Bureau of Economic Geology, The University of Texas at Austin Market Trends for Natural Gas SPE Unconventional, June 15, 2011

Bureau of Economic Geology, The University of Texas at Austin

Market Trends for Natural GasSPE Unconventional, June 15, 2011

©CEE-UT, 2

Dr. Michelle Michot Foss, CEE/BEG/JSG/UT

When we think about the world of energy…

…do we understand the present?• Our energy present is a function of our demographic and

economic past– Fundamental shifts are taking place

• For the foreseeable future, oil will remain critical to US and global energy supply– Natural gas will continue to gain market share contingent on

development of internal markets and global trade• New fuels and/or fuel technologies could increase in

importance– Pace depends on cost and timing; incumbent infrastructure is

dominant – the challenge of energy density• Materials and nonfuel minerals may be more important• We deal in political rather than economic trade offs

– Much of what we perceive in energy, economy, environment is a function of beliefs rather than evidence; perception is reality

©CEE-UT, 3


Oil Price BoundsDown?

• At the global level, clear intent from OPEC to sustain worldwide economic recover– Iraq and OPEC quotas; China

• U.S. production turnaround?

• Access, technology gains• Impact of climate policies and

inter-fuel competition

Up?

• Global recovery will stimulate demand, especially in “BRICs”

• Belief governments will not alter product subsidies

• Noncommercial demand for commodity derivatives

• U.S. macro

policy and

the dollar

USEIA (left); IEA

©CEE-UT, 4


NG Price BoundsDown?

• Sustained success with shales and other plays

• LNG shaves peaks• Access, technology gains• Inter-fuel competition displaces

gas

Up?

• Worldwide economic recovery, demand growth, “dash to gas” “no regrets” policy on climate

• Production growth slows• LNG demand prevents peak

shaving effects

USEIA (left); IEA

©CEE-UT, 5


How Does Unconventional Gas Fit In?

The Story…• “It’s a factory business…”

• “Have I got a shale deal to sell you…”

• “We can make money at $4…”

…and the “Back Story”• Unknown unknowns in

technology• Shifting upstream business

models• Impact of oil directed

drilling– Is natural gas price volatility

“dead”?

• Private lands event driven by historical price marker

©CEE-UT, 6










“dead”?


©CEE-UT, 7










“dead”?


©CEE-UT, 8


“[U.S. LNG market potential] is much more limited than typically realized… There is plenty of room for new spikes in Henry Hub price. But what about the possibility of a Henry Hub basis collapse? This could come about in two ways. One is the formation of a new gas bubble if new domestic [unconventional] supplies are more rapidly proved up than demand warrants. A second possibility exists with LNG.”

-Michot Foss, OIES NG 18, Feb 07

2010: “The 2003 NPC Study Was Prescient…”

©CEE-UT, 9


Compiled by CEE based on industry data

0

5

10

15

20

25

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2020 2025

Sen

do

ut C

apac

ity,

Bcf

/d

Mexico

Canada

US Operating Terminals, Including Expansions

USEIA - US Import Forecast, 2011, (Bcf/d, 0411)

USEIA - US Import Forecast, 2005 (Bcf/d)

USEIA - US Actual Net Imports (Bcf/d)

CEE-UT US/North America LNG Import Capacity AssessmentBased on agency pre-filings, filings, approvals and industry information. As of: May 2011 NOTE: Includes both onshore and offshore.

©CEE-UT, 10


Production Phases

-15%

-10%

-5%

0%

5%

10%

15%

20%

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

U.S. Dry Gas Production (Bcf)

U.S. Dry Gas Production 12-MO MA (Bcf)

Y-Y Chg Dry Gas Production (%), Jan 86-Feb 11

Jan 86 - Feb 06

Mar 06 - Jan 07Feb 07 - Feb 11

©CEE-UT, 11


$0

$2

$4

$6

$8

$10

$12

$14

$16

Henry Hub Monthly Average Spot Price ($/MMBtu)

Avg Feb 89-Nov 99 ($1.98)

Avg Dec 99-Jan 09 ($6.00)

Avg Feb 09-Apr 11 ($4.14)

“Glubbausage”!

CEE based on U.S. EIA

Searching for the bottom…

©CEE-UT, 12


What drives oil and gas prices?

An Experiment With FD Cost• Marginal barrel, MCF sets price• We can estimate price using “3x rule”

– “If you want to make any money in this business, you need to sell oil for 3x your drilling costs: 1/3 for the well, 1/3 for the tax collector, and 1/3 for yourself.” (DB Commodities Research, 16 July 2007)

• For oil, strong, sustained correlation between full, BE FD cost and market price

• Implications for natural gas• FD cost, price interactions are persistent

©CEE-UT, 13


Guitar, Man“Peak Oil” Explained!

Unknown source; posted on “The Oil Drum”

©CEE-UT, 14


$0

$20

$40

$60

$80

$100

$120

$140

$0

$50

$100

$150

$200

$250

$300

$350

All Carbon Steel Products Composite Index Global, U.S.$/tonneBrent, U.S. $/Bbl

http://www.meps.co.uk/index.htm All Carbon Steel Products Composite Price and Index, U.S. $/tonne, Jan 1997=100

©CEE-UT, 15


$0

$20

$40

$60

$80

$100

$120

$140U.S. Annual Breakeven Cost, $/BOE After 10% Return

Implied Oil Price (3 X Annual FD $/Bbl)

U.S. Crude Oil First Purchase Price, $/Bbl

U.S. breakeven cost is finding and development (FD) expense plus all production cash costs (production operating expense, general and administrative, net interest) plus income and non-income taxes. It is an average for the group of companies included in the U.S. EIA Financial Reporting System. Implied oil price is the price needed by producers based on a formula of 3X FD expense (excluding cash costs; i.e., "drillbit" cost only). When breakeven cost and/or implied price are above U.S. crude oil first purchase price (average price paid for production at the wellhead or lease), companies adjust capital expenditures downward.

Correlations between annual breakeven, implied oil price and crude oil first purchase price are close to 0.9. Standard deviation is roughly 19.

CEE analysis based on U.S. EIA FRS

©CEE-UT, 16


A Tough Business, Anyway

$-

$2

$4

$6

$8

$10

$12

1 2 3 4 5 6 7 8 9 10 11 12 13 14

10% Return

U.S. 10 Cash Exploration Costs $/MCFE

U.S. 10 Cash Operating Costs $/MCFE

U.S. All Source FD Costs 07-10 $/MCFE

Henry Hub Spot Price $4/MCF

Avg.Not all companies report current cash exploration costs

©CEE-UT, 17


$(3.00)

$(2.50)

$(2.00)

$(1.50)

$(1.00)

$(0.50)

$-

$0.50

$1.00

$1.50

$2.00

1 2 3 4 5 6 7 8 9 10 11 12 13 14

U.S. Cash Exploration Costs $/MCFE

U.S. Cash Operating Costs $/MCFE

U.S. All Source FD Costs, $/MCFE

Differences, 2009-2010

Avg.

Cost reductions are real……but gainers, losersImpact of “Wall Street” technology

©CEE-UT, 18


Used with permission

Break Even Gas PriceTop 30% Wells With Land Cost

©CEE-UT, 19


Kepes, et al, OGJ 4/4/11, Fiscal Regimes

“Currently, the relationship between costs and prices is unfavorable for dry gas wells. Assuming a Henry Hub price of $5/MMBTU and a negative gas price differential of 30¢/MMBTU, the available margin for the base case dry gas well is only $1.80/MCF. In the majority of the jurisdictions in North America most of this margin is used to pay royalties (often $1/MCF or more), severance taxes, property taxes, and corporate tax.”

©CEE-UT, 20


Living with negative margins…

“In the past few years, a glut of natural gas has driven down the price to half the 2008 average—a level where it costs a U.S. consumer $2.75 a day to meet a home's natural-gas needs, according to the American Gas Association. That's good news for consumers, but a recent study by consultancy Wood Mackenzie found that 40% of U.S. natural gas produced last year didn't meet break-even prices for producers.”

- Daniel Gilbert, WSJ, May 23, 2011

©CEE-UT, 21


“Canadian and U.S. natural gas producers are responding to the U.S. oversupply by shifting away from drilling activity that focuses solely on natural gas. Instead, companies are targeting oil and natural gas containing…NGLs…to capitalize on the rise in oil prices.”

NEB-Canada May 2011

…means shifting

strategies

©CEE-UT, 22


-100%

-50%

0%

50%

100%

150%

200%

250%

300%Y-Y Change Henry Hub Monthly Average Spot Price, %

Y-Y Change Total U.S. Supply (Dry Production + Net Imports), %

Y-Y Change U.S. Natural Gas Total Consumption, %

278%

-70%-74%

-39%

-23%

37%

Feb 90 - May 11Min/MaxSupply: -8%, 11%Consumption: -15%, 20%

Compiled by CEE using EIA

Relatively small changes in supply, demand swing price

Price Change & Volatility Matter

What are the demand side

drivers?

©CEE-UT, 23


Compiled by CEE; U.S. EIA

-200,000

-100,000

0

100,000

200,000

300,000

400,000

500,000

Natural Gas Nuclear Other renewables

Petroleum coke

Other gases and other

fuels

Coal Petroleum Hydro

Thou

sand

Meg

awatt

hour

sU.S. Net Generation by Energy Source

1996 Total Net Generation = 3.4 Billion Megawatthours2010 Total Net Generation = 3.9 Billion MegawatthoursNet Difference = 506 Million Megawatthours

Change in shares of net generation, 1996-2010 (total net generation, 2010), all %:

10 (23) 1 (20) 2 (4) 0 (0) 0 (0) -8 (44) -1 (1) -3 (7)

©CEE-UT, 24


ERCOT Peak Day by Fuel Type

Electric Reliability Council of Texas (ERCOT)

©CEE-UT, 25


Does Renewable Energy Create Volatility?

MCPE ($/MWh)

-40

-30

-20

-10

0

10

20

30

40

HoustonNorthSouthWest

Negative price intervals (15 min)

2006 76

2007 338

2008 4,894

2009 3,069

2010 4,445 (Nov)

April 26, 2009

Compiled by CEE using ERCOT data

©CEE-UT, 26


Bros/SG, used with permission, May 30, 2011

Note – precedes Germany announcement

©CEE-UT, 27


Environment Discontents• “Cleanest burning fossil fuel”• Hydraulic fracturing

– Water use, disposal, contamination (chemicals and methane)

– Seismicity• Air emissions

– Drilling operations– Fugitive methane

• Fugitive emissions from value chain• Is natural gas just too cheap?

©CEE-UT, 28


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

0

5

10

15

20

25

30

Actual Ratio, Crude Oil (WTI, Bbl):Gas (HH, Mcf) Prices

Rough 6:1 Oil:Nat Gas Ratio

MMBtu Ratio, Oil:Gas

Carpe Diem

Documents

Bureau of Economic Geology, The University of Texas at Austin Market Trends for Natural Gas SPE Unconventional, June 15, 2011