energy market update and opinion nov 27 2012

7/30/2019 Energy Market Update and Opinion Nov 27 2012

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Energy Market Update and OpinionNovember 27, 2012

Looking Ahead into 2013 ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

How we got to where we are today. A recap of 2012:

During the winter of 2011/2012 extreme mild weather generated weak heatingdemand while at the same time spikes in supplier rig counts, taking advantage of Shale plays throughout the country, created massive natural gas supplyincreases. These two factors resulted in the largest storage supply in history,causing NYMEX front-month pricing to drop below $3.00 much of the year.

In the spring of 2012, with pricing caving, a number of large Shale suppliers, Chesapeake Energy andothers, decided to close in wells to help limit supply. While it took awhile, hundreds of wells were shutin, or at least "dry" wells, which are "gas-only" wells, were capped and relocated to "wet" areas where

oil, gas liquids (propane, butane, etc.) and natural gas could be extracted from one well site. Thisbrought the supply factor down to a manageable level, but still left too much gas in the storagesystem.

Spring came and went and summer brought hotter weather, increased A/Cdemand, nuclear outages (SONGS), and switching from coal-fired to natural gasfired generation. This increased natural gas demand brought storage levelslower and the market back to the $3+ levels. As we rolled through fall, all eyeshave been on the weather and storage levels, which brings us to date. HistoricNYMEX and storage levels shown here.

H e r e is Ou r O u t l o o k f o r 2 0 1 3

In short, our major fundamentals are:

Production: Rising production is expected, as supply is robust.

Storage: Upper limits on storage capacity is expected to increase in 2013. Currently we are near thehistoric peak for this time of year and are still well above the five-year average.

Weather: We still expect mild weather for December: Departure from Normal graphs below:

1-7 days 8-14 days The weather is always the X-factor in assessing future pricing. Mild winter and/or cool summers arebearish while extended cold arctic blasts and blazing summers are bullish.

Demand: While the economy and manufacturing levels play a big part in the supply/demandequation, the weather (winter and summer) holds the reins and controls the pricing throttle.



D r i l l i n g d o w n . . .

Production: Even with all of the well shut-ins from earlier this year, we expect robust supply toremain throughout the year with horizontal rigs being the shale rig of choice, as their production ismuch higher than when first introduced a few years ago. Drill time is shorter, laterals are longer, andfracking techniques have been greatly improved. As mentioned earlier, many dry wells were shutteredin favor of "wet" or "liquid" plays, but still much natural gas is produced in these "wet" wells.Additionally, there are a "large" number of these wells that have been drilled and are just awaiting thepiping infrastructure to be finished in order to bring their gas to market.

As coal plants retire they are not being replaced. Whether it be for economics or costs to retrofit tomeet EPA standards, operating margins are not what they used to be and no longer cover their fixedcosts. Instead, gas fired plants are picking up the slack.

Bottom Line: Greater natural gas production will likely be required moving forward and is available.

Note: In the Marcellus, production is expected to "surge" adding 3.8 Bcf/day in the next twelvemonths which should easily recapture any shortfalls elsewhere in the production system. If there wasto be a weak link in the supply/demand equation, we don't expect it to be here . . . this year.

In short we expect natural gas supply to increase year-over-year.

Storage: Current storage levels are high, and given the Thanksgiving week and warmer weatherthere is an outside chance for even a small injection on the next storage report. If not, we expect thenext EIA storage report to show a very small withdrawal.

To catch a glimpse of lower-48 storage history, this graph shows levels up through Nov 16, 2012.

We believe that end-of-winter storage levels may well be reduced to around the 2,000 Bcf level this spring, withincreased storage capacity of 4150 Bcf for the 2013 injection season. If this proves out, we expect the sawtooth

design above will continue to rise.



We expect the "end of winter" storage levels to be near 2,000 Bcf. For the last 20 years, up until lastyear, we wondered what might happen if end of winter storage was at the 2,000 Bcf level. Last yearstorage bottomed out at 2369 and we saw what happened to spring/summer pricing.

Weather - Demand: Here are a few weather scenarios.

If we have a very mild winter as we did last winter, or something very similar to it, we would thenexpect the "end of winter" storage levels to be far above the 2,000 Bcf mark, perhaps in the 2,200 -2,300 range. With that much gas in storage, we would then expect to see a replay of last year, wheregas prices "necessarily" needed to drop below $2.50 and $2.00 to induce large amounts of gas to beburned instead of coal.

If there is a normal winter, say of two years ago, then we expect 2,000 Bcf as an end of March storagelevel and would also expect pricing to drop into spring and summer as production increases wouldelevate storage volumes above acceptable levels where overall storage capacity becomes an issue.

We expect the weather will fall between the two scenarios shown above.

If summer is as hot as last summer with great A/C demand, as we expect will happen, then again weexpect storage surplus volumes will be burned at lower coal-displaced pricing.

If this winter turns much colder than what is expected and/or if the summer is not as hot as it hasbeen in the past few years, then we anticipate 2013 end of winter storage levels to be somewherebetween the 1,500 to 1,800 Bcf range. This would likely keep pricing higher than expected as of thiswriting and delay much if not all of the gas/coal switching that is expected next spring/summer.

Weather Services International (WSI) indicates:

"WSI Expects a Return to More Moderate Winter Temperatures, but Still Anticipates SlightlyColder-Than-Normal Conditions across Northern and Western US" and indicates . . . "USGas-Heating Demand Expected to be Lowest Since 2006-07 Winter. However, from a gas-demand perspective, we expect this to be the mildest winter in the US since 2006-07. Intotal, our forecast calls for a 7.5% reduction in heating demand relative to last winter, but a4% increase relative to the 1981-2010 averages."

Pricing Projections: The EIA has indicated that they envision a median price of $3.35 throughout2013, whiles another one of our superb analysts has set his 2013 median pricing at the $3.55 level.

So some monthly prices may be below $3.00 while others might be upper $3 or lower $4 level.

Political Ramifications: A complete review and overall perception of our energy market would beremiss if we didn't talk briefly about political agendas and recent election results. It should beremembered that the current administration has a penchant for promoting "green" energy solutionswhile shaking a finger at the "coal" industry. Whether it's through presidential decree or through EPAdoctrines, it does appear as though there is a rocky road ahead for coal. With that in mind, the nextbest play as a substitute for coal-fired generation is natural gas. Fracking and water issues are alsostill suspect with this administration.

We believe the Keystone Pipeline will be built, but when remains to be seen.

California, being the "clean-air" leader it is, now has carbon credits tied to electricity purposes, asanother means of raising taxes and supporting bullet trains. More on this moving forward.

Contrarian Assessment

And lastly, to provide a contrarian opinion to the industry accepted "rosy" viewpoint of 100+ yearshale gas production and energy independence, we have included articles about the "The Shale GasBubble About to Burst" by Steve Horn.



Shale Gas Bubble About to Burst: Art Berman, Bill Powers

Bill Powers, editor of Powers Energy Investor , has a new bookset for publication in May 2013 titled, "Cold, Hungry and in the

Dark: Exploding the Natural Gas Supply Myth."

Powers' book will reveal that production rates in all of the shalebasins are far lower than the oil and gas industry is claimingand are actually in alarmingly steep decline. In short, the "shalegas bubble" is about to burst.

In a recent interview, Powers said the "bubble" will end uplooking a lot like the housing bubble that burst in 2008-2009,and that U.S. shale gas will last no longer than ten years. Hetold The Energy Report: "My thesis is that the importance of shale gas has been grossly overstated;the U.S. has nowhere close to a 100-year supply. This myth has been perpetuated by self-interestedindustry, media and politicians...In the book, I take a very hard look at the facts. And I conclude thatthe U.S. has between a five- to seven-year supply of shale gas, and not 100 years."

The hotly-anticipated book may explain why shale gas industry giants like Chesapeake Energy havebehaved more like real estate companies, making more money flipping over land leases than they doproducing actual gas.

Powers told The Energy Report : "Put simply: There is production decline in the Haynesville andBarnett shales. Output is declining in the Woodford Shale in Oklahoma. Some of the older shale plays,such as the Fayetteville Shale, are starting to roll over. As these shale plays reverse direction and theMarcellus Shale slows down its production growth, overall U.S. production will fall."

Powers believes we are quickly approaching a gas crisis akin to what occurred in the 1970s andbecause of that, prices will soon skyrocket.

Art Berman Also Sounds the "Shale Gas Bubble" Alarm

Arthur Berman, another investment insider, echoed Powers in a recent interview with Oil Price,remarking that the decline rates in production in shale basins nationwide are "incredibly high."

Berman is a petroleum geologist, Associate Editor of the American Association of Petroleum GeolgistsBulletin and Director of the Association for the Study of Peak Oil . He maintains the blog PetroleumTruth Report .

"In the Eagleford shale, which is supposed to be the mother of all shale oil plays, the annual declinerate is higher than 42%," he stated. "They're going to have to drill hundreds, almost 1000 wells in theEagleford shale, every year, to keep production flat. Just for one play, we're talking about $10 or $12billion a year just to replace supply."

Berman believes there's a possibility that this could lead to an economic crisis akin to which happenedduring the Big Bank bailouts of 2008.

"I add all these things up and it starts to approach the amount of money needed to bail out thebanking industry. Where is that money going to come from?," he asked the interviewee.

Who Will Be Left "Cold, Dark and Hungry" and Living in the "Dark Ages"?

It's a deep dive into shale gas production numbers that have led insiders like Powers, Berman andothers to conclude that the behavior of the industry is akin to Enron's behavior in the 1990s, describedby some as a "Ponzi Scheme" in a June 2011 investigation by The New York Times.

"What a glorious vision of the future: It's cold, it's dark and we're all hungry," Chesapeake Energy CEOAubrey McClendon said of anti-fracking activists in Sept. 2011. "I have no interest in turning the clockback to the dark ages like our opponents do."



The reality, though, is far murkier. It appears the real culprit "turning the clock back to the dark ages"may actually be the unconventional oil and gas industry after all.

Dear reader:

Our goal is to provide the best energy industry information for you to make sound energy decisions foryour company.

The information above is our best effort to provide information regarding the energy markets. It is our opiniononly and does not not constitute or include any guarantees or assurances of future accuracy.

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If you would like to discuss fixing a volume/rate/term, please give me a call. We are big proponents of "partial volume" hedges and can help you design a plan that fits your risk/budget.

Best regards,Robert Kramb

energy market update and opinion nov 27 2012

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