloped natural gas (and liquids) resource.

With the “discovery” of the Montney and northern B.C. shale plays, Canada is no longer resource limited for natural gas.

Source: EnCana, 2015

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3. Dynamics of North American Natural Gas Supply

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Gaining insight, instead of opinion, on the outlook for Northern America natural gas supply and prices requires:

Detailed cost-supply curves for each source of U.S. natural gas. Our unconventional resource cost curves contain 221 distinct natural gas plays.

Rigorous understanding of the “dynamic” nature of these cost-supply curves. Depletion of highly productive “core area” resources needs to be counter-balanced by addition of new resource plays and progress in technology.

Incorporation of constraints on industry activity. Projections need to account for limitations in infrastructure and lack of access to markets.

How Can One Obtain a More Rigorous, Confident Outlook for North American Natural Gas?

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Constructing “Dynamic” Oil and Natural Gas Supply Models

“Dynamic” oil and natural gas supply models need to contain four key features to help capture the key changes underway in the North American and gas supply sector:

A. Technology progress and geologic learning

B. Well D&C cost-price relationship

C. NGL pricing and costs

D. Resource depletion

Each of these key factors directly affects the “break-even” costs of natural gas supply and, when integrated with demand, the “market-clearing” price for natural gas.

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Dynamics of Marcellus Well Productivity

Application of improved technology to two major Marcellus Shale plays - - NE PA “Core” (Bradford County) and SW PA Liquids Rich area - - have led to significant improvements in well performance.


Bradford County.Well performance, that remained relatively flat from 2007 through 2012, improved vastly in the past two years.

SW PA Liquids Rich Area.Well performance, while erratic during the initial years, has nearly doubled recently.

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Effect of Oil Prices and the NGL Market on Marcellus Shale “Break-Even” Prices

The high Btu content of certain of the Marcellus Shale plays can materially boost economics as illustrated for a 7 Bcf (EUR) well with 1,200 Btu gas. The illustration shows that NGL market dynamics and higher (or lower) oil prices can significantly alter the “break-even” price for this wet shale gas play.

Dry Gas WellGas Price ($/MMBtu) $ 3.00

Oil Price ($/B) $ 50.00 EUR (Bcf) 7

Btu Content (MMBtu) 1,010 NGl Yield (Gal/Mcf) 0

NGl Pricing (% WTI) 35%NGL Boost ($/Mmbtu) 0

Break-Even Price ($/MMBtu) $ 4.59

Wet Gas Well (Depressed NGL Market)

Gas Price ($/MMBtu) $ 3.00 Oil Price ($/B) $ 50.00

EUR (Bcf) 7Btu Content (MMBtu) 1,200

NGl Yield (Gal/Mcf) 3.4

NGl Pricing (% WTI) 35%

NGL Boost ($/Mmbtu) $0.70Break-Even Price ($/MMBtu) $ 3.94

Higher Btu Gas

Wet Gas Well (“Normal” NGL Market)Gas Price ($/MMBtu) $ 3.50

Oil Price ($/B) $ 65.00 EUR (Bcf) 7

Btu Content (MMBtu) 1,200 NGl Yield (Gal/Mcf) 3.4

NGl Pricing (% WTI) 45%NGL Boost ($/Mmbtu) $1.52

Break-Even Price ($/MMBtu) $ 3.41

Higher Oil Price, Improved NGL

Market

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Resource Depletion:Barnett Shale Case Study

The Barnett Shale sparked the “shale gas revolution, showing that economically viable natural gas could be produced from deep, nano-darcy rock.

Natural gas production climbed rapidly, reaching 1 Bcfd in 2004 and nearly 6 Bcfd in 2012.

With the heart of the “core” area fully drilled, natural gas production has declined to below 4.5 Bcfd, with few well permits now issued.

Improvements in technology have been unable to counter resource depletion for this maturing shale gas play.

Barnett Shale Natural Gas Production

Barnett Shale Drilling Permits

Source: Railroad Commission of Texas, 2015

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2013 2014 2015 2016 2017

Appalachia Production* 13.7 17.9 20.7 22.3 24.5

Appalachia Consumption(Avg. for Year) 13.4 14.6 14.6 14.8 15.0

Appalachia Gas Surplus for Export 0.3 3.3 6.1 7.5 9.5

Fully Committed Takeaway Projects (cumulative) 3.3 7.0 10.7 17.3

Source: Range Resources Investor Presentation, 2015; Advanced Resources Int'l, 2015.*Assuming ARI’s natural gas and oil production tracks for 2015-2017.

Appalachian Pipeline Projects

The rapid growth in Marcellus/Utica natural gas production combined with inadequate take-away capacity created a natural gas (and NGL) supply glut in Appalachia, with high basis differentials at the Leidy and Dominion South gas hubs.

However, a series of new pipeline projects are due on-line that will expand Appalachian Basin’s pipeline capacity by 17 Bcfd during 2015-2017.

Source: Range Resources, 2015.

Appalachian Basin Natural Gas Production, Consumption and Pipeline Capacity (Bcfd)

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Concluding Thoughts


The natural gas supply marketplace is continuing to “muddle through” a most turbulent and uncertain period:

Still, the North American natural gas resource base is large and has steadily increased in past years.

How the outlook for growth in demand - - from exports, from new industrial plants, and from increased use for power generation - - converges with the “dynamics” of natural gas supply will set the prices for natural gas in the coming months and years.

Natural gas prices are below “break-even” for North American producers, portending further cuts in drilling and investment.

Improving well performance and lower well costs (“technology progress”) are enabling some producers to remain active in their “best” plays.

Aggressive development of high quality “core” areas (“resource depletion”) continues to counter “technology progress.”

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1 dynamics of north american natural gas supply prepared for: opening plenary: the dynamic energy...

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