Lessons from the Natural Gas Market

Gas to Liquids—The Stealth Utilization Alternative?There has been a robust debate over the use of the nation’s natural gas abundance to support LNG exports. As my colleague, Gordon Pickering, and I have explained ex-tensively in past issues of NG Market Notes, and, as the Department of Energy appears to now recognize, the value of stable, growing demand such as LNG destined for in-ternational markets is essential to stabilizing the course of development of the major shale gas plays. Along the same lines, for many years the industry has been working to displace oil-based fuels to by advancing natural gas vehicle (NGV) technologies and design. Both initiatives have found some hurdles to overcome. In the case of LNG exports, the major hurdle is resistance from industrial users worried that the added demand will raise prices, as well as from opponents of natural gas development who argue that no national purpose is being served if development impacts are incurred simply to export a money-making product. In the case of NGVs, the major hurdle is the need to change the refueling infrastructure and the vehicle fleets themselves, in or-der to use the fuel—changes that are much more practical to accomplish in large fleets or for long-haul trucks than in the nation’s vast population of private vehicles. Cer-tainly, advances in vehicle design and particularly in home refueling have made light-duty NGVs a more robust alternative than in the past, but could there be additional ways to extend the benefits of abundant natural gas into transportation?

For a long time, some sectors have advocated for a different use of natural gas, con-verting it chemically to oil-type fuels and using it directly in existing engines—“gas to liquids,” or “GTL.” I say, “a long time” in that the core technology involved, Fischer-Tropsch reformation, has been around in its basic form since the 1920s. Many advances were made in the technology (which can also be used to convert coal to oil) by nations that could not obtain the oil they needed. Over the last couple of decades, some very large and pretty small companies have undertaken serious initiatives to bring the tech-nology into the 21st Century. Two of the leading big companies have been Sasol and Shell. And, so far, a common element between them has been the active endorsement and par-ticipation of Qatar Petroleum (QP), the national oil and gas company of the State of Qatar.

I recently was honored to speak at the first World GTL Congress, in Doha, Qatar under the sponsorship of the Energy Minister. The Congress provided an in-depth and in-sightful view at the present state of GTL development, and it has changed significantly.

A publication by Navigant’s Energy Practice » February 2013

Contents1 Lessons from the

Natural Gas Market – Gas to Liquids—The Stealth Utilization Alternative?

5 Natural Gas Market Charts

8 Legislative and Regulatory Highlights

10 About Navigant

2

February 2013

In 2008, Oryx GTL, a partnership of Sasol and QP, reached full produc-tion with the first large GTL plant in Qatar, a 34,000 barrel-per-day plant in Ras Laffan Industrial City. It con-verts about 350 MMcf-per- day of natural gas from Qatar’s enormous North Field reserves in the Arabian Gulf into up to 34,000 barrels-per-day of diesel, jet fuel, and other use-ful chemical products. The plant has been in operation now for more than five years and its success has been highly publicized by QP and other Qatari entities such as Qatar Airways (who has demonstrated blending of the jet fuel in wide-body flights back and forth to London).

More recently, in a project that just reached its full ramp-up schedule last year, Shell partnered with QP to build Pearl, a 140,000 barrel-per-day facility also in Ras Laffan. The plant, along with the offshore natural gas plat-forms and pipelines to feed it, cost in excess of $20 billion, and carries some really impressive statistics, based on various presentations by Shell. For example, spanning more than 600 acres, its land footprint is as large as Hyde Park and Kensington Gardens in London, which actually makes it larger than the entire Principality of Monaco. At one point, it had 52,000 employees on-site, who formed their own municipal government. Shell in-dicates that just as the Oryx plant was able to do for Sasol, Pearl represents a platform for continuing development of the technology underlying GTL production, helping to find options for increasing efficiency while reduc-ing capital cost and operating cost.

These successes in Qatar have pro-vided an important diversification to the nation, which had emerged as the largest exporter of LNG in the world. The abundance afforded by U.S. shale gas development is having profound impacts on world markets, impacts that do not have to await actual U.S. exports to occur. This is because, up until 2008, the U.S. was expecting to be importing as much as 25 percent of its supply from LNG exporting nations such as Qatar, but the emer-gence of the U.S. abundance pushed all of that LNG back onto world markets. At the same time, of course, shale gas is being examined for possi-ble development in a number of coun-tries. Thus, it was critical for Qatar to find some diversified applications for its natural gas abundance, and GTL has provided an important one.

Qatar has a couple of major advan-tages. First, the government is not only supportive, but through its state-owned oil company, is actually a part-ner in both plants. A major user of the output, Qatar Airways, is also state-controlled. Meanwhile, there are the North Field reserves in the Arabian Gulf. The North Field has virtually no lifting cost. As one Shell executive put it, the economics of the projects are driven strictly by the incremental capital, not by an intrinsic cost of the natural gas. Put more simply, these projects have demonstrated that with free feedstock, it is feasible to make the economics work.

Which brings us to the U.S. Until re-cently, GTL has been greeted with a high degree of skepticism in the U.S. natural gas industry. As recently as 2011, when attending global GTL meetings in London, I observed very little interest in the development of U.S. GTL. However, some changes may be sneaking up on the industry. In terms of large projects by the major players, in December 2012 Sasol an-nounced that after a year of feasibility studies, it will be moving ahead with a very large facility in Lake Charles, Louisiana, that will be a combination GTL plant and ethane cracker. The total investment is expected to cost between $16- $21 billion, of which $11-$14 billion will be for a 96,000 barrel-per-day GTL facility. The plant is expected to start the first phase of its operations in 2017 and is said to be the largest single manufacturing invest-ment in Louisiana history, according to Governor Bobby Jindal. Meanwhile, Shell has indicated that it is reviewing various possibilities for GTL develop-ment in the United States.

Can this work when the feedstock is not free, when the plant will have to compete with other users of natural gas and probably with LNG export facilities for market supply? Sasol certainly seems to think so. Obvious-ly, the price spread between natural gas and oil is the critical driver of the economics. For example, oil at $100 per barrel is $17.24 per million Btus, as compared with natural gas in the single-digits—say, $4.50 per million Btus. That would then be an oil-gas spread of $12.74 per million Btus,

3

February 2013

which one would think could fund a pretty expensive plant to turn natural gas into petroleum products. How-ever, losses in the conversion pro-cess, energy and other operating-cost inputs, and the simple fact that the price spread between two commodi-ties is always uncertain, all constrain how much one would be willing to invest for a 20-year life. Thus, it is extremely important to have some means of stabilizing the economics, whether through ownership of natu-ral gas reserves, long-term contracts, or financial instruments. It would seem that, just as with QP’s involve-ment in Qatar, this would be a natu-ral investment for a producer. If the natural gas price is low, the producer could make money on the upgrade to oil products, and if the natural gas price is high, the producer could make money on the natural gas itself.

Aside from the basic economics of the currently large oil-gas price spread, there are other reasons that the time may have come for large-scale GTL in the US. First, it could be a more effec-tive way to use our natural gas abun-dance to fuel light-duty vehicles than it would be to wait for the whole con-sumer fleet to change to compressed natural gas (CNG). CNG works well in fleets, and LNG is making prog-ress in the heavy trucking market. However, most observers expect the light-duty vehicle market to be the last one penetrated, and to be subject to intense competition from electric, hybrid, and high-efficiency gasoline and diesel engines, all of which can refuel from the existing infrastruc-ture. As noted earlier, a lot of prog-ress is being made in vehicle design

and home refueling, but it might not hurt to have an additional avenue for getting natural gas into transpor-tation markets. If natural gas can be turned into liquid fuels that can be distributed through the existing infra-structure and blended to burn in the same vehicles, the progress in the use of natural gas in transportation can be much faster—and it can get into aviation markets as well.

GTL is also much cleaner than tra-ditional liquid fuels. Without get-ting into the chemistry specifics, it’s apparent just by looking at it. At the aforementioned World GTL Congress in Doha, Qatar, the major GTL compa-nies showed samples of their various products to compare with traditional petroleum-based diesel fuel, naphtha, chemical waxes, etc. Unlike the tra-ditional products, the GTL products were crystal clear, looking more like grain alcohol or spring water than something to go in your gas tank. The reports from every utilization sector are glowing, including increases in engine life, extended maintenance in-tervals, and reduced emissions.

Another significant reason for the U.S. to consider GTL as a comple-mentary alternative to LNG exports is the relationship to concerns sur-rounding development impact. In the case of LNG exports, many in the environmental community who have opposed hydraulic fracturing and other developmental impacts op-pose the exports on the basis that the economic benefit of the export rev-enues is not, in their view, important enough to outweigh what they see as the negative impacts of the devel-opment. Without getting into the ac-

curacy or inaccuracy of the negative impact claims, it would seem to be much more compelling to be able to say that the natural gas produced is directly displacing imported oil, as it would be in the case of GTL produc-tion. This nexus to national secu-rity is certainly important enough to warrant very serious consideration of large-scale GTL development. I would emphasize that GTL is not a replacement for LNG exports, as the U.S. needs both to bring supply and demand back into balance and sup-port sustained development of the U.S. natural gas resource.

Moving away from the large, multi-billion dollar installations, such as Lake Charles and the Qatari plants, there is a robust and growing popula-tion of small, modular GTL develop-ers. These approaches vary from each other, driven by startup companies, entrepreneurs, and venture capital. Each tends to work in the small, 1,000

GTL Chemistry and Process

Since fuels from the GTL process are cleaner than conventional refinery fuels, they present two main advantages over conventional refinery fuels: a higher performance (better thermodynamic ef-ficiency of combustion) and lower pollu-tion. They are, in fact, sometimes blended with refinery fuels to improve their quality. These advantages arise from the require-ment of the GTL production process that sulphur, among other elements, be re-moved from the natural gas feed stream to avoid catalyst fouling which could lead to premature catalyst deactivation.

More on GTL Chemistry and Process

4

February 2013

Mcfd/100 barrel-per-day context, in producing areas themselves. The pur-pose for these small modular instal-lations is to be able to handle asso-ciated natural gas that is produced with oil, either offshore or in remote areas where there is not another way to capture the natural gas, or when it is simply not commercially attractive to do so. The standard practice from time immemorial has been for oil pro-ducers, anxious to produce their oil, to simply flare the associated natural gas—this was the reason that until 1947, one could drive across Texas at night without headlights. The same thing has been happening in produc-ing regions such as the Bakken shale in North Dakota, where prodigious amounts of oil are being produced before the associated natural gas can

be collected and handled. In many countries, such flaring is no longer permitted, and in the middle of this decade the same will be true in the U.S. for new wells.

Thus, developing small, relatively flexible facilities that can be built on-site close to one or more oil wells, can collect the associated natural gas and turn it into GTL that can be blended with the oil as it is carried away, is taking on an increasingly high prior-ity. The highest level of activity in the past has been in offshore situations, but the nature of the rapidly expand-ing U.S. shale oil development could make modular GTL highly important.

I have noticed that when I participate in global GTL discussions, the North American presence is much greater

than it has been in past years. With the Sasol plant moving forward as a major first step, it could be that GTL is stepping into an unanticipated ma-jor role in helping the US get the most out of its natural gas abundance. For that to be true and sustainable, con-tinued advances in capital cost reduc-tion, operating efficiency, catalyst life, and the environmental footprint of the plants themselves will be essen-tial, but this is a sector worth watch-ing closely.

— Rick Smead

The opinions expressed in this article are those of the authors and do not necessarily represent the views of Navigant Consulting, Inc.

About the Author » Rick Smead is a Director in Navigant’s Energy Practice.

5

February 2013

Natural Gas Market Charts

MONTHLY GAS INDEX PRICE

$0

$2

$4

$6

$8

$10

Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13

$/M

MB

tu

Chicago Opal New YorkAECO-C SoCal Gas Henry Hub Sources: Navigant/Gas Daily

Monthly index gas prices fell last month, with Henry Hub decreasing 9% to $3.35/MMBtu for January from $3.71 for December.

NYMEX FUTURES SETTLEMENT PRICES AT CLOSE

$3

$4

$5

Dec-12 Mar-13 Jun-13 Sep-13 Dec-13

$/M

MB

tu

Sources: Navigant/NYMEX

Dec

Jan

Feb

The average 12-month strip price increased to $3.70/Mmbtu from $3.58.

DAILY GAS PRICE

$0

$2

$4

$6

$8

$10

$12

$14

$16

$18

$20

$22

Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13$/

MM

Btu

Chicago Opal New YorkAECO-C SoCal Gas Henry Hub

Sources: Navigant/Gas Daily

The daily spot prices ended the month about even with December, with Henry Hub at $3.44/MMBtu.

MONTHLY PRICES: OIL AND NATURAL GAS GULF COAST

$0

$6

$12

$18

$24

Dec-08 Dec-09 Dec-10 Dec-11 Dec-12

$/M

MB

tu

WTI (Cushing, OK), Crude Oil

Henry Hub - Natural Gas Sources: Navigant / Platts

Most recent comparison shows an increasing monthly price spread, with Henry Hub natural gas price at $3.35 versus WTI crude oil price at $14.03, an equivalent energy ratio of 4.2 times.

6

February 2013

Natural Gas Market Charts

U.S. DRY GAS PRODUCTION

52

54

56

58

60

62

64

66

68

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Bcf

/day

2009 2010 2011 2012 2013Sources: Navigant / EIA

U.S. dry gas production continues above 66 Bcfd.

U.S. WEEKLY NATURAL GAS RIG COUNT

200

400

600

800

1,000

1,200

1,400

Rig

s

2009 2010 2011 2012 2013

Sources:Navigant/ Baker Hughes

Jan OctSepAugJulJunMayAprMar DecNovFeb

U.S. natural gas rig count dropped slightly to 429.

U.S. WELLHEAD SHALE GAS PRODUCTION

0

5

10

15

20

25

30

Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12B

cf/d

ay

Marcellus Eagleford WoodfordFayetteville Haynesville Barnett ShaleOther

Sources: Navigant/ LCI

Total U.S. shale gas production continues strong at just over 29 Bcfd.

U.S. GAS STORAGE

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Bcf

Range (2003-2012) 2009 20102011 2012 2013

Jan OctSepAugJulJunMayAprMar DecNovFeb

Sources: Navigant / EIA

U.S. storage levels are now within the 10-year range for January.

7

February 2013

Natural Gas Market Charts

CANADA GAS STORAGE

50

150

250

350

450

550

650

750

Bcf

Range (2007-2012) 2009 20102011 2012 2013

Sources: Navigant / Enerdata

Jan OctSepAugJulJunMayAprMar DecNovFeb

Canadian storage inventories are now within the 5-year norm for this time of year.

U.S. TEMPERATURE OUTLOOK

The temperature outlook is for above normal temperatures for much of the southern U.S. except for the Southeast, as well as for Pennsyl-vania through the Northeast, and for below normal temperatures for the upper Great Plains and Rockies, as well as the Pacific Northwest.

U.S. MONTHLY NATURAL GAS DEMAND

40

50

60

70

80

90

100

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecB

cf/d

2009 2010 2011 2012 2013Sources: Navigant / EIA

Demand is showing a normal seasonal increase, and exceeds the average level of the prior four years at this time by about 6%.

NAVIGANT PRICE PREVIEW

Price forecasts average about $3.50 for 2013.

Source2013 Price Forecast (Nominal $/MMBtu)

EIA $3.74Barclay’s $3.70Goldman $3.75Raymond James $3.25Jeffries $3.40BNP Paribus $3.50Survey Average $3.56Navigant $3.45

Sources: Navigant Survey/Navigant

8

February 2013

Legislative and Regulatory Highlights

National

INGAA Study Finds Pipeline Authorization Times Increased after EPAct 2005

On January 17, the Interstate Natural Gas Association of America announced the release of its study entitled “Ex-pedited Federal Authorization of Interstate Natural Gas Pipelines: Are Agencies Complying with EPAct?”. The study found that despite the provisions of EPAct 2005 aimed at expediting federal authorizations for pipe-lines, federal authorizations taking at least 180 days after FERC’s issuance of an Environmental Impact Statement or Environmental Assessment rose from less than four percent to almost 20 percent after EPAct 2005. The study was based on a survey of 51 pipeline projects from both before and after the effective date of EPAct 2005.

BLM Announces Delay of Hydraulic Fracturing Rules for Public Lands

On January 18, the Department of the Interior’s Bureau of Land Management announced that it will delay finaliza-tion of hydraulic fracturing rules and will release a draft proposal for public comment during the first quarter of 2013. A draft rulemaking was proposed in May 2012, with the initial comment period closing in September 2012.

Central U.S.

FERC Approves Improvements on Alliance Pipeline’s Tioga Lateral Serving Bakken Shale

On January 17, FERC approved the request of Alliance Pipeline to amend the certificate of public convenience and necessity issued in September 2012 authorizing the con-struction and operation of its Tioga Lateral in North Dako-

ta. Alliance sought to increase the amount of compression on the pipeline to increase capacity from 106 MMcfd to 126 MMcfd, in order to enhance service to shippers from the Bakken shale to the Chicago hub. FERC’s approval found that the amendment would have no adverse effects on ex-isting customers or on existing pipelines

Nebraska Governor Approves Keystone XL Reroute

On January 22, Nebraska governor Dave Heineman notified President Obama and Secretary Clinton of his approval of a proposed reroute of TransCanada’s Key-stone XL Pipeline project through the State of Nebraska. The reroute proposal followed the January 2012 denial of TransCanada’s Presidential Permit for the Keystone XL pipeline, which is intended to move oil for process-ing from Alberta’s oil sands to the U.S. gulf coast. The Nebraska Department of Environmental Quality’s Fi-nal Evaluation Report found that the proposed reroute avoided the Sand Hills and many areas of fragile soils, but would still cross the High Plains Aquifer. Howev-er, the NDEQ found that with mitigation and commit-ments from Keystone, construction and operation of the pipeline would have minimal environmental impacts in Nebraska. The governor requested that the state’s evalu-ation be included in the Department of State’s Supple-mental Environmental Impact Statement.

Pacific Northwest

Errata Re: GTN’s Proposed Carty Lateral ProjectFERC Docket No. CP12-494-000

Last month we incorrectly stated that FERC’s Office of Energy Projects had authorized Gas Transmission North-west LLC’s request to construct a natural gas pipeline in Morrow County, Oregon serving Portland General Elec-tric Company’s planned Carty Generating Station. The correct information was that the Office of Energy Projects had issued a favorable Environmental Assessment.

9

February 2013

British Columbia

TransCanada Selected to Build Proposed Pipeline to Petronas/Progress Energy’s Proposed LNG Terminal at Prince Rupert

On January 9, TransCanada Corporation announced that it had been selected to design, build, own and operate the proposed $5 billion Prince Rupert Gas Transmission project to serve Progress Energy Canada’s recently an-nounced Pacific Northwest LNG project on Lelu Island near Prince Rupert. The proposed 470-mile pipeline, with an initial capacity of 2 Bcfd, will transport natural gas to the LNG project primarily from the North Montney region near Fort St. John, B.C. In addition, TransCanada announced plans to connect its existing NOVA Gas Trans-mission Ltd (NGTL) system serving the Western Canada Sedimentary Basin to the new Prince Rupert pipeline.

First Nations Regulations Completed for Kitimat LNG Project

On January 22, the Government of Canada’s Ministry of Aboriginal Affairs and Northern Development announced the completion of regulations for the development of the Kitimat LNG liquefaction terminal project. Along with the Haisla Natural Gas Facility Regulations, an agreement was also signed by the Haisla Nation and the Govern-ments of Canada and British Columbia allowing for the monitoring and compliance activities for the LNG facility to be performed and enforced by provincial officials, who have the necessary experience and expertise.

10

February 2013

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E N E R G Y

NATURAL GAS & LIQUEFIED NATURAL GAS (LNG) SERVICES

INSIGHT DELIVERED

Navigant’s natural gas and liquefied natural gas (LNG) experts provide clients

with insight into energy business strategies, project transactions, financing, op-

erations, trading and marketing. Our global perspective uniquely positions us to

provide both domestic and international expertise in:

» Strategy and planning

» Market analysis and planning

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» Independent due diligence

CHALLENGECHALLENGE

CHALLENGE

NORTH AMERICAN NATURAL

GAS SUPPLY ASSESSMENT

CHENIERE: LNG EXPORT

IMPACT ASSESSMENT

DOMINION: LNG EXPORT

IMPACT ASSESSMENT

SOLUTION

SOLUTION

SOLUTION

In 2008, Navigant released the first

major study of North American natu-

ral gas supply recognizing the poten-

tial for shale gas development. At a

time when the conventional wisdom

was that U.S. natural gas was a de-

clining resource, Navigant defied

the status quo and supported a fifty

percent increase over the then-pre-

vailing resource estimates. Today,

the prevailing estimates resemble

Navigant’s initial, ground breaking

evaluation from 2008, with natural

gas abundance being widely ac-

knowledged. Gas shale production

has been robust enough for LNG im-

ports to be replaced by LNG exports.

Navigant experts played a substan-

tial role in beginning North America’s

natural gas transformation.

Navigant provided a detailed as-

sessment and analysis of the U.S.

gas market impact of LNG exports,

for Cheniere Energy’s Department

of Energy (DOE) export application

for its Sabine Pass, Louisiana export

project. Navigant conducted the

analysis with its proprietary industry-

leading market model built upon

the Gas Pipeline Competition Model

(GPCM) and its expert analysis was a

key component of Navigant’s report

in support of the project. The appli-

cation for export by Cheniere is at

this time the first and only LNG export

project to have received DOE ap-

proval to non-Free Trade countries.

In support of Dominion’s application

to DOE for LNG long term export au-

thority to non-Free Trade countries,

Navigant provided a report assess-

ing the U.S. gas market impact of

exports from Dominion’s Cove Point,

Maryland facility. Navigant’s assess-

ment of the U.S. natural gas market,

including the Marcellus gas shale

basin, was captured in the market

and infrastructure reports provided

to the client. Both reports and the

analysis were based upon Navi-

gant’s leading North American

market model built upon GPCM,

and were filed in support of Domin-

ion’s LNG export application in

September 2011.

E n E r g y

Natural Gas Market Modeling and Scenario Analysis