perspectives on world natural gas markets

A Member of the Galway GroupLP

Galway Energy Advisors

www.galwaygroup.com

Advisors and Investment Bankers to the Energy Industry

November 6th, 2012

Perspectives on World Natural Gas Markets

Robert D. Stibolt

USAEE 2012

© 2012 by Galway Energy Advisors. All Rights Reserved.

Agenda

World Natural Gas Markets Today

Trading Market Price Perspectives

Fundamental Considerations

2


Agenda




3


We’re economists – we’re supposed to know something!

Can we develop reasonable natural gas price forecasts, but at the same time acknowledge the reality of price uncertainty?

How will the race between technology and resource depletion playout in the future?

Will technology emerge that we are not even aware of today (similar to the experience with hydraulic fracturing that we did not foresee)?

What can experts tell us about how rapidly technology will advance in the future, or even what that technology will be?

What will regional differences in markets look like as we go into the future (Asia/Europe/North America)?

An approach to more useful price and quantity forecasts

Start with trading market views

Augment with fundamental market analysis, though need to explicitly address uncertainty

Assessing the realistic range of uncertainty is useful in its own right4


There are five ways to assess prices and basis differentials in energy markets

3. Historical Statistical Extrapolation

2. Internal Judgment

4. Market Observations

1. Expert Surveys5. Fundamental Models


Our view: operate on the lower left boundary with a methodology that links liquid and illiquid points

3. Historical Statistical Extrapolation

2. Internal Judgment

4. Market Observations

1. Expert Surveys5. Fundamental Models

Gold

Oil

Gas

Electricity

Aluminum

p*

q*

Price

Quantity

Demand

Supply

Market Clearing

Price


Agenda




7


NBP Natural Gas Prices w/Probability Ranges

8

0

2

4

6

8

10

12

14

16

18

20

10/1/2012 10/1/2013 10/1/2014 10/1/2015 10/1/2016

$/MMBT

U

Maturity Date

NBP Forward Curve and Options‐Derived Ranges(October 26th, 2012)

Forwards

Low Case (5% Envelope)

High Case (95% Envelope)


NBP Volatility Curve – Traded Options vs. Modeled

9

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

0.000 2.000 4.000 6.000 8.000 10.000

Ann

ualized

%

Tenor

Indicative Volatility CurveNBP

Traded

Smoothed


Brent Crude Oil Prices w/Probability Ranges

10

0

20

40

60

80

100

120

140

160

180

200

11/1/2012 11/1/2013 11/1/2014 11/1/2015 11/1/2016

$/BB

L

Maturity Date

Brent Forward Curve and Options‐Derived Ranges(October 26th, 2012)

Forwards




Henry Hub Natural Gas Prices w/Probability Ranges

11

0

1

2

3

4

5

6

7

8

9

9/1/2012 9/1/2013 9/1/2014 9/1/2015 9/1/2016

$/MMBT

U

Maturity Date

NYMEX NG Forward Curve and Options‐Derived Ranges(September 10th, 2012)

Forwards



0

1

2

3

4

5

6

7

8

9

10

10/1/2012 10/1/2013 10/1/2014 10/1/2015 10/1/2016

$/MMBT

U

Maturity Date

NYMEX NG Forward Curve and Options‐Derived Ranges(October 26th, 2012)

Forwards




Correlation of historical returns varies widely and is unstable in most (but not all) cases

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‐100%

‐80%

‐60%

‐40%

‐20%

0%

20%

40%

60%

80%

100%

Correlation of Rolling 12‐Month ReturnsNBP/Brent

‐100%

‐80%

‐60%

‐40%

‐20%

0%

20%

40%

60%

80%

100%

Correlation of Rolling 12‐Month ReturnsNBP/HH

‐100%

‐80%

‐60%

‐40%

‐20%

0%

20%

40%

60%

80%

100%

Correlation of Rolling 12‐Month ReturnsHH/NGX


Summary Observations on Trading Markets

Price uncertainty as reflected by the trading markets is significantly greater than standard industry forecasts admit

Ranges observed in price histories are consistent with the traded range of uncertainty and refute the usefulness of purely deterministic price forecasts

Understanding market structure at a deeper level remains an essential

Correlation of historical returns is unstable and questionable as a predictive tool

Understanding of linkages among liquid trading points and linkages of liquid to illiquid trading points is needed to get a complete picture

13


Agenda




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Several North American LNG export projects have been proposed (Primarily Focused on Future Shale Gas)

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Sabine Pass LNGCheniere18 MTPA

KitimatEncana, Apache, EOG Resources

11 MTPA

CameronSempra Energy

12 MTPA

Cove PointDominion Cove

Point LNG5 MTPA

Freeport LNGFreeport LNG

12 MTPA

Progress LNGPetronas & Progress

8 MTPA

Shell CanadaPetroChina/Shell/K

ogas/Mitsubishi8 MTPA

LNG Export Project Name

Sponsor(s)Est. Size

Proposed Export Project

Jordan CoveVeresen6 MTPA

Lake CharlesSouthern Union,

BG LNG15 MTPA

Oregon LNGLNG Development Co.

9.6 MTPA

BC LNG ExportDouglas Channel

Energy Partnership1.8 MTPA

BG LNG

Corpus ChristiCheniere

13.5 MTPA

North Slope Gas?

Lavaca Bay LNGExcelerate3 MTPA

Elba IslandSouthern LNG

4 MTPA


North American export/import capacity additions has implications for linkage to broader world gas markets

Significant narrowing of the NBP/HH spread requires an increase in demand (or decrease of supply) sufficient to re-establish localized consumption of essentially all US shale gas production

Several scenarios (or aspects of scenarios) to consider:

High North American demand growth and full-cycle marginal cost of new natural gas too high to sustain ex ante profitability of North American LNG export projects

Full-cycle marginal cost of new natural gas decreasing with improving technology, resource base exceeding current estimates,North American LNG export projects built and remain online down to marginal operating cost

Significant shale gas development in other parts of the world (e.g. Argentina, China, Poland) and world gas prices – NBP, HH, and Asian delivery points are decoupled from crude and converging to a lower price level

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Recent Work Presented by Dale Nesbitt in Washington Regarding North American Demand

Gas burn for power generation accelerates substantially

Coal retirements drive it

New builds are gas-fired CC and CT

There are 23 quadrillion Btu of coal burned in the US today --equivalent to 18 TCF/yr. of natural gas at the estimated heat rate differential

If 25% of the coal fleet switched over, we would see about 5 TCF/yr. of additional gas consumption for power generation -- almost a doubling of that sector

At the margin, this would keep more domestic gas production at home, and possibly diminish impetus for LNG exports from the US

All other things being equal, Henry Hub gas price rises in this scenario

But not clear if the demand effect is big enough or happens soon enough to lead to export project cancellations

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What about the supply side?

Possible that the long-run supply curve in North America will turn out to be lower and flatter than initially thought

If supply is large enough demand growth may not matter much

Once export projects are built, they will operate down to marginal operating cost and gas exports could continue even as the NBP/HHspread narrows

Significant shale gas potential has been identified outside of North America

Greater impediments to development and a longer cycle outside ofNorth America, but the economics are compelling – and more so as the technology advances

Impact would be lower natural gas prices worldwide, not just in North America – a scenario in which the NBP/HH spread narrows aside from considerations of increasing North American demand

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Probabilistic assessment of supply using methods the USGS has used for oil would be informative

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World Petroleum Assessment 2012

Source: USGS


Resource-Cost analysis w/technological uncertainty

Monte Carlo Simulation (Geology, Exploration, Development, Production, & Transport)

Source: USGS


Arctic Resource–Cost Curves for Oil: Confirms that uncertainty on the supply side is significant

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Source: USGS


YTF Sub-Saharan Conventional Gas (USGS)

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Summary Conclusions

Uncertainty is and will remain high

Trading market views and more comprehensive fundamental market analysis appear to agree that this is the reality

High uncertainty remains around drivers of supply and demand

Supply: shale gas resources exist on every continent and reasonable to expect that long run full-cycle marginal cost will be about the same across the producing basins of the world

Demand: increased demand for natural gas as coal and nuclear power generation is retired and replaced by gas-fired generation

Advancing technology will affect both supply and demand

Some seemingly reasonable trends to watch

World natural gas prices set by traded gas indexes rather than linked to oil, continuing the decoupling of gas and oil prices

Narrowing of NBP/HH/Asian natural gas price spreads

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Acknowledgements

Dr. Mazen SkafStrategic Decisions Group

Dr. Dale NesbittDeloitte MarketPoint

Dr. Don GautierUSGS

Dr. Ben SchlesingerBenjamin Schlesinger and Associates

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