Michelle Michot Foss
Chief Energy Economist, The University of Texas at Austin
2012 Summer Seminar
August 5-7, 2012
Proof of Concept and Challenges:
U.S. Natural Gas
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U.S. Oil and Gas Today
The turnaround in production:
• Challenges “peak oil” and “peak gas”
• Pushed NG price lower, undermining climate, green energy
politics
• Contributed real economic benefits and returns to the
economies of host states (Texas, North Dakota, etc.) and
the U.S.
• Inspired potential new scenarios for U.S. energy security
and international geopolitics
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Success Breeds New Concerns
Economic/commercial risks and uncertainties:
• Sustainability of U.S. unconventional nonassociated gas plays at
low NG prices
• Increasing complexity in production stream
– Oil, NGLs are higher value targets for drilling and production,
but are oil price sensitive (WTI/Brent)
– Average associated gas yield is about 20% of marketed
production, potential increase probably limited to 30%
– We balance with nonassociated (dry) gas, which must be
replaced; drilling is sensitive to NG price (Henry Hub)
• Longer term, NG price must rise to a level that can support
marginal cost of supply, given demand
– Growth transition with implications for outlooks
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2000:2011 Production
Gains, 5.40
2000:2011 Production
Losses, (3.18)
2000:2011 Change in
Total Consumption, 1.04
(4.00)
(3.00)
(2.00)
(1.00)
-
1.00
2.00
3.00
4.00
5.00
6.00
TCF
Net Gains = 2.2 TCF
Gains in Production > Consumption
Small growth in total
consumption relative
to larger additions in
supply = current soft
price environment
EIA, U.S. marketed production, CEE analysis
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Price Eras and Drivers
CME, USEIA, CEE
$0
$2
$4
$6
$8
$10
$12
$14
$16Henry Hub Monthly Average Spot
Price ($/MMBtu)
Avg Feb 89-Feb 92 ($1.61)
Avg Mar 92-Dec 98 ($2.11)
Avg Jan 99-Dec 01 ($3.46)
Avg Jan 02-Sep 09 ($6.32)
Avg Oct 09-Jun 12 ($3.87)
GOM Hurricane Events
El Paso pipeline
explosion, Carlsbad, NM August 19, 2000
Enron bankruptcy
December 4, 2001
California market
failure, 2000-2001
Lehman Brothers
bankruptcy September 15, 2008
U.S. shale gas drilling boom
Peak LNG imports with
new regas capacity,March-August 2007
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Location, Location, Location
OCS-Gulf of Mexico27%
CBM6%
TexasBarnett Shale
0%
All Other (Conventional)
67%
OCS-Gulf of Mexico11%
CBM9%
TexasBarnett Shale
9%
OtherU.S. Shales
7%
All Other (Conventional)
63%
1997 Shares
2010 Shares
EIA, CEE
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The Dash for Oil
Baker Hughes, EIA/CME
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Oil
Gas19 June 2009
$4.36
10 June 2005$7.11
10 June 2005$53.74
19 June 2009$70.62
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-2.0% -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5%
Haynesville
Arkoma Woodford
Fayetteville
Marcellus
Barnett
Granite Wash
Cana Woodford
Other
Williston
Permian
DJ - Niobrara
Eagle Ford
Utica
Mississippian
Ardmore Woodford
Drilling Activity Trends, Feb 11-Jun 12
Baker Hughes, CEE
Growth is where the liquids are
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$-
$2
$4
$6
$8
$10
$12
$14
$/M
CFE
10% Return
2011 U.S. Cash Operating Costs $/MCFE
2009-2011 U.S. All Source FD Costs $/MCFE
Henry Hub Spot Price $4/MCF
Ave
rage
All
Commercial Recoverability is Key
Industry financials, CEE
“We want to push costs below
$3 rather than wait for nat gas
prices to catch up”
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Reductions in FD Capex but Cash Costs
Continue to Grow
• Spending is well above CF
• Credit revolvers depleting
• Increased scrutiny for
potential write downs
Bernstein Research, used
with permission
$-
$1
$2
$3
$4
$5
$6
$7
$8
Average All 2009 Average All 2010 Average All 2011
10% Return
U.S. Cash Operating Costs $/MCFE
U.S. All Source FD Costs $/MCFE
Henry Hub Spot Price $4/MCF
“Exploration groups love shale – they
can book a billion BOE. No one thinks
about the 6,000 wells the production
company has to drill.”
Industry financials, CEE
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Large Unexpensed, Uncapitalized
Costs Have Accrued…
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
$70,000
$80,000
$90,000
$100,000
2009 2010 2011
$ M
illi
on
s
Excluded from Full Cost Amortization Pool
Suspended Costs (Successful Efforts)
Costs not flowing through the income statement and not being reported as
costs incurred in the footnotes
Industry financials, CEE
• Delayed to match
reserve additions
or revenues
• Appear to have
ballooned with
falling gas prices
• Drawing attention
from ratings
groups
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…and PUD Bookings are Vulnerable
55,859
68,59370,707
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
2009 2010 *2011
U.S
. PU
Ds
(BC
FE)
* One operator did not report
(merger), difference is less than 3% Impact of SEC
5-year rule
Industry financials, CEE
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Perspective is Useful…
McKinsey & Company for Shell, 2001 NPC Study
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…Because Oil and Gas Technology
is Slow
Baker Hughes
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%% Horizontal
% Vertical
• Key transactions for horizontal technology,late 1980s (1989)
• First Barnett Shale well, 1981• Chevron Barnett test, 1997• Horizontal drilling applied in Barnett, 2003
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Short Run:
Weather; Producer Discipline
$0
$2
$4
$6
$8
$10
$12
$14
$16
-200
0
200
400
600
800
1,000H
en
ry Hu
b Sp
ot P
rice (w
ee
kly, $/M
MB
tu)
Act
ual
Sto
rage
Min
us
5-y
ear
Ro
llin
g A
vera
ge (
BC
F)
L48 Total
HH Spot ($/MMBtu)
Bearish: Actual above average (surplus)
Bullish: Actual below average (deficit) $4 in 2012 could be possible, IF… EIA, CME, CEE
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Will Oil:Gas Price
Spreads Persist?
“A ‘fair’ price for gas
would be at par with that
of oil, Qatar’s Energy
Minister Mohammed Al-
Sada said.” – November 15, 2011,
Bloomberg
USEIA, CEE analysis 0
5
10
15
20
25
30
35
40
45
Actual Ratio, Crude Oil (WTI, Bbl):Gas (HH, Mcf) Prices
Standard Conversion
0
10
20
30
40
50
60Actual Ratio, Crude Oil (WTI, Bbl):Gas (HH, Mcf) Prices
Standard Conversion
EIA, CME, CEE
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$3
$4
$5
$6
$7
$8
$9
$10
$11
Moderate Price Deck (Michot Foss, OIES NG 18, 2007)
Volatile Price Deck (Michot Foss, OIES NG 58, 2011)
Possible Scenarios
www.oxfordenergy.org
HH $3-6
Lower rather than higher prices
to 2015 with new supply
HH $3-10 ($6 median)
Higher, less stable prices to 2020 with
supply constraints and demand
recovery and growth
NG (HH)
price
dependent
(70-80%)
Oil price
dependent
(20-30%)
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Key Drivers for Scenarios
Variable Moderate Volatile
Shale deliverability Full deliverability Reality check
Non-shale deliverability Recovery Declines
Policy, regulation Favorable Unfavorable
Economic recovery Weaker Stronger
Gas-fired power Slow increase Rapid increase
Industrial Modest growth Strong growth
Midstream, downstream
bottlenecks
None Many
Oil:gas spread Wider Narrower
Business model “Lower price, higher
volume”
“Higher price,
lower volume”
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A Possible Outcome
$0
$1
$2
$3
$4
$5
$6
$7
$8
Re
al $
/MM
Btu
Foss/CEE Projection
EIA AEO April 2011
Actual Spot
YTD
Both supply and demand side
constraints
• Supply: effect of producer
discipline, above ground risks
• Demand: search for organic growth
• How to balance the surplus Timing?
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Bottom Line
• We have a large, rich resource endowment
• Investment was relatively easy to mobilize
– High price signal
– Private lands and minerals
• Conflicting conditions
– With recession, strong supply-demand imbalance
• Upstream and midstream businesses are both in transition
• Does $4 even work for incremental dry gas?
– Producer costs
– Drilling shifts, oil capex competition
– Reserves write-downs