Shale Oil:Impacts On Our Industry

2014/2015 Epic Class

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Basic Definitions

FrackingProcess of injecting liquid at high pressure into subterranean rocks, boreholes, etc., so as to force open existing fissures & extract oil or gas.

Shale Oil / Tight OilAlso called oil bearing shale which is “oil locked in rock”. Most commonly found in shale or siltstone Limestone a mile below the earths surface. Horizontal Drilling & Hydraulic Fracturing are the two basic methods of extracting the oil.

Oil ShaleOrganic rich, fine grain sedimentary rock that contains solid organic compound know as Kerogen. This product is mined like coal and is heated to temperatures up to 950 degrees F. - “Retorting”. Deposits are found around the world with WY, UT, & CO having the largest reserves in the U.S..

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North American CrudeSignificant Production Increase

Source: Oil & Gas Journal, http://www.ogj.com/articles/print/vol-110/issue-12/processing/us-refining-outlook-rosier-than.html3

Growth

Oil Sands

Shale Oil

North American CrudeProduction Growth Driven by Shale Oil

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Production has grown to over 3M bpd

Fracking Has a Long History In North America

Source: GAO5

1930's • First horizontal well drilled

1940's• Hydraulic Fracturing (HF) first introduced• 1947 - First experimental HF treatment conducted in KS• 1949 - First commercial HF treatment conducted in Stephens

County, OK

1950's • HF becomes commercially acceptable• 1955-More than 100,000 HF treatments performed

1970's

• Shale formations, such as Marcellus and Barnett, are known but believed to have zero permeability, thus not economical recoverable

• Federally sponsored research seeks to improve unconventional formation extraction

• 1979-Exploration begins in Barnett Shale

1980's • Mitchell Energy integrates lower cost approache which makes Barnett Shale economical

2000's • Operators begin exploring in the Marcellus Shale

Hydraulic Fracturing Overview

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• The “marriage” of fracking with horizontal drilling helped the boom in shale oil development

Shale Oil – Global Resources

• Shale Oil reserves found throughout the world

• Growth in production primarily in North America

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Shale Oil Fields In North America

Source: US Energy Information Administration 8

7 Key Shale Producing Regions

• Since 2007 – Shale Oil production from these regions responsible for:• 95% of domestic oil production growth • 100% of the domestic natural gas production growth

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Shale Oil & Gas Production Volumes

Oil Production Natural Gas Production

• Initial Shale exploration & development focused on gas production• Low natural gas prices in NA drove development of liquids rich fields from ~2007+ • Associated gas production from oil producing wells helps maintain gas production growth• Key Oil Regions include: Bakken, Eagle Ford, & Permian

Source: EIA February 2015 Drilling Productivity Report , http://www.eia.gov/petroleum/drilling/ 10

NA Forecasted Crude Oil Production

Source: Oil & Gas Journal, http://www.ogj.com/articles/print/vol-110/issue-12/processing/us-refining-outlook-rosier-than.html

• US Tight / Shale Oil production is predicted to peak in ~2020• Production relatively constant after 2020, contributing significant oil volumes

Peak Shale Oil Production

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Developing Shale Oil Plays• Wolfcamp/Cline

• West Texas, eastern shelf of Permian Basin• Estimated recovery of 30 billion barrels of oil

• Monterey • California Coastal and Peninsular regions• Downgraded to <1 billion barrels recoverable oil vs 2011 estimate of 15.4 billion barrels

• South Central Oklahoma Oil Province (SCOOP) • Oklahoma, southern region of Woodford’s Cana play• Springer shale gaining traction• Estimates of 8 billion barrels of recoverable oil

• Tuscaloosa Marine • Stretches between southeastern Mississippi and Louisiana• Estimated recovery of 7 billion barrels of recoverable oil

• Utica • Northeast Ohio, parts of Pennsylvania and New York, lies below Marcellus shale• Estimated to hold up to 5.5 billion barrels of recoverable oil

• Niobrara • Northeast Colorado, parts of Kansas, Wyoming, and Nebraska• 70,000 square miles• Estimated 2 billion barrels of recoverable oil

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US Crude Oil Production by Type

• Shale oil has resulted in production growth of light sweet crude in North America• Shale oil’s are characterized by low resid yields & low sulfur content

• Light sweet crudes tend to produce resids with poor quality

Source: EIA website: http://www.eia.gov/todayinenergy/detail.cfm?id=16591#

Production Growth

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• Eagle Ford & Bakken crudes contain little resid• Shale Oil = 2-3%

• How do these compare to other crudes? • Canadian Heavy = 30%+• Medium Sour = 15-18%• WTI = 10-15%

• API Gravity• Typical US refinery = 31.1 deg• Shale Oil = 40+ deg

A Universe of Crudes:Resid Yields

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US Imports of Crude Oil by Type

Source: U.S. Energy Information Administration, Crude Import Tracking Tool

• US shale oil light sweet crude production has displaced equivalent foreign imports• Essentially no light sweet/sour crude imported to US since early 2014• Other types of crude oil imports remain relatively consistent• US Energy Policy – bans the export of most crudes

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Oil Movements In North America & GloballySignificantly Changed by Shale Oil

• Increase in bbls PADD 2 to 3 / • Decrease in bbls PADD 3 to 2• Midwest - imports of Canadian backing out Gulf Coast bbls• Gulf Coast – Shale bbls backing out import bbls; down 2.3MBD since 2010• Net receipts for PADD 3 were positive in 4Q ’14 - first time in 30 years• Today…these bbls largely moved via rail (vs. pipeline) 16

• Shale oil development has driven large growth in North American crude oil production

• New production is light sweet crude

• This has displaced historic imports of similar crude grades

• This has changed the way crude goes to market

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The Shale Oil BoomWhat We’ve Learned So Far…

• Lack of Infrastructure • Path of least resistance to market • Pipelines = at capacity or not in place• Rail & truck = primary means to market today

• Rail Traffic – congestion/constraints• 2008 - Class I Railroads originate 9,500 car loads of crude oil• 2014 - Class I Railroads originate in excess of 450,000 rail cars.• 11% all domestic production now moved by rail.

• 2009 = 20k bbls/day• 2014 = 1.1M bbls/day

• Increased cost in traditional rail movements• Congestion on many lines & yards

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Shale Oil Transportation Rail Congestion

Source: Association of American Railroads – Dec, 2014

• Rail Car Supply/Demand• Costs = Peaked in ’14 at $2450/mo• Backlog for tank cars = 51,582 cars (3Q ‘14) • Current production rate = 35,000 cars /year

• Safety• New tank car design requirements• Approx 228,000 cars are DOT-111 tank cars of which 100,000 are

used to transport crude.• Regulations – on speed, structure, routes, etc.

“Fires Finally Dwindling, Days After Illinois Oil

Train Derailment”

“Spate of Derailments

Deepens Fear of Oil Train Disaster”

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Shale Oil Transportation Increased Rail Costs & Safety Concerns

Recent Headlines:

Source: Reuters 2/2/15; Jarrett Renshaw

• US Refining Industry - Evolved to maximize gasoline production• Based on crude slates expected to be heavier & more sour• Large investments - Coking, Conversion, & Technology - Facilitate fuels production / meet new fuel standards

• Changes in crude feed stocks = Impact on utilization of assets• Refineries handle a wide range of crudes…only have flexibility within a fairly narrow range• Industry challenged - Asphalt yields changing with daily crude selection• Imports have helped balance the shift in crude slates

• Logistically advantaged refiners (ie. easy access to shale oil)• Could be incentivized to open conversion capacity = resid production goes down

• New lease on life for some Refineries• Smaller/older = Some may now be able to run shale oil vs. costly upgrades for heavy/sour diets• Coastal = May now (recent past) be able to compete with domestic crude; instead of Brent

• Quality • Limited published information on quality changes• Impact felt in availability of hard pen asphalts

Refining & Asphalt Production

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• Logistics• Better crude pipeline & rail logistics – will continue to improve• Lead times driven up / Costs driven up / Regulations are increasing

• Transforming the industry• The global movement of oil is changing• Policy & politics could affect future oil industry practices

• Domestic Refiners• Refiners will have increasingly greater optionality for crude barrels• Refining economics & logistics will dictate:

• Crude selection• Asphalt availability• Grades produced• Asphalt production vs. alternative values • …All still sorting itself out

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Shale Oil Summary of Impacts

• OPEC driving down oil pricing to protect market share

• U.S. rig count down 49% in since October

• EIAs estimated daily production of crude = 9.3 M bpd• Down from 9.42 M bpd

• The EIA projects output will fall in 3Q for the first time in 4 years

• Lease rates for rail cars down 45% from peak ($1300/mo. in Jan)

• In November 2014 EIA estimated a total of 502,000 bpd of crude/condensate were exported

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Shale OilRecent Impacts of Lower Crude Prices

Source: U.S. Energy Information Administration

The future?...

…Continued Change is Certain!

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• Jeremy Alexander

• Jim Barlow

• John Barrington

• Drew Brooks

• John Brownie

• Todd Davis

EPIC Class of 2014-2015

• David Dishman

• Scott House

• Matt Kennedy

• Lee Schloss

• Vince Tallant

• Tyler Youvan

• Seth Hankowski (Dean)