Evaluating the Impacts of Market Shifts on Local Markets and Assets. Ron Norman May 20, 2009

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1 Evaluating the Impacts of Market Shifts on Local Markets and Assets Ron Norman May 20, 2009

2 Gas market outlooks are only one component of an effective marketing or procurement strategy Agenda Gas Market Gas Modeling Market Modeling Our view of market changes How do these changes impact asset values and strategies? How can producers, marketers, and buyers capitalize on these trends? Generation and End User Requirements Risk Management Energy Trading Strategy and Systems Effective Gas Marketing and Procurement Solutions Risk Management Business Portfolio Optimization Portfolio Optimization Marketing Marketing Strategy Strategy Capitalizing on market intelligence requires an integration of knowledge and tools across the value chain PA Knowledge Limited 2009 Page 2

3 Our view of near-term supply and demand trends Rig counts are down over 50%, but today s market remains oversupplied Increased LNG from new projects temporarily offsets production decline Balanced market returns in 2011 Eventual production declines due to drilling falloff BCF/day Jan-00 Jan-01 Jan-02 US Dry Gas Production Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan NYMEX Price $/MBTU, US Gas Rig Count / 100 Global LNG growth levels off in 2012; existing supplies are drawn away by Europe and Asia U.S. gas demand growth resumes Longer-term, unconventional gas fills supply gap previously thought to be filled by LNG imports Bcf/day Sources: EIA, Baker Hughes LNG Liquefaction Capacity Additions Qatar Africa Australia Indonesia Russia Other PA Knowledge Limited 2009 Page 3 Sources: IEA, public news releases

4 Price differentials will moderate, driven by new infrastructure and production shifts Projected Changes in Basis, 2008 to 2012 Declining Canadian supplies Ruby Mid-Con debottlenecked Midwest at crossroads of changes Increased shale gas REX NE Extension? Increased LNG supplies to East Coast Pipelines and LNG connect Texas and Louisiana markets FGT Phase VIII Expansion Reduced Basis vs. HH PA Knowledge Limited 2009 Page 4 Increased Basis vs. HH

5 LNG imports increase somewhat, but infrastructure will remain underutilized Forecasted LNG Imports Average, Regional Regas Capacity Canaport Neptune NE Gateway Everett Northeast East Coast imports favored over Gulf Unutilized Summer Winter Elba Island Cove Point Southeast Absolute levels strongly influenced by global demand rebound Gulf Gateway Lake Charles Pascagoula Cameron Sabine Golden Pass Freeport Gulf Coast Actual import volumes expected to be highly volatile Source: PA North American Gas Model PA Knowledge Limited 2009 Page 5

6 While broad changes in production and LNG imports will affect overall price levels, changing infrastructure and flows will impact local prices and asset values Example: the impact of REX on PEPL transportation holders With completion of REX West, utilization of PEPL between Missouri and Michigan increased Price differentials widened between PEPL pool and Michigan widened PEPL Daily price volatility increased by over 50% Those differentials and volatility will then decline when REX East opens $/MMBtu $4.00 $3.00 $2.00 $1.00 Estimated Value of PEPL Transportation Higher Utilization Higher Differentials Higher Volatility Lower Utilization Lower Differentials Lower Volatility MichCon - PEPL PA Knowledge Limited 2009 Page 6 $0.00 ($1.00) Jan-07 REX West interim service Jul-07 Jan-08 Jul-08 REX East interim service Jan-09 Jul-09 Jan-10 Estimated Value Jul-10 Jan-11 Jul-11 Based on transport from PEPL pool to MichCon Data sources: ICE, NYMEX 5/5/09, PEPL informational posting

7 The market is often late in anticipating infrastructure impacts MichCon - PEPL difference $2.50 $2.00 $1.50 $1.00 REX West opens Jan 2008 Evolution of Expected PEPL Pricing $0.50 Aug-07 Feb-08 Aug-08 Feb-09 Actual Future 4-Jan 2-Apr 2-Jul 1-Oct 27-Dec Example: the impact of REX on PEPL transportation holders Though REX West was under construction in 2007, in April 2007, forward curves showed no recognition, and as late as October 2007, markets forecasted a 10 to 20 cent impact of REX West on PEPL transportation holders Actual impacts exceeded $1.00 on average Our fundamental market models identify how such infrastructure changes will affect local prices (basis), utilization and volatility By understanding these changes before their impacts are priced by the market, procurement, analysis and valuation can be improved PA Knowledge Limited 2009 Page 7

8 Modeling and market analysis can be used to answer key questions throughout the value chain Producers How do I manage production and hedging programs through the downturn? How will LNG impact pricing dynamics for domestic production? What basis trends could impact my gas production? Pipelines & LNG Terminals Which pipeline projects remain viable given the shifts in production and prices? What can terminal operators do to manage the impacts of lower than expected deliveries? Should some LNG terminals be mothballed? End Users What will set bounds on future price movements? What supply options offer the best value? What about LNG? Where can modest asset investments add significant value to my portfolio? Marketers Which pipeline capacity will become more valuable? Where will the volatility of LNG deliveries create value for gas storage? PA Knowledge Limited 2009 Page 8

9 Integrating market outlooks into stochastic models Market simulations are most useful when results are used to understand breaks from history and to develop the forward curves, volatilities, and correlations used in analytical models The impacts of market changes on specific assets can be isolated Transportation capacity Storage capacity Supply and offtake agreements Gas fired generation Price differentials, volatilities, and correlations map into local portfolio optimization and risk models Parameter Default Enhanced M1 S1 M2 S2 M3 N1 N2 N3 St2 D1 Forward Curves Market Correlations & Volatility Supply Volatility Demand Volatility NYMEX, Historical Historical Historical Historical Long-term model results Adjusted for changes in pipeline and storage utilization Adjusted for changes in LNG imports Adjusted for changes in local power generation & dispatch PA Knowledge Limited 2009 Page 9

10 The best analysis uses multiple tools to evaluate asset investments and strategies Detailed Fundamental Market Modeling Fundamental Market Understanding Including Related Markets Long-term Prices and Flows Domestic Supply Models Global LNG Analysis Infrastructure Updates GPCM Optimization Software Fundamental Power & Environmental Models Res/Comm & Industrial Correlations LNG LNG LNG L Price, Flow, Consumption & Production Forecasts Fundamental Market Modeling 1.2 X <= % Asset Valuation X <= % Business Portfolio Optimization Utilization, Price and Volatility Projections Portfolio Simulation 5 600, Mean = E+07 M1 vs1 vm1 vi1 St1 N1 vw1 T13 N3 T35 $/MBtu , , , , ,000 Dth/day 0.2 S1 T12b T12a T43 T34 N5 D Values in Millions vm2 M2 N2 vi2 N4 vw2 T45 1/1/2005 4/1/2005 7/1/ /1/2005 1/1/2006 4/1/2006 7/1/ /1/2006 1/1/2007 4/1/2007 7/1/ /1/2007 1/1/2008 4/1/2008 7/1/2008 St2 PA Knowledge Limited 2009 Page 10

11 Takeaways for Risk Management and Portfolio Optimization More than ever, historical behavior is no indicator of future results The strategies that were appropriate for the last five years will not be the optimal strategies for the future In particular, Midwest players face difficult choices in how to position their portfolios The intelligent use of fundamental market models can make portfolio optimization and risk management models more forward-looking Forward curves, volatilities, and correlations can all be adjusted to generate new scenarios critical to identifying risks and opportunities Capturing value and identifying new risks in this changing market requires: Understanding of the drivers of market shifts that will cause the future to break from the past A holistic view of the market, including global LNG, domestic supply changes, infrastructure impacts, and underlying demand trends Sophisticated models for estimating asset value within a portfolio PA Knowledge Limited 2009 Page 11

12 For more information, contact: Ron Norman Member of PA s Management Group One Memorial Drive 16 th Floor Cambridge, MA Tel: Cell: ron.norman@paconsulting.com PA Knowledge Limited 2009 Page 12

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