Shale Plays After The Gold Rush

U.S.
Shale Gas
After The Gold Rush: A Different Perspective on Future Gas Supply and Price
Arthur E. Berman & Lynn F. Pittinger Labyrinth Consulting Services, Inc.
Houston SIPES Continuing Education Seminar Halliburton Conference Theater October 19, 2012
Labyrinth Consulting Services, Inc.
Houston SIPES Continuing Education Seminar
Slide 1
After The Gold Rush: Shale Magical Thinking

All difficulties arise from what seems easy. All great things arise from what is minute. One who thinks that everything is easy will encounter much difficulty. Tao Te Ching (If something sounds too good to be true, It probably is!)
It is doubtful that shale gas will meet supply expectations except at much higher prices: high shale gas decline rates & non-shale depletion are the main factors. Decline-curve analysis indicates lower reserves than operators claim. Natural gas demand has increased & supply is flat: EPA regulations will increase demand further. Shift to liquid-directed drilling & flight from dry gas will decrease gas supply. Capital expenditure necessary for supply maintenance is not supportable.
Slide 2
U.S. Production is Flat

Lower 48 States Gross Natural Gas Withdrawals
Lower 48 80 Texas Other States Federal OCS GOM Louisiana Wyoming New Mexico Oklahoma
70
60
Billions of Cubic Feet of Gas Per Day
50
40
30
20
10
Jan-05
Apr-05
Jul-05
Oct-05
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Apr-12
Jan-06
Jan-10
Source: EIA
Jan-12
Jul-12
Slide 3
An Industry Self Destructs By Over-Production

Henry Hub Natural Gas Spot Price
$16 $14.49 $14 $13.20
$12
Dollars Per Million BTU
$10
$8 $6.56 $6
$4
$3.25
$2 $1.86 $0
1/7/2005 3/7/2005 5/7/2005 7/7/2005 9/7/2005 11/7/2005 1/7/2006 3/7/2006 5/7/2006 7/7/2006 9/7/2006 11/7/2006 1/7/2007 3/7/2007 5/7/2007 7/7/2007 9/7/2007 11/7/2007 1/7/2008 3/7/2008 5/7/2008 7/7/2008 9/7/2008 11/7/2008 1/7/2009 3/7/2009 5/7/2009 7/7/2009 9/7/2009 11/7/2009 1/7/2010 3/7/2010 5/7/2010 7/7/2010 9/7/2010 11/7/2010 1/7/2011 3/7/2011 5/7/2011 7/7/2011 9/7/2011 11/7/2011 1/7/2012 3/7/2012 5/7/2012 7/7/2012 9/7/2012
Source: Reuters
Source: Natural Gas Intelligence
Shale gas made some sense while gas prices were increasing (2007-2008). Failure/inability to see the new market reality after mid-2008 price collapse doomed shale gas. Entry of major E&P companies and foreign investors misunderstood as validation of shale economics. McClendons losses reflect the condition of Chesapeake that, in turn, reflects the commercial failure of the shale gas business.
Labyrinth Consulting Services, Inc. Houston SIPES Continuing Education Seminar Slide 4
Haynesville Shale Production: The Onset of Declining Production

Haynesville Shale Gas Production
Gas Production Number of Wells Rig Count
3,500
6 2,500 5 2,000 4 1,500 3 1,000 2
500
0
1/ 1/ 20 3/ 08 1/ 20 5/ 08 1/ 20 7/ 08 1/ 20 9/ 08 1/ 2 11 00 /1 8 /2 0 1/ 0 8 1/ 20 3/ 09 1/ 20 5/ 09 1/ 20 7/ 09 1/ 20 9/ 09 1/ 2 11 00 /1 9 /2 0 1/ 0 9 1/ 20 3/ 10 1/ 20 5/ 10 1/ 20 7/ 10 1/ 20 9/ 10 1/ 2 11 01 /1 0 /2 0 1/ 1 0 1/ 20 3/ 11 1/ 20 5/ 11 1/ 20 7/ 11 1/ 20 9/ 11 1/ 2 11 01 /1 1 /2 1/ 011 1/ 20 3/ 12 1/ 20 5/ 12 1/ 20 12
Data from DI
12% of U.S. natural gas production. Current production is in decline despite adding new wells. The mystery of efficiency: spare-capacity wells (drilled but not connected to sales).
Number of Producing Wells & Number of Rigs x 10
3,000
Reserves are Over-statedDecline Rates are Higher than Anticipated

Haynesville Shale Base Decline
Gas Production 6 5.5 1400 5
Number of Producing Wells 1600
4.5 4
1200
Number of Producing Wells
1000 3.5 3 2.5 2 1.5 1 200 0.5 0

Ja n0 M 8 ar -0 M 8 ay -0 8 Ju l-0 Se 8 p0 N 8 ov -0 8 Ja n09 M ar -0 M 9 ay -0 9 Ju l-0 Se 9 p0 N 9 ov -0 9 Ja n10 M ar -1 M 0 ay -1 0 Ju l-1 Se 0 p1 N 0 ov -1 0 Ja n11 M ar -1 M 1 ay -1 1 Ju l-1 Se 1 p1 N 1 ov -1 1 Ja n12
48% Annual Base Decline Rate
800
600
400
Data from DI
Haynesville Shale annual base decline rate is ~53%, which translates into ~3.8 Bcf/d of gas production that needs to be replaced annually (ITG, 2 February 2012). Our work indicates 48% annual decline rate & 3.3 Bcf/d annual production replacement.
Slide 6
The Number of Wells & Cost to Replace Base Decline in the Haynesville Shale
Haynesville Shale Base Annual Replacement
3.50 3.3 3.3
Jan 2008 - May 2010

3.00
2012 Replacement
2.50
885 Wells
2.00
956 Wells $2.9 Billion per Bcf/d Total Cost: $9.6 Billion
$2.7 Billion per Bcf/d Total Cost: $8.9 Billion
1.50
1.00
0.50
0.00 885 956
Data from DI
More wells are required to replace the same gas volume every year. For 2012, 3.3 bcf/d base replacement will require drilling 956 new wells & cost $9.6 billion. Falling rig count and evaporation of capital mean that supply cannot be replaced. This is true for all shale gas plays.
Haynesville Shale Decline Curve Analysis

Overall Average EUR = 3.7 Bcf for Haynesville Wells: ~1,000 wells w/ avg 26 months of data, Development drilling cost ~ $3.25/Mscf assuming $9 MM well cost and 75% NRI. Petrohawk and EXCO are outperforming: Chesapeake improving, passing Encana. Fetkovitch type curve used to calibrate b factor: EUR ~20% higher this year than last years for the same wells. Unable to account for shut-in or curtailments due to low gas prices.
EUR 8/12 DCA Chesapeake CHK 2008 CHK 2009 CHK 2010 CHK 2011 CHK WTD AVG Petrohawk HK 2008 HK 2009 HK 2010 HK 2011 HK WTD AVG Encana ECA 2009 ECA 2010 ECA 2011 ECA WTD AVG EXCO EXCO 2009 EXCO 2010 EXCO 2011 EXCO WTD AVG Overall Average 2,335 2,971 3,543 3,538 3,370 7,543 4,873 Rate Controlled Rate Controlled 5,036 3,341 3,112 3,022 3,126 4,965 5,113 3,921 4,496 3,676
EUR 6/11 DCA 2,059 2,436 Insufficient Data 2,371 3,761 3,998 Insufficient Data 3,963 2,555 Insufficient Data 2,555 4,059 Insufficient Data 4,059 3,001
NUMBER OF WELLS 23 110 191 207 531 3 46 75 67 191 34 82 60 176 30 87 118 235 263
Slide 8
Haynesville Shale Decline Curve Analysis: Chesapeake Energy
Slide 9
Slide 10
Slide 11
Barnett Shale Decline Curve Analysis: Chesapeake Energy DFW
Slide 12
Total Barnett play production estimate based on improvement in type well from 1.0 bcf pre-2009 to 1.4 bcf post-2009
Data from HPDI
Slide 13
1,400
Marcellus Shale Production Cumulative Production and Months Online Through 12/2010
Susquehanna Cty
Outperforming Type Well

4.2 Bcf Type Well
1,200
Bradford Cty
Cumulative Production, Mscf
1,000
Tioga Cty
800
Underperforming Type Well

Greene Cty Washington Cty
600
400
Lycoming Cty
200
Fayette Cty
0 0 2 4 6 8 10 12 14 16 18 20
Average Months Online
Slide 14
Marcellus Shale Relative Performance Map
Slide 15
Shale Gas is not Commercial below $5/mmBtu point forward.

Overall Average EUR - Calculated Break-Even Gas Price for 8% Discount Rate Barnett Fayetteville Haynesville Full-Cycle Point-Forward Full-Cycle Point-Forward Full-Cycle Point-Forward Break-Even Gas Price, $/mmBtu $8.75 $5.63 $8.31 $5.06 $8.68 $6.80 EUR/Wel (Bcf/Well) 1.34 1.34 1.19 1.19 3.00 3.00 Well Cost ($mm) $3.50 $3.50 $2.80 $2.80 $9.50 $9.50 Royalty 22.5% 22.5% 22.5% 22.5% 22.5% 22.5% Land* ($/acre) $5,000 $0 $5,000 $0 $5,000 $0 Expense (LOE, G&T., G&A ($/net mcf) $1.50 $0.75 $1.50 $0.75 $1.50 $0.75 Severance Tax 7.50% 7.50% $0.11/mcf $0.11/mcf 7.50% 7.50% F&D ($/net mcf) $4.92 $3.37 $4.78 $3.04 $4.87 $4.17 Total Cost ($/net mcf) $6.41 $4.12 $6.42 $3.93 $6.37 $4.92 * Land cost assumes 169-acre spacing and 50% of leased land developed Marcellus Full-Cycle Point-Forward $7.84 $5.61 2.00 2.00 $5.50 $5.50 22.5% 22.5% $5,000 $0 $1.50 $0.75 0% 0% $4.99 $3.56 $6.03 $4.31
SCI Barnett B.E. Price at our EUR (1.34 vs. 2.45 bcf ): $5.63
SCI Fayetteville B.E. Price at our EUR (1.19 vs. 6.5 bcf ): $5.51
SCI Haynesville B.E. Price at our EUR (3.00 vs. 2.45 bcf ): $6.04
Simmons & Company International, September 2012
Slide 16
The Demand Side of The Equation
Data from Brattle Group
Data from EIA
2011 consumption was 1.5 Bcf/day higher than in 2010.

So far in 2012, consumption has increased > 2.5 Bcf/d compared to 2011. Most of this increase is from coal-to-gas fuel switching for electric power generation. EPA regulations of power sector will result in an additional 6.6 Bcf/d by 2020: 58 GW coal plant retirements through 2015. Additional ~10-20 GW based on retrofitting costs.
Slide 17
The Demand Side of The Equation

Natural Gas Price & Usage For Electric Power Generation
YOY Monthly Gas Use 4.00
2012/2011 Monthly Change in Gas Usage For Power Generatioin (Bcf/Per Day)
HH Gas Price $5.00
3.50 $4.49 $4.26 $4.31 3.00 $4.11 $3.97
3.4
$4.54 $4.42
$4.50
Henry Hub Monthly Average Gas Price (Dollars Per Million BTU)
3.0
$4.05 $3.90 $3.56 $3.29 $3.17
2.8
$4.00
2.8
2.8
$3.50
2.50
2.1
$2.93
$3.00
2.00
1.8$2.67
1.50 $2.50 $2.18 $2.42 $2.44
$2.50
$2.00 $1.94 $1.50
1.0
1.00
0.6
0.50
0.6 0.2 -0.1 -0.2 -0.2
0.7
0.3 0.0 0.0
0.1
$1.00
Jan-July 2012/2011= +2.7 bcf/d

$0.50
0.00
-0.50
Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12
$0.00
Data from EIA
Rising natural gas price will not save producers in the near-term because of the relationship of price to fuel switching. Critical price points at $2.50, $2.75, $3.00, $3.25 and $3.50/mmBtu based on recent history. Power producers may switch to coal just to work through excess stockpiles.
The Shift To Liquid-Prone Shale Plays

Gas- and Oil-Directed Rig Count (Smith Bits)
SB US GAS RIGS 2,500 SB US OIL RIGS PCT Oil/Gas 400%
Haynesville Operator Rig Count

CHK EXCO ECA XTO HK
120
350%
The current rig count is 28, down 1 from last week. The maximum rig count was 221 in the week ending 11/7/2008. CHK is down 36 rigs from the week ending 3/12/2010. The listed operators were flat this week.
100
2,000 300%
Percent Oil- to Gas-Directed Rigs
80
Number of Rigs
1,500
250%
Number of Rigs
200%
60
1,000
150%
40
100% 500 50%
20
1/ 4/ 08
5/ 4/ 08
9/ 4/ 08
1/ 4/ 09
5/ 4/ 09
9/ 4/ 09
1/ 4/ 10
5/ 4/ 10
9/ 4/ 10
1/ 4/ 11
5/ 4/ 11
9/ 4/ 11
1/ 4/ 12
5/ 4/ 12
1/4/08 2/4/08 3/4/08 4/4/08 5/4/08 6/4/08 7/4/08 8/4/08 9/4/08 10/4/08 11/4/08 12/4/08 1/4/09 2/4/09 3/4/09 4/4/09 5/4/09 6/4/09 7/4/09 8/4/09 9/4/09 10/4/09 11/4/09 12/4/09 1/4/10 2/4/10 3/4/10 4/4/10 5/4/10 6/4/10 7/4/10 8/4/10 9/4/10 10/4/10 11/4/10 12/4/10 1/4/11 2/4/11 3/4/11 4/4/11 5/4/11 6/4/11 7/4/11 8/4/11 9/4/11 10/4/11 11/4/11 12/4/11 1/4/12 2/4/12 3/4/12 4/4/12 5/4/12 6/4/12 7/4/12 8/4/12 9/4/12
Source: Smith Bits
Source: Smith Bits
The percentage of oil- to gas-directed rigs has increased from 21% to 339% since 2008. Haynesville Shale rig count is now 28, down from 221 in November 2008. Every additional oil-directed rig means less gas will be produced (average Eagle Ford IP is 2 mmcf/d vs. Haynesville 8 mmcf/d).
9/ 4/ 12
0%
Slide 19
Total U.S. Decline Rates Have Increased Since the Advent of Shale Gas Plays
Steepening Decline Curves
Increasing Drilling Productivity is Required to Grow Top Line Production
70 60 50 y a d40 r e p f 30 c B 20 10 0
2000 2002 2004 2006 2008 2010
Source: ARC Financial Research
32% annual decline rate 23% annual decline rate
In 2001, annual decline rate for U.S. natural gas production was 23%. Now, annual decline rate is 32%. Gas consumption has increased from 54 to 65 bcf/daymore to replace.
Gas Supply Maintenance Capital and Cash Flow Generation
Analysis of top 34 publicly traded gas producers indicates that the cost of supply replacement is $22 billion per quarter. 2010 cash flow for those companies was $12 billion per quarter so there is a $10 billion quarterly cash flow deficit.
Capex-to-Cash Flow Ratios

Ticker CRK CRZO ATPG XCO UPL KWK PVA MUR PXP FST MMR SM PQ RRC NBL CXO BBG GDP CHK COG DNR ROSE SFY SWN EOG NFX XEC CWEI BRY CPE PXD DVN OXY WTI APA APC WLL CNQ CVE ECA TLM Share Price 1-Year Cash Debt to as of Change in Gas as % of Margin Total Cap Capex-to-Cash Flow 04/10/12 Mkt Cap ($B) EV ($B) Price Production 4Q11 (kboepd) Production ($/boe) (Yahoo Finance) $15.45 $0.70 $1.90 -48% 46 92% $17.32 54% 769% $26.09 $1.00 $1.70 -28% 22 86% $21.32 59% 542% $6.63 $0.30 $2.70 -60% 25 34% $28.70 96% 417% $6.02 $1.30 $3.10 -71% 92 98% $15.19 55% 336% $19.51 $3.00 $4.90 -60% 121 97% $22.10 54% 318% $4.41 $0.70 $2.60 -67% 69 82% $7.82 65% 304% $3.95 $0.20 $0.90 -75% 19 63% $32.75 45% 302% $51.98 $10.10 $9.60 -31% 192 42% $46.50 6% 286% $40.50 $5.20 $8.40 16% 105 50% $26.70 54% 282% $11.35 $1.30 $3.00 -68% 57 70% $18.99 59% 282% $8.83 $1.40 $2.10 -50% 28 66% $24.17 22% 214% $64.58 $4.10 $5.00 -10% 93 56% $29.21 40% 203% $5.66 $0.40 $0.50 -35% 15 83% $14.51 40% 196% $56.79 $9.00 $10.90 1% 104 79% $23.80 46% 195% $93.16 $16.50 $19.50 -2% 233 60% $34.47 36% 189% $96.29 $9.90 $12.00 -7% 71 38% $48.55 41% 186% $22.74 $1.10 $1.90 -45% 53 90% $24.62 42% 186% $15.35 $0.60 $1.10 -29% 18 86% $11.01 80% 181% $20.69 $13.20 $28.20 -38% 599 82% $21.65 37% 180% $30.63 $6.40 $7.30 17% 99 94% $18.91 31% 176% $17.80 $6.90 $9.40 -24% 67 6% $62.47 36% 173% $47.03 $2.50 $2.70 3% 32 51% $28.00 27% 164% $27.12 $1.20 $1.60 -34% 29 49% $34.55 42% 161% $29.30 $10.20 $11.50 -26% 242 100% $16.39 25% 146% $104.00 $28.00 $32.40 -8% 442 58% $33.96 28% 144% $33.09 $4.40 $7.30 -54% 144 56% $32.26 43% 144% $69.19 $5.90 $6.30 -39% 100 56% $30.94 11% 136% $72.99 $0.90 $1.40 -26% 15 24% $73.10 61% 132% $44.20 $2.40 $3.80 -13% 36 28% $37.92 62% 126% $5.52 $0.20 $0.30 -20% 5 42% $46.56 57% 124% $105.12 $12.90 $15.10 3% 137 44% $31.02 31% 122% $68.94 $27.90 $30.60 -23% 680 65% $23.07 31% 100% $89.61 $72.70 $74.80 -11% 749 28% $50.89 13% 96% $18.54 $1.40 $2.10 -16% 50 52% $35.73 57% 80% $93.50 $35.90 $44.10 -26% 759 50% $45.21 20% 66% $74.63 $37.70 $52.30 -8% 683 57% $31.18 46% 52% $51.17 $6.00 $7.40 -28% 71 16% $51.16 31% 5% $31.29 $34.20 $42.70 -31% 580 35% $43.16 27% N/A $33.38 $25.10 $30.40 -11% 231 47% $28.06 27% N/A $18.19 $13.30 $19.00 -43% 600 96% $17.29 33% N/A $12.18 $12.50 $17.30 -47% 362 59% $31.72 33% N/A
Source: Bernstein Research & Yahoo Finance
Unsustainable capital expenditures will limit capability to deliver on supply. Further constraints on cost-of-capital will limit options.
Natural Gas Price Scenarios
Considerable uncertainty in price forecasts. Credible forecasts put average 2012 gas price at $2.40$2.70/mmBtu. 2013 average gas price in $3.40-$4.50/mmBtu range.
Slide 23
After The Gold Rush: Conclusions

Demand is increasing and production is beginning to decrease. High decline rates & need for continued drilling/high capex have not been factored into supply & price forecasts. Cognitive distortion is rampant about U.S. energy supply and price. Shale gas is not commercial at prices below $7/mmBtu full-cycle cost. Government is now on the natural gas band wagon: regulation & legislation will effectively mandate increased gas demand. Natural gas will be there when we need it but historical supply & price volatility will be part of the future. Beware of what you read and hear: the change in supply & price may occur faster than many now forecast!
Slide 24
Once You Pass Through The Looking Glass

Everything about natural gas fundamentals in North America supply, demand, seasonality, storage and priceis now extreme.
Peter Tertzakian
Strange Thinks Look Normal.
Slide 25
U.S. Shale Gas
After The Gold Rush: A Different Perspective on Future Gas Supply and Price
Arthur E. Berman & Lynn F. Pittinger Labyrinth Consulting Services, Inc.
Houston SIPES Continuing Education Seminar Halliburton Conference Theater October 19, 2012
Slide 26

Shale Plays After The Gold Rush

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U.S.

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

After The Gold Rush: Shale Magical Thinking

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

U.S. Production is Flat

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

An Industry Self Destructs By Over-Production

Dollars Per Million BTU

Source: Natural Gas Intelligence

Haynesville Shale Production: The Onset of Declining Production

6 2,500 5 2,000 4 1,500 3 1,000 2

Number of Producing Wells & Number of Rigs x 10

Billions of Cubic Feet of Gas Per Day

Reserves are Over-statedDecline Rates are Higher than Anticipated

Number of Producing Wells 1600

1000 3.5 3 2.5 2 1.5 1 200 0.5 0

48% Annual Base Decline Rate

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

Jan 2008 - May 2010

$2.7 Billion per Bcf/d Total Cost: $8.9 Billion

0.00 885 956

Haynesville Shale Decline Curve Analysis

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

Haynesville Shale Decline Curve Analysis: Chesapeake Energy

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

Haynesville Shale Decline Curve Analysis: Chesapeake Energy

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

Haynesville Shale Decline Curve Analysis: Chesapeake Energy

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

Barnett Shale Decline Curve Analysis: Chesapeake Energy DFW

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

Data from HPDI

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

Outperforming Type Well

Cumulative Production, Mscf

Underperforming Type Well

Average Months Online

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

Marcellus Shale Relative Performance Map

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

Shale Gas is not Commercial below $5/mmBtu point forward.

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

The Demand Side of The Equation

Data from Brattle Group

Data from EIA

2011 consumption was 1.5 Bcf/day higher than in 2010.

Labyrinth Consulting Services, Inc.

Houston SIPES Continuing Education Seminar

The Demand Side of The Equation

HH Gas Price $5.00