the scottmadden energy industry update (natural gas edition)

Copyright © 2012 by ScottMadden, Inc. All rights reserved.

Highlights of Recent Significant Events and Emerging Trends

December 2012

The Energy Industry Update (Natural Gas Edition)


Table of Contents

View from the Executive Suite 3

Executive Summary

From the CEO to Shareholders: Some Quotes and Themes

Utility and Energy Stock Prices: Are Electrics and Diversifieds Undervalued?

Gas Delivery O&M Costs

Dodd-Frank: Consternation for Gas Utilities?

Natural Gas Demand 11

Power Sector Gas Consumption Is Off the Charts

Sufficient Widening of the Oil-to-Gas Price Ratio Could Fundamentally Alter Gas Demand

The Alignment of Gas and Power Infrastructure and Processes Will Be Increasingly Important

Natural Gas Vehicles: Increasing Interest, Especially with Cheap Natural Gas

Bulls and Bears Views on United States as the “Saudi Arabia of Natural Gas”

Natural Gas Supply and Prices 18

All Estimates Show Abundant Gas Supply

Shale Gas: Increasing Abundance in the Ground and Risks to Bullish View

Natural Gas Prices: Low Near Term, but Extended Outlook Is Less Predictable

U.S. Natural Gas Real Spot Prices (Henry Hub) – A History of Price Volatility

Is a Supply Response to Low Gas Prices Taking Hold...and How Long Might It Last?

Gas Pipelines and Storage 25

Historical Flow Patterns Are Changing

Despite Excess Inventories, Low Gas Prices Have Tempered Interest in New Storage Capacity

Pipeline Infrastructure

Gas Pipeline Safety: A Priority

2

View from the Executive Suite



Executive Summary

4

Managing with Uncertainty Fatigue

As the economy grows (slowly) and we assess the implications of the outcome of the 2012 election, many policies affecting the power and

gas industries are in flux. From fracking regulation to power plant emissions to renewable incentives, litigation and political uncertainty

about what prevailing policies might emerge in 2013 has put the timing and, in some cases, the scope of new rules in limbo. Despite this

uncertainty, the energy industry is running out of time on some strategic actions and is moving to make investments (or retirements) in

power supply, infrastructure expansion (or shoring up reliability “hotspots”), and new technologies.

Knock-On

Effects of

Cheap Natural

Gas

Low natural gas prices have affected the nation’s power supply, challenging the economics of proven solar and

wind renewable technologies and altering the traditionally favorable dispatch position of coal-fired power

As the gas-fired power generation grows, the linkages between natural gas and power operations become

increasingly important, and regulators and industry leaders are contemplating how to improve that coordination

Cheap gas-fired generation also appears to be impacting retail choice markets. Retailers’ commodity (energy)

costs have declined with gas prices, helping them compete with utility provider-of-last-resort service

Low natural gas prices have also led to increasing interest in the use of natural gas as a transportation fuel,

although fueling infrastructure, while growing, requires further expansion

Securing cost recovery for required infrastructure investments is easier than if commodity prices were high

Environmental

Requirements

Becoming

Real

EPA has finalized new regulations on SO2 and NOx emissions as well as mercury and air toxics, even as it

proposes greenhouse gas regulations for new power sources that effectively ban new coal-fired power plants

Deadlines for compliance with EPA’s proposed regulations are fast approaching, delayed only by litigation. The

electric industry is beginning to adjust its generation complement accordingly, as the shale gas boom makes gas-

fired power compelling for new generation, at least for the moment

Safety Front

and Center

More than a year after the Fukushima Daiichi nuclear event, the U.S. nuclear industry has begun working its “way

forward” to ensure the public that it is incorporating its key lessons

With aging pipes and after some high-profile incidents, gas pipeline and distribution operators have strengthened

their safety programs as regulators use a carrot-and-stick approach to spur safety-related improvements

Grid Policy

Push and Pull

Smart metering has hit bumps in some jurisdictions, as both customers and regulators have concerns about cost

and issues with personal privacy and security

Compliance filings with FERC’s Order 1000, intended to spur power transmission investment, are due in 2012.

Sticky issues around cost allocation, planning, and rate incentives remain largely unresolved


From the CEO to Shareholders: Some Quotes and Themes

Electric and Combination

Utilities

Electric Distribution Utilities

IPPs and Merchants Gas Local

Distribution Companies (LDCs)

Gas Pipelines

Mergers, Acquisitions, Divestments, and Retirements

“Purchasing and/or constructing natural gas-fired electric generation facilities”

“Invested nearly $900 million in transmission and distribution infrastructure”

“Successfully integrating the companies and achieving annual cost savings targets”

“Analyzed the investment in environmental controls required for a number of our facilities…expect to deactivate facilities”

“Working innovatively…to transport [customers’] supplies to market from transportation-constrained areas”

“Backlog of…shale wells shut in and waiting for development of natural gas gathering and processing infrastructure”

“Acquire and develop energy transportation assets”

“Build or acquire logistics assets strategic to market fundamentals”

“Share capital costs and risks through JVs or alliances”

“Leverage economies of scale from incremental acquisitions and expansions”

“Actively pursing projects to serve power generation load”

Operations and Financial Issues and Initiatives

“Developing our human capital and talent pool”

“Facing higher untracked pension expense”

“Higher capacity factors...due to lower gas prices improving off-peak economics for combined cycle over coal units”

“New cost and performance improvement initiative”

“Hedge a substantial portion of our coal-fired baseload generation”

“Lower the commodity price risk…through the use of swaps and basic hedges”

“Target a 12% reduction in GHG emissions for every therm of gas delivered…by 2015”

“Interstate and intrastate transportation rate challenges”

5 Sources: Company annual reports, web sites, and investment analyst presentations


From the CEO to Shareholders: Some Quotes and Themes (Cont’d)

Electric and Combination

Utilities

Electric Distribution Utilities

IPPs and Merchants Gas Local

Distribution Companies (LDCs)

Gas Pipelines

Growth Initiatives and Capital Projects

“Established our new transmission operations segment”

“Advanced our commercial transmission business through formation of a joint venture”

“Implementing emission controls and performance upgrades”

“Integrating advanced grid technologies into existing electric networks”

“Implemented some actions and upgrades at our nuclear facilities stemming from the Japan learnings”

“Replace and upgrade our extensive electric, gas, and steam networks”

“Implementing first large-scale smart grid project… sensors and transmitters”

“Deployment of 1.3 million smart meters…by the end of 2013”

“Development of the…first power plant in the U.S. with a federal limit on GHG emissions”

“Higher market prices to provide adequate returns on some investment in environmental controls necessary to meet… anticipated requirements”

“The catalysts for the future are shale gas, utility infrastructure development, and the market's demand for low-cost, efficient, and available energy sources”

“Invest...in projects to accommodate the growing NGL supplies”

“Execute expansion projects to serve new gas-fired power generation growth”

“Remained committed to infrastructure improvement and pipeline replacement”

“Optimizing liquids opportunities in western U.S. business”

“Further expand our renewable fuel- handling capabilities”

“Enhance the stability of our cash flows by investing in pipelines and other fee-based businesses”

“Design and improve our gas gathering infrastructure”

Customer-Side Initiatives

“Develop and implement efficiency and demand response programs”

“Launched a special emergency restoration improvement program”

“Businesses receive incentives to reduce energy use when demand is highest”

6 Sources: Company annual reports, web sites, and investment analyst presentations


Utility and Energy Stock Prices: Are Electrics and Diversifieds Undervalued?

7

Note: *Part regulated, part unregulated

Sources: SNL Financial; www.multipl.com (S&P 500 monthly multiples); ScottMadden analysis

Selected Month-End Index Price-Earnings Ratios

(Trailing 12 Months Earnings) (Dec. 2004–Jan. 2012)

Valuation Gap: Price-Earnings Ratios for Large Diversifieds Compared with Other Energy Sectors

Gas LDCs and MLPs have Outperformed the Dow Since Mid-2009, While Other Utility Indices Have Lagged

Selected Stock Index Values (Oct. 2009–Oct. 2012)

(Oct. 30, 2009 = 100%)

Index Performance as of Late October 2012 Since Late

Oct. 2007

Since Late

Oct. 2009

Since Late

Apr. 2011

DJ Industrial Avg. 94% 135% 102%

SNL Energy Large Diversified 90% 133% 113%

SNL Energy Small Diversified 117% 143% 105%

S&P Gas Utilities 141% 187% 125%

S&P Electric Utilities 82% 124% 112%

SNL Merchant Generator 46% 111% 106%

Citigroup MLP 124% 159% 105%

DJ Utility Index 90% 132% 112%

Index = 100%

“Positive on fundamentals…[D]espite the mild winter, most utilities

should see above-average long-term EPS growth, generally

driven by capex rather than economic growth.”—Macquarie

“The [natural gas MLP] group is trading at a spread to the 10-year

Treasury of 372 basis points compared to its long-term average

of 300 basis points.”—Deutsche Bank

“Exceptionally mild weather conditions to drag on electric and gas

distribution businesses…We expect hybrid* utilities and IPPs to

generally experience a negative impact from lower year-over-year

commodity prices, though large hedge positions will likely offset

much of the potential downside.”—J.P. Morgan

0

5

10

15

20

25

30

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Se

p-1

0

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c-1

0

Ma

r-11

Ju

n-1

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Se

p-1

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c-1

1

Pri

ce

-Ea

rnin

gs

Ra

tio

SNL Large Diversified

SNL Gas Utility

SNL Midstream Energy

S&P 500

Large diversified (electric & gas) valuation gap vs. selected other indices

0%

50%

100%

150%

200%

250%

Oct

-09

No

v-0

9

De

c-0

9

Jan

-10

Feb

-10

Mar

-10

Ap

r-1

0

May

-10

Jun

-10

Jul-

10

Au

g-1

0

Sep

-10

Oct

-10

No

v-1

0

De

c-1

0

Jan

-11

Feb

-11

Mar

-11

Ap

r-1

1

May

-11

Jun

-11

Jul-

11

Au

g-1

1

Sep

-11

Oct

-11

No

v-1

1

De

c-1

1

Jan

-12

Feb

-12

Mar

-12

Ap

r-1

2

May

-12

Jun

-12

Jul-

12

Au

g-1

2

Sep

-12

Oct

-12

DJ Industrial Avg.

SNL Energy Large Diversified

SNL Energy Small Diversified

S&P Gas Utilities

S&P Electric Utilities

SNL Merchant Generator

Citigroup MLP

DJ Utility Index

http://www.multipl.com/


Gas Delivery O&M Costs Showing Improvement...

$0

$2

$4

$6

$8

$10

$12

$14

$16

-20% -15% -10% -5% 0% 5% 10% 15% 20%

Ga

s O

&M

pe

r D

ek

ath

erm

Deli

ve

red

($)

Three-Year Compound Annual Growth Rate in Total Gas O&M Expense (%)

8

Median: -7.3%

Size indicates relative scale by total DTH delivered

Median: $8.58

Thirty Largest Gas Delivery Companies—Gas O&M per DTH and Gas O&M Cost Growth

Notes: Rankings based upon 2010 gas delivery volumes. Medians are medians for top 30, not all gas utilities

Sources: SNL Financial (FERC Form 2 data); ScottMadden analysis


...But Dispersion and Relative Improvement Levels Change When Production Costs Are Excluded

$0

$1

$2

$3

$4

$5

$6

-20% -15% -10% -5% 0% 5% 10% 15% 20% 25% 30%

Ga

s O

&M

pe

r D

ek

ath

erm

Deli

ve

red

($)

Three-Year Compound Annual Growth Rate in Total Gas O&M Expense (%)

9

Median: 2.2%

Size indicates relative scale by total DTH delivered

Median: $2.15

Thirty Largest Gas Delivery Companies—Gas O&M per DTH and Gas O&M Cost Growth

(excluding Production Cost)

Notes: Rankings based upon 2010 gas delivery volumes. Medians are medians for top 30, not all gas utilities

Sources: SNL Financial (FERC Form 2 data); ScottMadden analysis


Dodd-Frank: Consternation for Gas Utilities?

10

-

500,000

1,000,000

-

100

200

300

400

2008 2009 2010 2011

No

. o

f V

olu

mes

Tra

ded

(M

MB

TU

)

No

. o

f C

on

tracts

T

rad

ed

(M

illio

ns)

# Contracts Traded

Volumes

ICE North American Natural Gas OTC Contracts (2008–2011)

-

500

1,000

1,500

PG

&E

-C

itygate

NG

PL

-T

XO

K

Henry

Chic

ag

oC

itygate

s

Dom

inio

n -

So

uth

So

Cal

Bo

rder

Col G

as

TC

O

CG

-M

ain

line

TE

TC

O -

M3 Ka

ty

Vo

lum

e (

000s o

f M

MB

TU

/day)

Top Ten Hubs by Volume – ICE Day-Ahead Index (2011)

Internal Discussion Draft

The Law

Dodd-Frank Act (D-F) was enacted in July 2010; took effect in Oct. 2012

Title VII of D-F puts energy-based swaps under U.S. Commodities Futures Trading Commission (CFTC) jurisdiction

D-F requires mandatory clearing and trade execution, mandatory position limits, record retention, and reporting

— Characterization as “swap dealer” (SD) or “major swap participant” (MSP) carries additional capital, margin,

and reporting requirements

— OTC swaps not centrally cleared are subject to higher capital requirements

— Non-“swap dealers” and “major market participants” may still have record-keeping obligations (eff. Apr. 2013)

Important exemptions

— End-user exception

— Forward contract exclusion*

— De minimis exception (<$8 billion notional amounts over 12 months or $25 million just with “special entities”)

Gas

Industry

Issues and

Concerns

CFTC lags in D-F rulemaking: As of October 2012, only 127 of 398 required rules had been finalized

Additional record-keeping requirements may require enhanced trading and risk management systems

Mandatory cleaning could limit customization, meaning greater mismatch between hedge and the risk being hedged

Subjective regulatory determination of what is hedging vs. speculation (always challenging; shades of FAS 133)

Need for Board authorization to elect end-user exemption

CFTC determination pending on some key industry questions about application of D-F

— Whether gas storage and transportation contracts are swaps due to embedded volumetric optionality

— Whether reservation charge and additional charge for use of service, common in gas storage and electricity tolling

agreements, constitute swaps

— Whether to modify threshold aggregation (for SD/MSP designation) (now entities sharing 10% common ownership)

Note: *A contract may still be considered a forward contract exempt from D-F even if it includes optionality, is booked out (as defined in D-F), or is a physical exchange transaction

Sources: Morgan Lewis, Dodd-Frank Act: Are You Ready? webinar (Sept. 13, 2012); MRV Associates, Living with Uncertainty: Energy Companies and Dodd-Frank (Oct. 9, 2012); Cornerstone Research,

Characteristics of U.S. Natural Gas Transactions (May 15, 2012); ScottMadden analysis

Natural Gas Demand



Power Sector Gas Consumption Is Off the Charts in 2012...

12 Source: EIA, “Natural Gas Markets: Recent Changes and Key Drivers,” at LDC Gas Forum (Sept. 2012)

Daily U.S. Natural Gas Burn for Power Generation

(2005–2011 and YTD 2012)


...Going Back as Far as 2001

13 Sources: EIA Form 923 data; ScottMadden analysis

-

200

400

600

800

1,000

1,200

Ga

s C

on

su

mp

tio

n (

in B

CF

)

Monthly U.S. Natural Gas Burn for Power Generation (High-Low Range for 2001–2011 vs. YTD 2012)

Previous monthly highs during this time period were

set in 2011 for Apr., May, July, Nov., and Dec.

2001–2011 max-min

range

Through June 2012


Sufficient Widening of the Oil-to-Gas Price Ratio Could Fundamentally Alter Gas Demand

$0

$5

$10

$15

$20

$25

$30

Jan-9

7

Jan-9

9

Jan-0

1

Jan-0

3

Jan-0

5

Jan-0

7

Jan-0

9

Jan-1

1

$/M

MB

TU

West Texas Intermediate Crude vs. Henry Hub Natural Gas Spot Price (Jan. 1997–Sept. 2012)

Henry Hub Spot Price…WTI Spot Price ($/MMBTU)

Oil-Gas Price Ratio (per MMBTU) (1997-2012) High 9.81 Low 0.34 Average 2.04 Median 1.48 At 9/11/12 5.93

14

Low natural gas prices coupled with sustained $90 to $100/barrel oil prices have created an oil-gas BTU-equivalent ratio of nearly 6X

For chemical uses to be attractive, a rule of thumb is 7-to-1 ratio of $/barrel of oil vs. $/MMBTU of gas; at $100 oil and $3 gas, this ratio is significantly higher

If these ratios are sustained, substitution effects could lead to increased demand for natural gas for CNG vehicles, methanol for transportation (or as synthetic diesel), ethane for chemical feedstock (in lieu of naptha), as well as new natural gas technologies

For chemical applications, industry will have to invest in ethane cracking facilities—not built in the United States since 2001—close to end-users

However, producers of “wet” plays must maintain liquidity in the face of low prices until these additional demand streams grow

Sources: EIA data; ScottMadden analysis; industry news; American Chemistry Council; Lazard; Dow Chemical

Global Ethylene Cash Cost Curve

($/Metric Ton) as of Oct. 2011

Sou

rce: Lazard

(citing D

ow

Ch

emical C

o.)

U.S. NGLs competitively priced on chemical feedstock supply curve


The Alignment of Gas and Power Infrastructure and Processes Will Be Increasingly Important

15

Announced Coal Plant Retirements (2012–2021) (as of Aug. 2012) Interstate Natural Gas Pipelines (as of Year-End 2009)

Gas-power interdependence is back on the front burner

— EPA regulations, cheap shale gas, and increasing renewables penetration lead swings to gas generation

— FERC had looked at this in the mid-2000s, as post-merchant, pre-Katrina bubble led to a significant increase in the ratio of gas to total generation

Recent weather events (Texas, Southwest) have refocused attention on increased year-round power-sector gas demand

Emerging pipeline adequacy and operation concerns

— Capacity constraints — Flow patterns

— Scheduling differences — Curtailment

— Pipeline pressure and line pack

0

500

1,000

0 2 4 6 8 10Pre

ss

ure

(P

SI)

Hours

Time for 500 MW Unit to Exhaust Line Pack (36” Line @ 800 PSI)

Modern CT

Older CT

Steam Generator

Sources: EIA; SNL Financial; NERC

Source: SNL Financial


Natural Gas Vehicles: Increasing Interest, Especially with Cheap Natural Gas

16

Growth Drivers, Expectations, and Barriers

Increased level of domestic gas reserves, concerns over dependency of oil, and initiatives and policies designed to decrease greenhouse gas emissions have increased interest in alternative fuel vehicles

Limited refueling availability, higher costs, shorter driving ranges, lack of infrastructure, and heavier fuel tanks have prevented the wide acceptance of NGVs over petroleum-fueled vehicles

If the price differential between natural gas and gasoline is sustained, the number of NGV fueling stations is likely to continue to increase. Use of natural gas as a transportation fuel has been growing at a rate of 10%–12% since 2006 and is expected to grow 25% by 2016

The federal government has renewed its focus on natural gas-fueled transportation with incentives for fleet conversions and NGV purchases and funding for research toward new NGV technologies

However, some industry stakeholders oppose federal incentives, arguing that the market should determine NGV options

Incentives and Policies Promoting NGVs

NAT GAS Act of 2011

Tax credit toward incremental purchase costs, fuel, and infrastructure

Alternative Fuel Tax Exemption

Alternative fuels used in a manner that the IRS deems nontaxable are exempt from federal fuel taxes

Improved Energy Technology Loans

DOE loan to eligible projects that reduce air pollution and promote early commercial use of advanced technologies

Regional Corridors

Planned networks of refueling stations located along key truck routes (i.e., major highways)

Other State Incentives

Other state funding, tax credits, and exemptions available in NY, GA, VA, OK, and CA

NGV Fueling Stations in the United States Total U.S. NGV Fueling Stations vs. Retail Gasoline Price

Sources: Industry news; ScottMadden research


Bulls and Bears Views on United States as the “Saudi Arabia of Natural Gas”

The Bullish View

European gas production is dropping—the U.K., for example,

has become a net importer of LNG

Spain’s gas is 80% LNG

Japan’s possible dismantling of its nuclear sector will put

pressure on gas supply, already seen in its landed LNG prices;

perhaps a similar situation emerging in Germany

Europe is highly dependent upon Russia, which has used

resources as geopolitical levers, for gas supply

Several U.S. LNG facilities are considering reversing trains for

export, with Sabine Pass (LA) fully approved

Potential U.S. LNG will make global LNG supply curve more

elastic, limiting long-term increases in price

17

The Bearish View

Soft economic conditions could contain gas demand growth,

and Asian demand is uncertain

Somewhere from 60%+ of European gas needs locked in with

long-term contracts of unknown duration

Hard to develop LNG export capacity quickly, and it will require

long-term contracts with anchor tenants to justify investment

Plenty of competition: Canada, Qatar, Australia, and others

now; possible rich shale resources in China, Russia, and

Africa; Russia, as swing producer, could be a spoiler

Potential for political impediments at home to gas exports

Price relationships are influenced by currency exchange rate,

which could change with different policy

Notes: NBP is National Balancing Point (U.K.); JCC is Japan Customs-Cleared Crude; JKM is Japan/Korea Marker. All

are market hubs used for LNG pricing

Sources: EIA International Natural Gas Workshop (Aug. 13, 2012), presentations by Brattle Group; Benjamin

Schlesinger and Associates, Kenneth Medlock (Rice Univ.), Howard Rogers (Oxford Institute for Energy Studies)

Selected International LNG Price Trends

(Various Locations)

$0

$2

$4

$6

$8

$10

$12

$14

Gulf toJapan

JCCForward

Gulf toU.K.

NBPForward

$/M

CF

All-In U.S. LNG Cost at Gulf (Illustrative) vs. Japan and U.K. LNG Hub Prices

Regas Tariff

Panama Canal

Boiloff

Fuel

Vessel Charter

15% + $2.25

Henry Hub - Jan 2015

Japan U.K.

Source: B. Schlesinger & Assocs. (citing Deutsche Bank)

Source: K. Medlock (Rice U.)

Henry Hub NBP JKM LNG-Crude Index

Natural Gas Supply and Prices



All Estimates Show Abundant Gas Supply

19

Source: ANGA, “Natural Gas: Reshaping Energy,” NABE-USAEE Shale Gas Webinar (Mar. 13, 2012)


Shale Gas: Increasing Abundance in the Ground

20

Industry and government agencies continue to see ample shale gas resources

Production continues, although it leveled off when natural gas prices were in the $2 to $3 per MMBTU range, and the dry rig count is now at its lowest level since 1999

Utica Shale remains a promising but largely unexploited play

— Initial estimates by USGS of 38 TCF technically recoverable, nearly the size of Eagle Ford

— Only 144 horizontal wells in Ohio to date vs. 26,000 in Marcellus; USGS estimates that 110,000 wells needed to extract Utica gas

2012 Shale Resource Assessment: Texas Still Big

1,000

1,200

1,400

1,600

1,800

2,000

2,200

Jan

-1973

Dec-1

974

Nov-1

976

Oct-

1978

Se

p-1

980

Au

g-1

982

Jul-1

984

Jun

-1986

Ma

y-1

988

Ap

r-1990

Ma

r-1992

Fe

b-1

994

Jan

-1996

Dec-1

997

Nov-1

999

Oct-

2001

Se

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Au

g-2

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Jul-2

007

Jun

-2009

Ma

y-2

011

BC

F p

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Mo

nth

U.S. Dry Natural Gas Production (Jan. 1973–July 2012)

Dry Gas Production: Rapid Acceleration, But Now??

Estimated Technically Recoverable Shale Gas Resources by Play (2011–2012 EIA, USGS, and PGC Estimates)

Shale Play Location Technically

Recoverable Gas (TCF)

Barnett North Texas 43–53

Fayetteville Arkansas 13–110

Haynesville Louisiana and East Texas 66–110

Marcellus Northeast United States 84–227*

Utica Northeast United States 38**

Woodford Oklahoma 43–53

Notes: *This estimate of the Marcellus also includes estimated shale gas from other nearby lands

in the Appalachian area; but, according to an official for the estimating organization, the

Marcellus Shale is the predominant source of gas in the basin. **USGS estimate

Sources: U.S. Geological Service; U.S Government Accountability Office; U.S. Energy Information

Administration; “Natural Gas Production Levels Off with Price Decline,” at

RealClearEnergy.org (June 18, 2012); industry publications

For Some Plays, Wide Estimates of the Gas Resource


Shale Gas: Risks to Bullish View

21

Production curves (output yield from fields and wells) vary within and across various shale plays

— Some skeptics point to rapid decline rates

— No “one-size-fits-all” assessment of shale play productivity; assessments still evolving

Reserves and ultimate supply are smaller than technically recoverable resources—a key question is how much at what price

Externalities—and responses thereto—could play a role in slowing development

— Stringent EPA regulation or local opposition, such as New York’s ban on fracking, could make availability of the shale resource moot

Economics are brutal in the current environment

— Series of write-downs on North American shale stakes by BHP Billiton ($2.84B), BP ($2.1B), BG ($1.3B), and others as “land rush” meets $3 natural gas prices

— While current gas prices offer breakeven for some wet plays; most dry gas is not in the money at $3

Water consumption remains a concern in some areas

— Water usage rates in recently drought-prone areas like Texas are emerging as a point of concern

— Industry proponents, however, point to the large percentage of water consumed by municipalities and irrigation

Barnett

Eagle Ford

Haynesville

Marcellus

Niobrara

250

125

600

85

300

Average Freshwater Use per Shale Well (000s of Gallons)

4,600

5,000

5,000

5,600

3,000

Drilling Hydraulic Fracturing

Source: GAO

$4.00

$6.00

$3.20 $3.74

$6.10 $6.24

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

Marcellus/Fayetteville

Other Fayetteville Barnett Haynesville EagleFord

Selected Estimates of Breakeven by Shale Play

($/MMBTU)

UBS (June 2011) Baihly, et. al. (May 2011)*

Median 2013 Henry Hub

Futures Price**

Notes: *Based upon paper for Society of Petroleum Engineers and assuming EURs as of 2009

**Monthly futures prices as of Oct. 23, 2012

Sources: The American Oil & Gas Reporter (May 2011); World Oil (July 2012); UBS Investment Research,

“NYT Shale Gas Allegations Seem Exaggerated” (June 27, 2011); industry publications


Natural Gas Prices: Low Near Term, but Extended Outlook Is Less Predictable

Gas Prices Remain Depressed

Natural gas prices are not projected to return to pre-recession levels in the near to intermediate term

U.S. government forecasts (shown right) reflect steady 2%+ per year growth

Some contrarians, however, posit $6/MMBTU natural gas by 2015

Demand May Pull up Prices, but Supply Response and Impact of Worldwide Demand Create Uncertainty

Industrial gas demand: Slow increase in the medium term, tempered by the sluggish U.S. economy

Short-term gas demand from power generation is projected to increase, but that demand growth levels off longer term (~10 years)

More Canadian gas may go to Asia as LNG export facilities in western Canada emerge to take Canadian gas traditionally exported to the United States—now displaced by shale gas

Some big question marks: the impact of production efficiencies, drilling inventory, and gas demand response

Notes: *2005 forecast is in $/MCF and is an average wellhead price, not a Henry Hub

average price

**Natural Gas Week (Aug. 6, 2011)

Sources: Industry news; EIA; IEA; FERC; SNL Financial; Natural Gas Week

$8.94

$4.00

$4.39

$3.94 $3.60

$4.11 $4.16 $4.27 $4.30 $4.42 $4.59 $4.72 $4.80

$0

$2

$4

$6

$8

$10

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Pri

ce

in

$/M

MB

TU

2009 Forecast

2007 Forecast

2011 Forecast

2005 Forecast

Jan. 2012 Forecast

Actual EIA Projected

EIA Actual and Projected Henry Hub Average Spot Price

and Selected Forecasts ($/MMBTU*) (in 2010$)

Despite the apparent smooth trajectory, gas

price volatility may remain, driven by pipeline

constraints, increased gas consumption for

power generation, and changing basis

relationships.

Selected 2013 Gas Price Forecasts ($/MMBTU) JP Morgan $4.25 Morgan Stanley 3.95 UBS, RBC 3.75 NGW** Scorecard Average 3.66 Raymond James 3.25 Moody’s ≥3.00

22

Latest EIA

forecast:

$3.12


$0

$5

$10

$15

$20

$/M

MB

TU

(2012$)

U.S. Natural Gas Real Spot Prices (Henry Hub) – A History of Price Volatility

23

Sources: World Bank Commodity Price Data, adjusted by BLS CPI (less food and energy) to 2012 dollars (based upon 1H2012 inflation index); NERC; naturalgas.org

Fuel Use Act

(restrict plants

using gas or oil

as primary

fuels)

Regulated Era

$0

$2

$4

$6

$8

$10

$12

$14

$16

$18

Jan

-19

70

Fe

b-1

97

1

Ma

r-19

72

Ap

r-1

973

Ma

y-1

974

Jun

-19

75

Jul-

197

6

Au

g-1

97

7

Se

p-1

97

8

Oct-

19

79

No

v-1

98

0

De

c-1

98

1

Jan

-19

83

Feb-1

984

Ma

r-19

85

Ap

r-1

986

Ma

y-1

987

Jun

-19

88

Jul-

198

9

Au

g-1

99

0

Se

p-1

99

1

Oct-

19

92

No

v-1

99

3

De

c-1

99

4

Jan

-19

96

Fe

b-1

99

7

Ma

r-19

98

Ap

r-1

999

Ma

y-2

000

Jun

-20

01

Jul-

200

2

Au

g-2

00

3

Se

p-2

00

4

Oct-

20

05

No

v-2

00

6

De

c-2

00

7

Jan

-20

09

Feb-2

010

Ma

r-20

11

Ap

r-2

012

$/M

MB

TU

(2012$)

Deregulated Era

Natural Gas

Policy Act

(begins

wellhead

price dereg.)

Winter of 76–77

Order 436/500 (transport

service to all customers)

Order 636

(gas pipeline

unbundling)

Decontrol of

NGPA prices

begins

Natural Gas

Wellhead

Decontrol Act

Natural Gas Clearinghouse

formed

HL&P Bidding

Program NYMEX futures

contract

established

Order 637 (differentiated

pipeline rate structures) Order 698 (NAESB

stds. – pipeline/

generator comm.)

Order 720

(pipeline

posting

requirements)

Arab Oil

Embargo

PURPA First retail gas

choice program

Real Spot Natural Gas Prices (Jan. 2000–July 2012) (2012$)

Transition Era Order 380 (elim. min. bills

for LDC – “take-or-pay”)


Is a Supply Response to Low Gas Prices Taking Hold... and How Long Might It Last?

24

Drilling Pullback Started with Sub-$3 Gas

Some producers are pulling back dry gas production

Gas rigs are being repurposed for oil production

Some recent announcements:

— Chesapeake: “Bare minimum” levels

— Conoco: Shutting in 100 MMcf/day

— EQT: Suspends gas drilling indefinitely in Huron, coalbed methane plays in App. Basin

— Quicksilver: Focusing on oil, liquids projects

— Noble: Low price “circuit-breaker” tripped; suspending dry gas production in Marcellus until $4/MMBTU gas for three consecutive months

Others are continuing, or at least remaining mum

Curtailment or supply response?

LNG Safety Valve?

Landed LNG in European hubs exceeds $8/MMBTU

With transport and regas ~$2/MMBTU, prolonged low ($3) domestic gas prices could energize a U.S. LNG export market

Varied opinions on whether LNG export is economically viable or prudent for energy security or domestic gas consumers

Lag effect: As recently as mid-February, domestic

production was up from last year (nearly 20%) but

trending downward, as Canadian imports and LNG

imports have been reduced significantly (down nearly

30% and 50%, respectively, from Winter 2011). As rigs

are reduced, one might expect a continued ramp-down

in domestic dry gas production.

Sources: EIA; Baker Hughes; Energy Intelligence Natural Gas Week

$-

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

0

200

400

600

800

1,000

1,200

1,400

Jan

-10

Ma

r-10

Ma

y-1

0

Jul-1

0

Se

p-1

0

Nov-1

0

Jan

-11

Ma

r-11

Ma

y-1

1

Jul-1

1

Se

p-1

1

Nov-1

1

Jan

-12

Ma

r-12

Ma

y-1

2

Jul-1

2 Hen

ry H

ub

Sp

ot

Gas P

rices (

$/M

MB

TU

)

Nu

mb

er

of

U.S

. R

igs

Rig Count vs. Spot Gas Prices (Jan. 2010–Aug. 2012)

Henry Hub Spot Gas Prices

Gas Rigs

Horizontal Rigs

Gas Pipelines and Storage



Historical Flow Patterns Are Changing from Longitudinal (One Direction)...

26 Source: Midwest ISO Gas-Electric Interedependency Workshop (May 10, 2012)


...To a Developing “Grid” Flow Pattern

27 Source: Midwest ISO Gas-Electric Interedependency Workshop (May 10, 2012)


Despite Excess Inventories, Low Gas Prices Have Tempered Interest in New Storage Capacity

28

Working Underground Natural Gas Storage

Capacity Additions (2008–2011)

Note: *“On the horizon” are planned by storage companies and reported on in the trade

press but have not been filed with FERC. Pending projects (new and enhancements) in

which an application has been submitted, but final FERC decision has not yet been

reached

Sources: EIA, “Natural Gas Markets: Recent Changes and Key Drivers,” at LDC Gas Forum

(Sept. 2012); FERC Office of Energy Projects

U.S. Natural Gas Injection Season (1999–2012)

30

9.5

8

# Working gas capacity (BCF)

Major projects “on the horizon”*

Pending projects*

2.5

2.1

Pending and Announced Natural Gas Storage Projects

(as of June 2012) Total About 52 BCF

Source: FERC

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Jan

1

Jan

3

Fe

b 1

Fe

b 3

Ma

r 1

Ma

r 3

Ap

r 1

Ap

r 3

Ma

y 1

Ma

y 3

Jun

1

Jun

3

Jul 1

Jul 3

Au

g 1

Au

g 3

Se

pt

1

Se

pt

3

Oct

1

Oct

3

Nov 1

Nov 3

Dec 1

Dec 3

Wo

rkin

g G

as (

BC

F)

Month - Week

Working Gas Weekly Underground Storage Volumes (in BCF) (1994–2011 vs. 2012 through mid-Sept.)

1994–2011 max-min range

2012 YTD


Pipeline Infrastructure—Transmission

29

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

Pre-1940 1940-1949 1950-1959 1960-1969 1970-1979 1980-1989 1990-1999 2000-2009

Mil

es

of

On

sh

ore

Tra

nsm

iss

ion

P

ipe

lin

e

Southeast

Northeast

Western

Gulf

Midwest

Unknown

Onshore Gas Transmission Pipeline by Decade of Construction and by Region (Miles)

11,860

22,450

70,699 71,220

30,250 26,412

31,503

27,400

4,899

Most of U.S. pipeline infrastructure is aging; 59% is 40 years or older. The 1950s and 1960s saw significant levels of construction

— By comparison, the pipeline infrastructure is older than much of the U.S. highway system

The Northeast and Southeast regions have the oldest transmission pipe, with 39% older than 50 years

59%

Transmission Pipelines by FERC Region

Sources: PHMSA (as of Jan. 2012); ScottMadden analysis

FERC Region Miles of Main% Older than

50 Years

Total # of Leaks,

Onshore Transmission

Midwest 88,305 34% 480

Gulf 71,998 36% 488

Western 55,046 31% 147

Northeast 43,846 39% 327

Southeast 37,497 39% 185

Grand Total 296,693 35% 1,627


Pipeline Infrastructure—Distribution

30

0

50,000

100,000

150,000

200,000

250,000

Pre-1940 1940-1949 1950-1959 1960-1969 1970-1979 1980-1989 1990-1999 2000-2009

Mil

es

of

On

sh

ore

Dis

trib

uti

on

P

ipe

lin

e

Southeast

Northeast

Western

Gulf

Midwest

Unknown

Onshore Gas Distribution Pipeline by Decade of Construction and by Region (Miles)

68,553

26,528

108,334

198,752

132,488

156,730

234,043

208,340

85,934

Compared to transmission, the distribution infrastructure is newer; 33% is 40 years or older, and 49% constructed since 1980

The Gulf and Northeast regions have the oldest distribution pipes, with 26% and 25% older than 50 years, respectively

33%

Distribution Pipelines by FERC Region

FERC Region Miles of Main% Older than

50 YearsTotal # of Leaks

Midwest 352,814 12% 128,875

Northeast 285,465 25% 186,630

Western 260,325 15% 95,705

Southeast 197,881 9% 76,393

Gulf 123,216 26% 65,395

Grand Total 1,219,701 17% 552,998

Sources: PHMSA (as of Jan. 2012); ScottMadden analysis


Gas Pipeline Safety: A Priority

31

AL

HI

IL IN

IA

KY

LA

MN

MA MI

MN

MS

MO

NJ

NY

NC

OH

PA

SC

TN

VT

VA WV

WI NH

CT

AL

AR

FL

GA

MD DE

RI

ID

KS

MT

NE

NM OK

OR

TX

UT

WA

WY

AZ

CA

CO

NV

SD

ND

• The PUC created a safety citation program

• PUC required to consider a gas utility’s safety performance when determining the utility’s rates

Cost recovery mechanisms approved

The Railroad Commission implemented new penalty guidelines for violations of its oil and gas safety measures

PUC implemented preventive safety measures

Sources: Washingtonwatch.com, Van Ness Feldman, SNL Financial; E. Baker & J.

Davis, “Gas Pipeline Safety,” available at www.scottmadden.com

Cascade Natural Gas incurred safety violation fine

Pipeline safety has become a top priority for the gas industry, driven by several trends over the past several years

The abundance of shale gas and increasing dependence on natural gas as a supply source have created higher demand on some transmission pipelines

Recent high-profile incidents have demonstrated that risks such as leaks, defects, and improper operations can have severe consequences

2008–2010 was marked with more than $650 million in damages from transmission onshore gas pipeline significant incidents and 87 fatalities (with 71 occurring in 2010 alone) out of 156 total incidents

To meet a possible doubling of natural gas demand, an additional 24,000 miles of pipeline may be required. Gas companies will be major players in this future build-out of transportation infrastructure for power generation

Selected Gas Pipeline Safety Incentives and Penalties

Federal Incentives

Pipeline Safety, Regulatory Certainty and Job Creation Act of 2011

• Designed to strengthen safety requirements and inspections and clarify

accountability for pipeline operators for accidents

Advance Notice of Proposed Rulemaking

• Requests the public to comment on whether gas transmission pipeline

regulations should be strengthened. Potential changes include eliminating

certain regulatory exemptions for pipelines constructed prior to 1970 and

expanding integrity management


ScottMadden – Exceptional quality. An Exceptional consulting experience.

ScottMadden, Inc., is a leading management consulting firm that specializes in the energy industry, clean tech and infrastructures, and corporate and shared services. The combination of our industry knowledge, consulting experience, and tailored approach distinguishes us from other firms. Our small teams of consultants bring deep experience and knowledge to each challenge and collaborate with our clients. We help clients develop practical solutions that produce results.

For nearly 30 years, ScottMadden has served more than 300 clients, successfully delivering thousands of projects. Our clients are located throughout North America and beyond and include some of the largest names in the energy industry as well as many other Fortune 500 companies. We are proud of our heritage and our ability to offer each client individual attention regardless of size.


Recent ScottMadden Insights – Available at ScottMadden.com

Natural Gas Gas Pipeline Safety, by E. Baker and J. Davis http://www.scottmadden.com/insight/354/Infrastructure-Investment-in-the-Gas-Industry.html

Natural Gas Benchmarking, by E. Baker, J. Davis, and Q. Watkins http://www.scottmadden.com/insight/557/Natural-Gas-Benchmarking.html

Public Power, Municipal, & Cooperative Utilities

Five Strategic Priorities for Generation and Transmission Cooperatives, by B. Kitchens and M. Miller http://www.scottmadden.com/insight/516/Five-Strategic-Priorities-for-Generation-and-Transmission-Cooperatives.html

Managing Generation Assets, a G&T Cooperative Strategic Priority, by B. Kitchens and M. Miller http://www.scottmadden.com/insight/556/Managing-Generation-Assets-a-GT-Cooperative-Strategic-Priority.html

Fossil Generation

What’s Trending in Fossil Generation, by T. Williams http://www.scottmadden.com/insight/548/Whats-Trending-in-Fossil-Generation.html

Electric Transmission Exelon Transmission Company Development Strategy Case Study, by E. Baker and J. Yuknis (Exelon Corp.) http://www.scottmadden.com/insight/552/Exelon-Transmission-Company-Development-Strategy-Case-Study-.html

Supply Trends—What Are The Impacts on Transmission?, by T. Williams http://www.scottmadden.com/insight/549/Supply-Trends-What-Are-The-Impacts-on-Transmission.html

Capital Project Management

Capital Project Management Organization and Capability Assessment, by R. McAdams and J. Niedermuller http://www.scottmadden.com/insight/518/Capital-Project-Management-Organization-and-Capability-Assessment.html

Smart Grid Smart Grid and Meter Data Management Systems, by J. Jacobi and J. Kerner http://www.scottmadden.com/insight/504/Smart-Grid-and-Meter-Data-Management-Systems.html

An Introduction to Smart Grid Communications, by J. Jacobi and J. Kerner http://www.scottmadden.com/insight/503/An-Introduction-to-Smart-Grid-Communications-.html

Energy Industry A Special Edition of the Energy Industry Update, by S. Pearman http://www.scottmadden.com/insight/551/A-Special-Edition-of-The-Energy-Industry-Update.html

http://www.scottmadden.com/insight/557/Natural-Gas-Benchmarking.html





http://www.scottmadden.com/insight/516/Five-Strategic-Priorities-for-Generation-and-Transmission-Cooperatives.html















http://www.scottmadden.com/insight/556/Managing-Generation-Assets-a-GT-Cooperative-Strategic-Priority.html















http://www.scottmadden.com/insight/548/Whats-Trending-in-Fossil-Generation.html









http://www.scottmadden.com/insight/552/Exelon-Transmission-Company-Development-Strategy-Case-Study-.html















http://www.scottmadden.com/insight/549/Supply-Trends-What-Are-The-Impacts-on-Transmission.html















http://www.scottmadden.com/insight/518/Capital-Project-Management-Organization-and-Capability-Assessment.html













http://www.scottmadden.com/insight/504/Smart-Grid-and-Meter-Data-Management-Systems.html













http://www.scottmadden.com/insight/503/An-Introduction-to-Smart-Grid-Communications-.html













http://www.scottmadden.com/insight/551/A-Special-Edition-of-The-Energy-Industry-Update.html















www.scottmadden.com

Natural Gas Practice We help companies adapt to rapid change in the natural gas

industry by providing strategic and operational improvements that

deliver value to clients. We have consulted with leading gas utilities

in the United States in areas such as strategic and business

planning, operations assessments, regulatory strategy and rate

case support, and merger/acquisition support. We perform gas

projects for a variety of clients including leading gas utilities and

diversified utilities.

For more information about our Natural Gas Practice, contact:

Stu Pearman

Partner and Energy Practice Leader

[email protected]

919.781.4191

Ed Baker

Partner

[email protected]

404.814.0020

Jason Davis

Director

[email protected]

404.814.0020

Research ScottMadden Research provides clients with valuable insight on

developments, trends, and practices in energy and sustainability.

Through its semi-annual Energy Industry Update and other

occasional publications, our research team helps clients discern and

analyze critical issues and inform their business decisions.

We also provide customized, project-based research and analytical

support on matters of interest to our clients.

For more information about our research capabilities or content, see

the Insight section of our web site or contact:

Brad Kitchens

President

[email protected]

404.814.0020

Stu Pearman

Partner and Energy Practice Leader

[email protected]

919.781.4191

Jake Jacobi

Partner and Clean Tech & Infrastructure Practice Co-Leader

[email protected]

404.814.0020

Chris Vlahoplus

Partner and Clean Tech & Infrastructure Practice Co-Leader

[email protected]

404.814.0020

Greg Litra

Partner and Energy, Clean Tech & Infrastructure Research Lead

[email protected]

919.781.4191


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the scottmadden energy industry update (natural gas edition)

Documents

abundant gas supplyshale

gas demandthe alignment

gas pipelines

low gas prices

use of natural gas

natural gas demand

coordination cheap gas

gas price ratio