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A return to "normalcy" in US gas?
April 15, 2010
ENERGY &ENVIRONMENTENERGY &ENVIRONMENT
1eei - gas dynamics -15Apr10 - WAS-v1.ppt
BCG serves the full range of management issues
2eei - gas dynamics -15Apr10 - WAS-v1.ppt
BCG is global 5,000 professionals - 69 offices in 38 countries
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WarsawBerlinPragueBudapestViennaRomeMunich
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3eei - gas dynamics -15Apr10 - WAS-v1.ppt
We have extensive experience throughout power and gas
Gas: 327(21%)
PowerCorporate
Retail & Customer Service
Oil: 292(18%)
Sustainability: 220 (14%)
BCG energy projects in past five years
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Focus on Power experience
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Focus on Gas experience
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Sourcing& trading
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Corporate
4eei - gas dynamics -15Apr10 - WAS-v1.ppt
US natural gas – a return to normalcy?
At least for now, natural gas – rather than climate change – has turned out to be the real wild card in the US electricity market
Gas is one of the dominant drivers of electricity prices, and thus its price is critical for shaping future generation choices and profitability of existing units
Following the merchant gas building boom (on the heels of sustained low gas prices), concerns grew about domestic gas shortages
• Apparent linkage of natural gas to oil prices• Policy focused on enabling increased access to LNG...• ... despite safety and quality concerns i, and plus exposure to a foreign gas cartel and oil-
indexed gas prices• CCGTs replaced by nuclear and (clean) coal as preferred source of future base load
What does the recovery of extensive and economically recoverable unconventional resources mean for LNG
Is natural gas once again the preferred choice for new generation?
5eei - gas dynamics -15Apr10 - WAS-v1.ppt
In 2005, the US was about to be linked to a global gas market, but instead it "discovered" unconventional
Expectations(2003-2005)
Expectations(2003-2005)
High growth of US gas demand until 2020
Limited growth of U gas production
Plenty of available new LNG
Attractive US net-back prices for LNG producers (moderate oil price)
LNG imports expected to reach 50bcm n 2008, 160 bcm in 2020 (EIA)
+
+
+
Today / Tomorrow2008-2012
Today / Tomorrow2008-2012
Negative to moderate growth of gas demand
Still plenty of U reserves, yet production to stabilize/ decline to reflect lower investment and price signal
Oversupply of LNG due to GLOBAL low demand
Some decoupling in Europe, reducing netback
+
+
+
????
What happened(2006 -2008)
What happened(2006 -2008)
Moderate growth of gas demand
Plenty of U gas reserves, production costs decreasing
Tight supply situation in gas exporting countries
High oil prices, making European market very attractive
LNG imports at ~ 10 bcm
+
+
+
6eei - gas dynamics -15Apr10 - WAS-v1.ppt
High gas prices drove growth in unconventional gas supply LNG flowed to even higher priced markets due to oil price indexed contracts
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
97 98 99 00 01 02 03 04 05 06 07 08 09
0
5
10
15
20
25
30
35
Gas price($/mmBtu)
Year
Unconventional gas(Bcf/day)
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
97 98 99 00 01 02 03 04 05 06 07 08 09
0
20
40
60
80
100
120
Gas price($/mmBtu)
Oil price($/bbl)
Source: Waterborne LNG; EIA;UBS; BCG analysis
YearAsia Weighted Avg. contract
Oil price
Asia Weighted Avg. spotEuropean contractNorth American spot (Nymex)
High US prices drove significant development of unconventional gas resources...
High US prices drove significant development of unconventional gas resources...
...while high oil prices kept globalLNG prices even higher
...while high oil prices kept globalLNG prices even higher
Unconventional gasproduction
Gas price
+15bcf/d in 10 years
7eei - gas dynamics -15Apr10 - WAS-v1.ppt
Shale gas is the dominant type of unconventional gas
Fast growing production...Fast growing production... ...with most potential still to come...with most potential still to come
• The only real growth relay for gas in the US• Expected to reprensent 1/3 of US/Ca. prod. by 2030
– ~9 Tcf per year by 2025 (~2 Tcf today)• Some emerging plays in Canada too
– too early to asset full potential
• Historical plays (SG Tier 1) most likely "gone"...– Limited to no entry logic for IOCs
• ... but entering Shale Gas still possible– SG Tier 2 still offer upside potential– SG Tier 3 has embedded "speculative" logic
0
10,000
20,000
30,000
Production [kboepd]
2008 2025
Tight Gas Coalbed Methane Conventional GasShale Gas
+11%
-1%
-1%
-1%
Source: Rystad UCube; BCG analysis
8eei - gas dynamics -15Apr10 - WAS-v1.ppt
Many contributors to shale gas production... Forecasted production available for each company, in each shale gas basin in US and Canada
0
5
10
15
20
25
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
Production [bcfd]
Divisions represent individual basins
Source: Rystad UCube; BCG analysis
Tier 1 refer to "initial" SG development wave in basin that are already significantly developed (e.g. Barnett Shales)
Tier 2 refer to new SG development on-going e.g. Marcellus
Tier 3 refer to the next likely wave of SG development, in places where only land grabbing has happended
Shale gas Tier 18
Shale gas Tier 29
Shale gas Tier 310
Additional Tier 3 potential?
Shale gas Tier 18
Shale gas Tier 29
Shale gas Tier 310
(U.S. only)
(U.S. and Canada)
(U.S. and Canada)
9eei - gas dynamics -15Apr10 - WAS-v1.ppt
...though four basins dominate 85% share today falling to 65% in 2025
9
0
2
4
6
20 04
20 09
20 25
Production [bcfd]
Barnett Shale – Producing
46% 14%
0
1
2
3
20 04
20 09
20 25
Production [bcfd]
Fayetteville Shale – Producing
17%
9%
0
2
4
6
2004 2009 2025
Production [bcfd]
7%
22%
0
2
4
6
20 04
20 09
20 25
Production [bcfd]
13%
22%
Haynesville Shale – Developing Marcellus Shale – Developing
1. Shale gas production doesn't include NGL or any conventional gasSource: Rystad UCube; BCG analysis
Shale gas Tier 18 Shale gas Tier 18
Shale gas Tier 29 Shale gas Tier 29
10eei - gas dynamics -15Apr10 - WAS-v1.ppt
Shale gas economics vary significantly between basins... Marcellus with best estimated economics
Break even pointBreak even point IRRIRR NPVNPV
3.2
4.75.1 5.1
6.1 6.3
0
2
4
6
8
Marcell
usHayn
esville
Fayett
eville
Barnett
Core
Woodfor
d
Barnett
Non
core
Breakeven economics ($MMBtu1 )
0 20 40 60 80 100
Marcellus
Haynesville
Barnett Core
Fayettevile
Woodford
BarnettNoncore
Pretax IRRs at 8–10/MMBtu NYMEX gas
(%)
2.01.7
1.3 1.2
2.9
2.0
Marcell
us
Hyane
sville
Fayett
eville
Barnett
Core
Woo
dford
Barnett
Non
-Core
NPV/Mcfe for a sample well2
86% 47% 69% 64% 33% 31%
1. For a 10% pretax IRR 2. Pretax valuesSource: Deutche Bank
12eei - gas dynamics -15Apr10 - WAS-v1.ppt
While outlook for unconventional gas has risen, US LNG forecasts have strongly declined
Source: EIA annual energy outlook (2009 and 2008)
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 20260
100
150
200
50
2008
2005
bcm/yr
2009 updated
-90 bcm
-30 bcm
EIA net LNG imports projections – Reference scenarios
13eei - gas dynamics -15Apr10 - WAS-v1.ppt
Gas demand has dropped in all regions worldwide, with LNG absorbing much of the impact
North AmericaNorth America North-West EuropeNorth-West Europe AsiaAsia
353 337
4238
375395
1st half 2008 1st half 2009
Canada
USA
-5%
-10%
-4%
in bcm in bcm in bcm
53 48
4540
46
25
24
23
22
16
14
40
208
1st half 2009
189
1st half 2008
Other1
NL
FR
IT
GER
UK
-9%
-3%
-11% 51 47
20
17
1st half 2008 1st half 2009
64
S.Korea
Japan
-10%71
-8%
-3%
-13%
-10%
-10%
1. BE, LX, CH, ATSource: Snam Rete Gas; GRT Gaz; GTS; BAFA/BMWi/BDEW; DECC; E-Control; BP Statistical Review of World Energy; Natural Resources Canada; IEA Natural Gas Monthly Survey, BCG Analysis
-8%
14eei - gas dynamics -15Apr10 - WAS-v1.ppt
In Europe, Russia and domestic production compensated for drop in demand
Origin of gasOrigin of gas Essential changesEssential changes
93 85
4647
43
25
18
1712
8208
1st half 2008
4189
1st half 2009
Net storageLNG
Domestic production
(UK, NL, GER, IT)
Norway
Russia
North Africa-1
-8
-
-18
+4
in bcm Reduction of domestic production by ~8 bcm• NL -6%; UK -12%; DE -5%
Significant reduction of imports from Russia by ~17 bcm
• Reduction of expensive supply contracts• Effect of crisis in Ukraine ~2-3 bcm
Norway slightly increased production
Additional LNG imports of ~4 bcm• Via Zeebrugge and UK/Interconnector• LNG oversupply with low prices
Net withdrawal from storage facilities of ~4 bcm
• Due to crisis in Ukraine and cold winter
Source: Snam Rete Gas; GRT Gaz; GTS; BAFA/BMWi/BDEW; DECC; E-Control; BP Statistical Review of World Energy; BCG analysis
15eei - gas dynamics -15Apr10 - WAS-v1.ppt
In the US, LNG was hit hard by financial crisis and U gas development
US LNG demand: 2008US LNG demand: 2008
1. Range includes discrepancies between estimates for 2008 and other effects like variations in inventory and lossesSource: Cedigaz: IEA: BCG analysis
33
10
0
10
20
30
40
Pre-financial
crisisforecast
Local gasproduction
Netpipelineimports
Demand Real
(bcma)
Real growth of 5.5–5.9 (-1% conventional and +12% non-
conventional) versus previous forecast
Real growth -13%
Real growth +0.5–0.7% versus +3% pre-financial crisis forecast
1
Financial crisisFinancial crisis
Reduced economic growth has significantly hindered the development of LNG demand
• Power and gas consumption growth highly correlated with economic growth
• LNG imports take the first impact due to their flexibility and position in supply curve
Unconventional productionUnconventional production
Unconventional production is direct competitor of LNG in US• Covering gap derived from drop in imports from Canada and
decline in conventional production
During 2008, unconventional gas supply in the US rose +12%
• Full year impact of developments launched in high gas price environment
However, there may be a near term role for LNG in the US
16eei - gas dynamics -15Apr10 - WAS-v1.ppt
Fast decline of unconventional production fields allows a fast adjustment of market balance
Fast growth in US unconventional production
in 2004-2008...
Fast growth in US unconventional production
in 2004-2008...
...followed by a sharp decrease in drilling
activity in 2009
...followed by a sharp decrease in drilling
activity in 2009
...could lead to a fall in unconventional supply if
investments are discontinued
...could lead to a fall in unconventional supply if
investments are discontinued
0
250
500
750
1,000
1,250
1,500
1,750
Unconventional rigs1
Total gas rigs
# gas rigs in US
292
259231226
212
0
100
200
300
400
2004 2005 2006 2007 2008
+8%
(bcma)
-55%
-40%
1. Includes rigs in Barnett, Fayetteville, Greater Green River, Haynesville, Marcellus, Piceance, Williston, and WoodfordSource: EIA; Land Rig Newsletter; Baker&Hughes
2004 2005 2006 2007 2008 2009
Marcellus Shale and Haynesville Shale rig count even growing in '09 vs. '08
"Without continuing investments, production rates will not be maintained due to the steep decline rates (60% within the first year) of shale gas wells." (Center for Strategic and International Studies, mar-2009)
"Unconventional wells have steep decline rates, and any decrease in drilling will quickly result in dramatically lower gas production from these plays." (American Association of Petroleum Geologists, sep-2009)
17eei - gas dynamics -15Apr10 - WAS-v1.ppt
In this environment, will LNG may be competitive with unconventionals...
1. And, of course, gas prices in other markets vs. US gas prices 2. At the end of 2008 3. Assumes new capacity expected to come online in 2009-2012Source: Cedigaz; BCG analysis
Unconventional productionUnconventional production
Constant investment in E&P required to keep current production rates
• Unconventional gas fields decline fast• New drilling activity is required to keep
production levels
Additional investments in transportation are needed to allow the flow of additional unconventional production into the market
• Rockies connection currently limited; Rockies Express facing challenges and with limited flow (18 bcma) vs. production potential
• Marcellus shale holding limited access to New England, where the highest prices are registered
New investment decisions in unconventionals will consider whether gas prices support
FULL COST of investment
LNGLNG
Investments in regas terminals already committed
• Current terminals hold > 100 bcma of capacity2 (vs. 10 bcma of LNG imports in 2008)
– These terminals concentrate ~$10bn of accumulated investment
• Terminals under construction hold c. 90 bcma of additional capacity
Connections of regas terminals to the networks already done or committed
LNG importers holding Use Or Pay contracts against these investments
New flows of LNG in the US will consider whether gas prices support MARGINAL COST
of investment1
18eei - gas dynamics -15Apr10 - WAS-v1.ppt
... as LNG at marginal cost (since long) competes with full cost of unconventional gas?
Shale gas full costShale gas full cost LNG marginal costLNG marginal cost
0
2
4
6
8
0.8-1.9
4.5-6.0
0.8-1.9
6.3-7.4
0.8-1.9
3.5-5.0
4.3-6.9
Shale Gas-Barnett
5.3-7.9
Shale Gas-US average
7.1-9.3
Coal BedMethane1
Transportation
Lifting
$/MMBtu
0
2
4
6
8
0.10.3
0.5-3.3
0.3
1.0-2.7
0.30.3
0.8
1.0-2.7
0.7
1.6-3.3
2.3-6.8
TX
Liq.
E&P
$/MMBtu
•Own Liquef.•Own Vessel•Own E&P
•Tolling Liquef.•Own Vessel•Own E&P
•Tolling Liquef.•Chartered Vessel•3rd party E&P
1. Assumes reference values for WIlliams Fork/S.Piceance and Wasatch basinsSource: Cedigaz; BCG analysis
19eei - gas dynamics -15Apr10 - WAS-v1.ppt
This may create a near term opening for LNG in the US Significant room in the US -2011 situation
Global LNGGlobal LNGUS Regas capacity3 US Regas capacity3 U gas production2U gas production2
0
100
200
300
400
bcm
2008 20110
100
200
300
400
bcm
2008 2011
-100%0
100
200
300
400
2011
bcm
2008
300
0
100
200
300
400
20112008
bcm
LNG import (EIA 2009)
Main uncertainties•China as possible alternative •Duration of window also dependent on strategic behaviors of U gas producers
New LNG
Jap, Korea
Production decrease
1. U and L scenarios; 2. Low scenario assumed low rig count until 2011, high scenario until end 2010. 3. Average capacity (6600hrs) - 2011 figures accounts only for regas in operation or under construction as of Oct 2009Source: EIA, Cedigas, BCG analysis
"Excess" LNG1"Excess" LNG1
20eei - gas dynamics -15Apr10 - WAS-v1.ppt
Longer term evolution of LNG price driven in part by players' conduct
• LTC with ToP and oil- indexation remainMarket
structure
Market liquidity
Price stability
Market shares
"Return to the good old world"
"Return to the good old world"
"Goodbye oil-indexation"
"Goodbye oil-indexation"
"Aggressive producers go downstream"
"Aggressive producers go downstream"
• Spot market volume increases, but remains relatively low
• High price stability• Prices bound to oil-price
• Small changes• Utilities only in competition
with each other
• Reduced LTC (with and without ToP) indexed to hub prices
• Increased spot market volume
• Reliable price indication
• High price volatility• Contracts may provide
more price flexibility
• Moderate changes• Wholesale share will shift• Increasing competition
among utilities
• Low share of LTCs• Diverse supply channels
for end-customers compete
• High spot market volume• Very reliable price
indication
• Medium price stability• Volatility depends on
player‘s specific price strategy
• Significant changes in downstream market
• Broad competition with increasing pressure
Source: BCG analysis
21eei - gas dynamics -15Apr10 - WAS-v1.ppt
Current spot price (9 – 10 €/MWh)
Producer with significant interest in oil-price indexing ... Link to OPEC-set oil prices has created tremendous value for producers
SRMC in $/MMBtu
Netherlands
Norway
Russia
0 100 200 300 400
Italy Algeria
8
LNG
Denmark
UK
6
4
2
0
Gas supply North-west Europe 2008 in bcm
Germany0
5
10
15
20Cost in €/MWh
Oil-linked import price (BAFA 20€/MWh)
Demand2008
Merit orderMerit orderExpected profits under current price conditions of
delivery into North-west Europe Expected profits under current price conditions of
delivery into North-west Europe
1,5
5,17,6
5,9
7,4
9,8
Algeria
4,2
2,00,3
13,3
UK1
12,2
2,6
0,3
9,1
Norway
17,4
7,1
LNG
2,2
Russia Nether- lands
8,8
... however pressure to have a competitive position in short- and long-term
Profit with
oil-link
Profit at
spot- price
Poten- tial loss
1. In a balanced market continental oil linked prices influence gas to gas pricing in UK -> UK has the same interest in keeping the oil-gas linkSource: Wood Mackenzie; EU Sector Inquiry; BCG analysis
Profits/profit decline in € bn
22eei - gas dynamics -15Apr10 - WAS-v1.ppt
At the same time, U gas production efficiency is improving Example: Chesapeake Fayetteville Shale operations
Source: Chesapeake
Days versus DepthDays versus Depth Depth versus DollarsDepth versus Dollars
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
0 5 10 15 20 25 30 35Days from spud
Measured depth (m)
~40% less time
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
0 0.5 1.0 1.5 2.0 2.5Drilled and cased cost ($ mln)
Measured depth (m)
2006 2007 2008
~60% less cost
2006 2007 2008
"Halliburton expects plenty of demand for its shale technologies which are intended to help cash-strapped exploration and production companies increase efficiency and maximize the value " The Oil Daily, 20 Nov. 2008
"We believe that the most effective cost control will be achieved by the ongoing implementation of new oil field service technologies, particularly for the upstream segment. " Uralsib, 8 Dec. 2008
23eei - gas dynamics -15Apr10 - WAS-v1.ppt
What about the longer term prospects? When oversupply cleared, prices back to $7-9 inducing investments in unconventionals again
LNG regas.cap.
Pipelineimport1SWTight gasCBMOnshore Conv.
Shalegas
DW
600 700650550150 250 750450100 500 80030050 3502000 400 bcm/yr0
2
4
6Short-runmarginal
costin $/mBTU
LNG regasification
capacityDWSWTight gasCBM
PipelineimportOnshore Conv.
Shalegas
300250 600550 800150 700650 750100 450 50035050 2000 400 bcm/yr0
10
2
4
6
8
Long-run marginal cost/
Break-even price2
in $/mBTU
Note: Lower 48 states1. Pipeline imports primarily from Canada and likely to decline as Can. prod declines and demand from oil sands increase2. Price yielding 10% IRR including all costsSource: EIA AEO 2009; Wood MacKenzie; Rystad; BCG analysis
2012 possible supply curve
2009 supply curve Similar demand levels in 2009 and 2012
Break-even price of shale gas with main
influence on gas price in Atlantic
24eei - gas dynamics -15Apr10 - WAS-v1.ppt
Several scenarios for 2012+ .... Not all with same probability – need to be prepared for all ?
U gas LNG
Eur price
U gas LNG
Eur price
U gas
Eur price
• Recovery of US demand (carbon?)
• New LNG costs going down (liquefaction back to 200-300M$/Mtpa)
• Some disappointments on U Gas (volume and cost)
Back to normal, LNG pushed out
Sustained spot LNG
Interspersed supply
U gas LNG
Eur price • Very high growth of US
demand (dash for gas)• Shale unable to cope w/ demand
• Abundant LNG
New US gas boom
U gasLNG
Most probable
Why not?
Unlikely
???
• End of LNG surplus bringing prices back in the $6-8/MMBtu range
• U gas production growing back quickly after 2010/2011
• Global oversupply maintained after 2012- 2014
• European prices depressed (decoupling)
• LNG entering into the US below full costs
25eei - gas dynamics -15Apr10 - WAS-v1.ppt
To many gas increasingly looks prudent again Turbine supplier order books returning to pre-crisis levels
Solar TurbinesPratt & Whitney
Siemens Westinghouse(SGT6-6000G)
Siemens Westinghouse(SGT6-5000F)
Kawasaki
Mitsui Engineering
GEHitachiDresser-Rand
VericorMAN Group
Mitsubishi HeavyIndustries
OPRARolls-RoyceTurbomeca
194 223 265 271 278
143146
153 149 143
52
51 53 55122126
131 135 128
282286
284338 332
23
33
345
6
45454548
0
200
400
600
800
1,000
1,200
36
12
1,122
36
28
2012
15 0
4 32
15 1
4 3136
12
30
16
992
12 1
2932
40
12
29
2009
941
12 1
21
12
40
10
28
29
20112010
1,062
2013
1,109
0
3127
Source: Forecast International, Gas Turbine Forecast
High confidence Good confidence
Expected production volumes in units by supplier (2009-2013)
26eei - gas dynamics -15Apr10 - WAS-v1.ppt
But as before, environmental policy could change everything
1. Based on the equilibrium case, and power sector wide optimizationSource: EIA, BCG analysis
Federal RES alone would reduce gas demand by 8% Federal RES alone would
reduce gas demand by 8%
Carbon legislation w/o RES would increase gas demand
up to 16%
Carbon legislation w/o RES would increase gas demand
up to 16%
Combination of RES and CO2 would increase demand
at high CO2 prices
Combination of RES and CO2 would increase demand
at high CO2 prices
2008 BAU
62
$12/T CO2,
20% RPS
67
$30/T CO2, 20% RPS
68
$50/T CO2,
20% RPS
Gas demand (Bcf/d)90
80
70
0
+4
64
2008 BAU
69
$12/T CO2
$30/T CO2
75
$50/T CO2
+10
0
70
80
90
Gas demand (Bcf/d)
74
6464
2008 BAU
59
20% RPS with 1/4 EE
-5
0
60
70
80
90
Gas demand (Bcf/d)
2020 20202020
27eei - gas dynamics -15Apr10 - WAS-v1.ppt
... and key uncertainties
How will Obama's energy policy (energy efficiency, power generation mix, RPS, CO2) impact US natural gas demand?
What is the future cost structure of unconventional plays? Will unconventionals experience further technological revolutions?
What US markets could unconventional production be serving in the future, given transportation constraints (and, therefore, what prices will these projects be capturing)?
• Which pipeline projects will succeed and how much will they cost? • Is there a possibility to monetize unconventional reserves through liquefaction projects (ie: Kitimat)?
What is the real potential of unconventional production in the US?
Are Canadian imports going to be available and competitive?• Development of NG production in Canada vs. Tar Sands and domestic demand• Competitiveness of new developments (ie: Horn River) vs. transportation costs to NA (ie: Transcanada)
How attractive is the US market price expected to be vs. other accessible markets (ie: NW Europe, Far East)?
What can US LNG operators that hold regas assets or Use or Pay contracts do to mitigate their sunk costs?• Should companies sign long term deals that cover partially / do not cover sunk costs?• Could new LNG plays emerge in the US, rendering additional profits for LNG operators (ie: role of storage, bi-directional
regas-liquefaction investments, etc)?