Wood Mackenzie Gas Market Outlook

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1 Wood Mackenzie Gas Market Outlook Southern Gas Association April 20, 2009 Amber McCullagh

2 Short-Term Outlook

3 2008 markets were volatile as underlying fundamentals shifted rapidly Three primary phases: Run-up Easing Crash Cold winter and hot spring more than outweigh supply growth Weakening storage position and high oil prices mean a high risk premium LNG imports very weak Supply growth continues more rapidly than anticipated Weather and currency slow industrial and power demand growth Deep global recession suppresses power and industrial gas demand, as domestic and foreign markets are weak Supply still strong due to lagged effects of drilling declines 3

4 But 2009 prices should stay within a much tighter range In recent weeks, storage surplus has continued to build rapidly But, in contrast to 2008, prices have stabilized Gas prices are now competitive with East Coast coal, providing solid support on the downside Supply will contract sharply on the heels of drilling declines, but price upside is also limited, as small increases mean less coal displacement 4

5 Supply

6 Strong momentum from last year will mean a year-over-year supply increase Production is not likely to decline rapidly month-over-month until May Lagged effects of drilling declines Wells in Barnett and Fayetteville were awaiting completion, tie-in, or pipe Gulf of Mexico recovery Year-over-year growth of 700 mmcfd in 2009 despite the strong drilling cuts Major operators that announced cuts have forecast moderate production growth this year Lower-48 production 6

7 Initial drilling declines were mostly conventional, but recent declines have extended to mature unconventionals Barnett Early declines in counties that accounted for less than 20% of new production that came on in 2008 As of January end, only 17% of productive capacity affected Declines spread rapidly into core counties in first quarter Production response to become pronounced in Q2 Piceance Williams will go from 26 rigs to 9 EnCana will drop 5 rigs Production to decline this year 7

8 But for the most part, emerging shales survive cuts Operators have made significant investments in acquiring acreage Drilling expected to be robust to hold acreage Haynesville Petrohawk and Chesapeake to maintain Haynesville activity at previously planned levels despite cuts elsewhere. Petrohawk dedicating 70% of budget to Haynesville BC Apache to invest $260 Million in the play. EnCana, Quicksilver and EOG also committing capital to further test and develop the play. Industry to drill wells in the play Marcellus Range and several others stepping up activity. Range deploying six fit-for-purpose rigs. Chesapeake planning to reach 20 rigs in the play by end of 2009 Fayetteville Southwestern maintaining spending and drilling 100 more wells. Chesapeake expected to maintain 20 rigs in the play nearly double early 2008 levels Source: Wood Mackenzie NAGS & Upstream Service 8

9 Why have operators laid down rigs? Economics Poor development economics in low gasprice environment Barnett non-core and Piceance with high development costs seeing strong cuts Corporate Cash flow issues at corporate level Cuts in Barnett core because of unavailability of capital Cash diverted away from areas with acceptable economics that don t have acreage issues Source: Smith Bits and Wood Mackenzie Source: Smith Bits and Wood Mackenzie 9

10 The pace of rig-count declines should decelerate going forward As market was tight early in 2008, service companies were able to include strict lay down clauses into contracts Operators are paying up to $15,000 a day per rig not to drill. Operators spending an estimated quarter billion dollars for buying out term contracts Steepest decline numbers are behind us? Operators have already released a majority of rigs in plays with marginal economics January collapse in drilling activity from expiration of annual budgets and contracts With declines in unconventional plays, rig levels close to operator-announced 2009 levels Since downturn is associated with a deep recession, no sharp rebound expected in the near term 10

11 Meanwhile, LNG imports will also increase from last year s very low levels Current outlook is for 1.9 bcfd of North American imports this summer, but there is significant upside Weak Asian and European demand Somewhat offset by low storage levels in Europe Some liquefaction projects have been delayed slightly, but still significant capacity additions this year Could mirror 2007 import levels US LNG imports by terminal 11

12 As global liquefaction capacity ramps up 2009 additions Rasgas 3: 200 mmcfd, Q4 Qatargas 2: 600 mmcfd, April Tangguh: 200 mmcfd, mid-year Sakhalin 2: 400 mmcfd, March Yemen LNG: 200 mmcfd, mid-year Global liquefaction capacity 12

13 offsetting declines in Canadian supply/imports WCSB Production Outlook vs. Net Exports to US (Annual Total) WCSB Production Outlook vs. Net Exports to US (Year-Over-Year) 13

14 Demand

15 Until 2008, gas demand growth was driven by increased gas-fuelled power demand US Demand by Sector US Demand from the Power Sector 15

16 But economic weakness and a prolonged recovery presents a significant headwind Short-term (through 2010) outlook remains very bleak Deleveraging has begun but nowhere near complete yet Exports weak given lack of global demand Consumer retrenches to more sustainable consumption-income ratios, meaning downward pressure on largest component of GDP Fiscal stimulus packages not sizable enough to outweigh demand contraction Annual growth does not exceed 3% until 2013 GDP growth 16

17 So gas prices have approached the near-term coal floor Power sector gas demand at different prices Cumulative displacement by region from $6.00/mmbtu 17

18 But 19.4 GW of coal-fired generation is planned come online by the end of 2012 All of this capacity is in construction, site prep, or testing Steel in the ground Highly efficient, baseload capacity that will push marginal gas-fired units off the supply stack and other gas plants toward the margin Identified new capacity 18

19 Meaning gas demand for power is likely to weaken in 2010 and Assuming a constant price, power demand declines between 2009 and 2011 for price below $7/mmbtu 2008 Power Demand 18.2 bcfd US GDP growth 2009 (2.9%) US gas demand for power (bcfd) at different prices $4 $5 $ % %

20 Industrial gas demand will move with the economy, meaning severe weakness this year Little stimulus from low prices this year due to global demand weakness Capacity utilization in the steel sector is less than 50% Jan/Feb chemicals production was at Sept (hurricane-affected) levels Medium-term recovery is protracted due to slow economic growth Long-term competitive position improved due to strong US resource base and resulting lower prices Industrial gas demand and GDP growth 20

21 Storage build will defer some excess supplies Year-over-year surplus of more than 400 bcf by March, suggesting potential for further price declines Strong supply growth throughout 2008 and Q leads to a record Oct inventory level near practical maximum Given storage additions in 07, 08 and 09, new practical storage max is estimated to be 3.9 tcf for 2009 US working gas storage inventory levels 21

22 Prices recover with stronger demand, reduced supply in 2010, but gains are modest Prices down with Central Appalachian Coal prices in 2009 Average Henry Hub price of $4.20/mmbtu Consistent with gas rig counts dropping to 750 Some recovery in Summer 2010 as supply plateaus at lower level and industrial demand recovers Henry Hub price around $5.20 Supports activity Small further gains in 2011 Reduced upstream activity from 09 and 10 carries Henry Hub to $5.50-$5.75 Price outlook 22

23 Key takeaway points Rig count declines will take time to change the supply trajectory Momentum growth carried over from 2008 Investment in key plays like the Haynesville continues Prices are low and could stay that way all year Risk of higher LNG imports Asian demand is tanking and weak European economic growth is expected to offset much of the increased storage injection required after the interruption of Russian gas flows The economy is not yet stabilized, and industrial demand and total power load could continue declining 2009 storage should reach toward constraints Although the market will anticipate a rebound in 10, true recovery looks unlikely in the near-term 23

24 Long-Term Outlook

25 Long-term supply, demand, and GDP outlook will be lower Global optimization still ongoing, but huge North American shale resource base is likely to anchor long-term prices Drilling can be ramped up relatively quickly in response to rising prices Short-term weakness as prices do not support aggressive investment Key long-term drivers Global LNG: weak demand in other markets is likely to mean LNG forced into US to protect oil-indexation in Europe GDP growth: short-term changes have a lasting impact due to lower starting point and lack of strong rebound Carbon? Not included in base case but presents significant uncertainty 25

26 Potential carbon legislation is the primary risk to the long-term outlook Very modest carbon tax, in line with recently proposed legislation Increase of 1-3 bcfd in gas demand for power in 2015 Building to an increase of 6-10 bcfd by

27 Wood Mackenzie Kintore House Queen Street Edinburgh EH2 4NS Global Contact Details Europe +44 (0) Americas Asia Pacific Global Offices Australia - Canada - China - Japan - Malaysia - Russia - Singapore - South Africa - United Arab Emirates - United Kingdom - United States Wood Mackenzie has been providing its unique range of research products and consulting services to the Energy industry for over 30 years. Wood Mackenzie provides forward-looking commercial insight that enables clients to make better business decisions. For more information visit: 27

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