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1 Georgia Senate Regulated Industries Committee Energy Hearing Atlanta, Georgia August 13, 2008 Terry Ciliske En*Vantage, Inc tciliske@envantageinc.com www.envantageinc.com U.S. Energy at a Crossroads Slide 2 2 We have been here before Almost three years ago I came before this committee to discuss the status of the energy industry following the devastation of the dual hurricanes that hit the U.S. Gulf Coast in 2005. In those remarks I pointed out the storms merely exacerbated issues that were already underway. Slide 3 3 What has been our response after being in this situation before? Yogi Berra was known to say: If you come to a fork in the road, take it. He also said: If you don't know where you are going, you might wind up someplace else. So where have we ended up regarding a national energy policy? Or did we end up somewhere else? Slide 4 4 What were the underlying issues back then? Lack of sufficient capital investment in energy infrastructure and production to provide cushions against shocks to the system; Regarding oil I stated to the committee: Fact: World oil production currently has little or no cushion for immediate production increases. Fact: Any cushion that might exist in world oil supply is generally of poorer quality feedstock. Fact: World wide upgrading (refining) capacity is tight, especially for poorer quality crude's. Energy Transportation and Conversion capacity had reached practical limits without significant new capital investment. Regarding natural gas my comments included: Fact: Natural gas in North America was trending from a continental commodity to a globally based commodity. Fact: Despite accelerated drilling for natural gas in North America, supply growth has been non-existent for a number of years. Fact: Natural gas infrastructure is currently putting artificial constraints on managing local supply/demand issues in the U.S. Slide 5 5 Todays Takeaways Is there a singular issue causing the current energy problems? Perhaps the comic strip Pogo said it best: We have met the enemy and he is us. Many of the previously listed items still remain outstanding; however, significant progress is being made. Concerns that a near term retrenchment in prices will lessen our resolve in correcting long term problems. The bottom line remains: The U.S. remains vulnerable to energy supply disruptions and price dislocations. Broad, constructive plans must be made and implemented. Slide 6 6 To understand the issues, we must have a clear understanding how the energy supply chain is intertwined Downstream Petrochemicals Refining Propane Retailing Gas Retailing Gas Distribution Gas Storage Gas Transportation Gas Gathering Exploration & Production Processing & Treating NGL Transportation NGL Storage NGL Fractionation Midstream Upstream Oil Gathering & Transportation Crude Oil Refining Product Transportation Product Terminals Product Retailing Natural Gas Crude Oil Power Retailing Power Distribution Power Generation Mining Coal Rail Transportation Slide 7 7 Over the past three years, weve seen an unprecedented increase in oil related energy costs without the major exogenous events such as those that occurred in 2005. What is going on? Slide 8 8 Is it a refining issue? Over the last couple of years one of the popular scapegoats was lack of refining capacity and the mantra became no new refinery has been built in the U.S. in 30 years. We have been building the equivalent of a new refinery each year for more than a decade with another 700,000+ bbld of capacity that will be completed in the next 2-3 years. However, the performance of the industry is deteriorating. Slide 9 9 Over the last few years the real shortage or tightness has been in light sweet crude signifying the world limits on light sweet crude production and lack of sophisticated refining capacity Slide 10 10 Is it a U.S. demand issue? In response to high prices and a weakening economy, U.S. gasoline demand has begun falling due to demand reduction (or destruction) while inventories are neutral. Slide 11 11 Is it a developing world demand issue? The vast majority of oil demand is occurring in the developing world, not in the European and the U.S. markets where demand is falling. The NY Times reported on July 28 th that countries with subsidies accounted for 96 percent of the worlds increase in oil use last year. These subsidies, while encouraging political stability in those countries, prevent demand destruction due to price as they prevent the higher prices from flowing through to consumers. Even without subsidies many parts of the world have not seen the percentage increases in fuel prices that the U.S. has experienced due to the relative weakness in the U.S. dollar compared to other currencies. Slide 12 12 Is it a crude oil supply issue? It is estimated that some 70-80% of the world oil production is controlled by state-owned oil companies who have limited incentive to keep up with demand and maintain lower prices. Do they have the incentive to increase production and lower prices? Major oil companies are seeing their production fall as they are shut out of areas around the world for exploration and development. Many industry participants are skeptical of world supply growth estimates especially as development costs escalate. Much of the incremental oil production is heavy and/or sour crude oil that is difficult to refine and limits refinery options, decreases yields and increases costs. Slide 13 13 Oil Surplus vs. Price As the world surplus of crude oil productive capacity diminishes, we are witnessing increasing price volatility as exogenous events or a fear of them roils the markets Slide 14 14 Crude prices are settling back after the recent run up. We are still three times above the pre-Katrina levels. Slide 15 15 Slide 16 16 Natural Gas Issues Gulf of Mexico production has never fully recovered following the hurricanes of 2005 (we are down almost 25% from before the storms). Until the last twelve months, overall production in the U.S. was flat; now growing rapidly. This past winter was the coldest in many years. New gas fields are coming online but require extensive infrastructure build out. Slide 17 17 Last winter was the coldest since the winter of 2000/2001, contributing to higher natural gas prices Slide 18 18 This past spring we saw the lowest natural gas inventories since April 2004 which was below the five year average Slide 19 19 Natural gas and crude oil price relationships Slide 20 20 After years of essentially running in place, the elevated rig count is finally starting to have an affect on natural gas production Sources: Baker Hughes; EIA Slide 21 21 Incremental gas production is coming from Barnett Shale, Rockies, Anadarko, and Arklatex regions based on reserve growth. This is spurring a boom in new processing capacity. Slide 22 22 The Unconventional gas becomes Conventional and is poised to become some of the largest contributors of energy in the U.S. Shale PlayRecoverable Reserves (TCF) Production (mmcfepd)Active Rigs 2005A2008E2012E Barnett Shale (TX)30-501,0984,3005,800-6,400179 Fayetteville (AR)25-45-8001,800-2,00050 Woodford (OK)10-12256001,100-1,20046 Haynesville (TX, LA)250-1003,000-6,00010-15 Bakken (ND, MT)3-4.3 Bboe-4801,200-1,30072 Marcellelus (Appalachia)50-75-25300-60015 Total Prod (Excl. Bakken)1,1235,82512,000-16,200Approx 375 % of US Gas Volumes2%11%20%-27%19% Source: Company Reports, Lehman Brothers Report 8/4/2008 and EnVantage Estimates Slide 23 23 U.S. LNG imports are plummeting in the face of higher global competition for supplies Recent long term contracts for LNG elsewhere in the world are running $16-20/MMBtu. Most LNG liquefaction plants under construction or development are running anywhere from six months to three to four years behind schedule for myriad reasons. Slide 24 24 Based upon forward NYMEX prices, we continue to expect minimal LNG imports into the U.S. for at least the next 16 months. Only if the weather becomes brutally cold this winter is it likely that prices will need to be driven up to the levels of Europe and Asia to attract substantial quantities of LNG. As natural gas prices rise in Europe, LNG deliveries to the U.S. decline Slide 25 25 Natural gas imports from Canada are also down this year due to falling Canadian production and greater demand in Canada associated with oil from tar sands production Slide 26 26 Slide 27 27 Oil and natural gas are not the only energy commodities that have seen a hyperbolic price increase Coal prices shown are for a relatively high-Btu coal selected in each region, for delivery in the "prompt quarter. The prompt quarter is the quarter following the current quarter. For example, from January through March, the 2nd quarter is the prompt quarter. Starting on April 1, July through September define the prompt quarter. Average Weekly Coal Commodity Spot Prices (Dollars per Short Ton) Business Week Ended August 01, 2008 Slide 28 28 Whats driving the coal price boom? It is not the growth of the U.S. power industry Last year nearly 60 coal projects were cancelled or delayed due to rising costs and other economic factors Barriers Refusal by regulators to issue permits Local opposition to new coal fired plants Concerns about growing risks associated with potential carbon emission issues Why the boom? European and Asian demand growth Mining problems in Australia and South Africa Better value of U.S. coal in the world market due to the drop in the dollar Slide 29 29 Why is coal relevant to the discussion about natural gas? Low natural gas prices can displace coal by running natural gas fired power plants and shutting down coal fired power plants. Not that a big of an option during summer peak loads Has this happened before? Yes, February 1992 and October 2006. In both cases the lower natural gas prices only lasted two to three weeks until the increased demand for natural gas caused prices to rise. Slide 30 30 Current coal and natural gas prices are nearing convergence. If natural gas prices continue to soften this fall, gas demand is likely to increase markedly Slide 31 31 Conclusions Natural gas and coal remain the best options from a security of supply standpoint for hydrocarbon fuel. Natural gas is the most environmentally benign. The U.S. currently has the lowest priced natural gas prices on the margin when compared against the net importing areas such as Asia and Europe. A renaissance is occurring in domestic natural gas production combined with significant investments in all forms of infrastructure. Net growth in natural gas storage capacity for the first time in years Most significant build out of pipeline infrastructure in 30-40 years Domestic natural gas production up 8% this year Approximately 700,000 Bbld of U.S. based crude refining capacity to be added by the end of 2010. The recent price drop in energy prices (and in particular natural gas) can be temporary. A severe winter, bad storms, world events, etc. can lead to temporary or permanent increases in the commodity. A long-term multifaceted approach to energy supply diversification combined with energy use efficiencies must be implemented through combined efforts of private industry, state and federal governmental agencies.