Ponzi Scheme Keeps US Market Well Supplied

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1 June 30, 2011 Ponzi Scheme Keeps US Market Well Supplied Conjuring up images of the dot-com bubble of the late-1990s, the industry leveled charges of unprofessional journalism against a story by the New York Times claiming shale gas was just a giant Ponzi scheme. Also rejecting the article s conclusions, traders, instead, are putting more stock in an Energy Information Administration release reporting April US gas production was up 1.1% from March. According to the EIA, gains from drilling activities in the Haynesville and Marcellus shale helped to boost overall supplies higher. The EIA report trumped the New York Times story and coupled with cooler weather US prices settled back to levels just above $4.00/MMBtu by month end. In addition, weak economic data and high unemployment rates in the U.S. did not help to budge gas prices. Based on an increase in the rig count, calls for production to eventually fall off seem premature at this point. The futures market seems to back this outlook with both the prompt and futures curve virtually flat with current prices, a sign that the market sees stable production levels into Early June NYMEX Futures Contract Prices gas trading 8 Jun 24 Forward Strip generated a 6 flurry of excitement as 4 prices approached 2 June Settlement: $4.33/MMBtu $5.00/MMBtu, but the reality 0 of cooler weather and Source: N YM EX ample production soon dampened enthusiasm as prices settled back to levels just above $4.00/MMBtu. Natural gas demand dropped for most of June as the heat wave passed. In the second week, it decreased by 4.6% ($/MMBtu) Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12

2 from the prior week. The power sector showed the largest decrease at 9.6% due to lowering air conditioning demand. Despite a moderate rise in consumption in the electric power generation sector towards the end of the month, during week of June 19 it was still 10% below levels of the same week last year. Also reducing demand for gas was a rebound in US nuclear production. Outages at nuclear facilities were at the lowest level of the year with the amount of gas needed to replace nuclear generation falling to only 1.75 Bcf/d, down from 7.2 Bcf/d in early May. Another main culprit of the depressed gas prices is abundant supply in the domestic market. Supply remained high throughout the month, even during the third week when Canadian gas pipeline imports decreased and pipeline exports to Mexico increased. During the same week, production increased 0.6% from the previous week and is 7.2% higher on a year-to-year basis. According to data from Baker Hughes, gas rig count oscillated between 870 and 887 during the month. The count on June 24 stood at 873, which is 9% lower than count of same week last year. Even though the gas rig count gradually declined, supply has been sustained at an oversaturated level. This could be partly attributed to the associated gas from increasing oil production, as the oil rig count reached 1,003 on June 24, its highest level on record. Despite high US Natural Gas Storage (Bcf) production levels Current 5-Year % Last Month 1 Year Ago and dwindling Region 17-Jun Avg. 1 Change 2 20-May 14-May East 1,072 1, % demand for natural West % gas, working gas Producing % Total 2,354 2, % 2,024 2,165 storage fell below 1 Avg. working gas in storage inventory for prior five years for calendar both the 5-year week in question. 2 Current week's inventory as a percent over or under the five-year average. average and levels Source: EIA/ DO E seen last year, though they were still comfortably adequate. Not until the week of June 17, when storage levels reached 2,354Bcf, was the net build of 98Bcf higher than the 5-year average build of 86Bcf and last year s build of 81Bcf. The storage build came after weeks of below- normal injections. One explanation is the narrowing summer-winter spreads that barely let producers cover the costs of storage hence giving no incentive to wait for winter

3 deals. Oct 2011 to Jan 2012 spreads were trading at 43 cents, which is extremely tight compared to an average of 70 cents over the past five years. Stocks are well above historic levels in the Guulf Coast producing region, but are relatively lower in the demand centers. In addition to the tight storage economics, rising production from nearby shale fields could also be reducing injection incentives. Traders in the US market have seen the winter/summer price differential at Henry Hub virtually disappear. For example, during January, prices in New York exceeded $16/MMBtu while Henry Hub remained around $12/MMBtu below the New York price. Numerous factors may contribute to the lack of seasonal price variation at Henry Hub including low interest rates driving the cost of production area storage lower and coal prices creating a floor price for summer gas. But the disconnect with seasonal variation at hubs in end-demand regions may be even more influenced by changed fundamental gas flow patterns in the US. In recent years significant new production from the States of Oklahoma, Arkansas, Colorado and Wyoming as well as at the Marcellus in West Virginia and Pennsylvania has changed the traditional southwest to upper Mid-West and northeast pipeline flows. Henry Hub prices are also de-linked from oil with benchmark gas prices trading at only a quarter of oil on an energy equivalent basis. Even though West Texas Intermediate crude dropped from $102.70/bbl in beginning of June to $90.10/bbl towards end month, there was no Crude Oil & Natural Gas Prices impact on 18 WTI gas prices. 15 Instead Henry Hub is 12 bouncing 9 Heavy Fuel Oil Henry Hub along a floor 6 price set by 3 coal used in 0 power generation. $ / MMBtu Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11

4 The sustained low prices continue to raise the prospects for US liquefaction and LNG export. Freeport LNG, who is eyeing LNG exports from its Gulf coast terminal, recently told regulators they are planning to expand capacity at the proposed liquefaction facility by 50%. The company said it is now looking to build a three train 12 MMt/y facility as opposed to the original two train 8 MMt/y design. The expansion plans mean Freeport LNG will no longer look to small to midscale liquefaction provider Chart Industries to supply four 2 MMt/y trains. Instead the project will now use Air Products for the liquefaction technology. The same low price environment is not boding for LNG imports and terminal operations. Indicative of the oversupplied market is Dominion s desperate attempt to force shippers into sending cargoes into its Cove Point terminal in Maryland. The company, which has not received a cargo since February, is in need of LNG to ensure the facilities tanks remain cold. Late last month the terminal operator requested the Federal Energy Regulatory Commission to alter the tariff rates at the facility as well as require capacity holders BP, Shell and Statoil to take responsibility for bringing in periodic volumes to maintain the facilities functionality. The capacity holders have of course scoffed at this filing by Dominion and say that the impetus to keep the terminal in working order should not be placed on them. Other than Dominion s plea, June was not an overly eventful month for LNG imports. North America brought in just 12 cargoes representing around 1.25 Bcf/d. Trinidad was the country s main source for LNG as it delivered six cargoes, five of which went into the Everett terminal in Massachusetts. Meanwhile, a few hours north across the border in Canada, Canaport resumed imports after being down for maintenance last month. The New Brunswick terminal received two cargoes including a Qatari Qmax vessel and a conventional sized cargo from Trinidad. The lack of imports in the Gulf recently has limited re-export activity from the US. Preliminary sounding indicate that July imports could fall even further. However, Freeport is currently scheduled to receive a Yemen cargo in July aboard the 150,000 m3 Grace Cosmos from GDF Suez. It is

5 understood that ConocoPhillips has secured the cargo and will likely market it as a re-export from Freeport sometime in early Aug.