Lessons from the Natural Gas Market

U.S. Natural Gas Development – How Are We Doing? MIT, Deep Horizon, and GaslandOn June 25, a team at the Massachusetts Institute of Technology released an interim report entitled “The Future of Natural Gas,” the result of a two-year, interdisciplinary examination of the natural gas industry in considerable depth. This 104-page report is just a first step, with a much larger final report scheduled for release this autumn. The report is the third in a series of in-depth energy analyses undertaken at MIT, the first two having addressed nuclear power and coal. The report provides a great focal point for examining where this industry stands now, to what extent its considerable promise is coming to fruition, and what the impediments to that promise might be.

It is not necessary here to try to paraphrase everything in the report. Even its execu-tive summary is a good bit longer than the typical Lessons from the Market piece. The full interim study may be viewed and downloaded at http://web.mit.edu/mitei/research/studies/naturalgas.html. However, there are a couple of fundamental find-ings that should be highlighted.

First, the study fully confirms the natural gas resource abundance, both North Amer-ican and global, that has become increas-ingly apparent since the end of 2007. The global numbers are even more impressive than the oft-touted 100 years of domestic supply. Recoverable global gas resources are estimated to be as much as 16,000 trillion cubic feet, which exceeds 150 years of world natural gas consumption. This abundance is largely based in unconventional resources, especially shale that requires some degree of hydraulic fracturing.

Which brings us to the study’s second important observation – a pretty obvious one: for development to proceed quickly, the industry and its critics need to come to some kind of common understanding around the environmental impact of new develop-ment. The study calls these issues “manageable but challenging.”

The study explores in depth the significant carbon advantage that natural gas enjoys over other fossil fuels, and predicts that in a carbon-constrained world, natural gas consumption will grow a great deal – especially in power-generation applications – up to the point that legal carbon constraints would become so severe that even natural gas would need some form of carbon capture to be acceptable. (An observa-tion here is that the likelihood of this extreme regulatory case looks somewhat remote as the struggle continues for passage of the first step). The study also recognizes

A publication by Navigant Consulting’s Energy Practice » July 2010

Contents1 Lessonsfromthe

NaturalGasMarket–U.S. Natural Gas Development – How Are We Doing? MIT, Deep Horizon, and Gasland

4 NaturalGasMarketCharts

7 LegislativeandRegulatoryHighlights

10 AboutNavigantConsulting

MIT calls the environmental impact of shale gas development “manageable but challenging”

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that the use of natural gas to back up intermittent renewable resources such as wind might lead to a lot of new gas-fired facilities without much increase in near-term consumption – if price relationships stay where they have been in the past.

An interesting aspect of the study is its treatment of liquefied natural gas. As would be expected, the business-as-usual case shows surging domes-tic production at prices far below oil equivalence, causing the United States simply to be an unattractive market for world LNG. This unat-tractiveness was amply demonstrated recently when the Energy Minister of Qatar told the Middle East Economic Survey that his country planned to divert over 75 percent of its exports planned for the U.S. to markets in China, Poland, and India. Those countries are apparently still pay-ing oil-based prices, which run about three times the U.S. gas price.

However, the MIT study examines another scenario for LNG. What might happen if, as the world’s LNG export, import, and shipping in-frastructure matures, LNG pricing departs from its current bifurcated structure, wherein some Asian and European markets pay oil-based pric-es while markets such as the United States pay gas-based prices, to a pric-ing structure more like the oil indus-try’s, which is uniform worldwide except for differences in transporta-tion cost? In this scenario, the study predicts that the United States would attract very large volumes of LNG, not necessarily at the expense of the domestic producing industry. Instead

of simply displacing domestic sup-ply, the study predicts, the combined abundance of LNG and domestic gas would act to gain new markets for natural gas, expanding the over-all contribution of this resource to the nation’s economy and air qual-ity. Without a thorough review of the study, it is hard to say how likely this change in the global LNG structure is, but it is certainly an attractive view of the future.

Well, that’s all the good news. A re-ally thorough, well-staffed team of experts has confirmed the contribu-tion that natural gas might be able to make to the nation and the world, if it can be developed. But then we come to the pair of elephants in the living room, one real and one questionable: the Gulf disaster with the resultant loss of industry credibility, and the re-cent release of the film Gasland.

The tragic ongoing saga of Deepwater Horizon happens against an indus-try history that has seen about 35,000 offshore wells successfully drilled, 2,200 of which have been in deep water (thanks to John Hofmeister, former president of Shell Oil, for that statistic). This is objective proof that it only takes one. The Administration reaction – shutting down deep water drilling and making permits for shal-low water drilling much more diffi-cult to get – has already caused some major drilling operations to leave the United States. What could be the

impact of this on the natural gas in-dustry? It is probably much less seri-ous than in the domestic oil industry (and, of course its impact on the al-ready ravaged Gulf Coast economy). In the natural gas industry, offshore production had already been over-taken by growth onshore, to the point that the temporary loss of about 80 percent of offshore in the 2008 hurri-canes had no appreciable effect on the market, since we were no longer criti-cally reliant on offshore production.

So even though new offshore devel-opment of gas will suffer right along with oil, the ability to supply the na-tion from onshore gas is especially good news. There is also a really fun-damental difference between drill-ing a well from a pad on which you are standing, as opposed to drilling a well at the bottom of the ocean, at depths where even a nuclear subma-rine cannot go. This difference was very apparent when one independent producer experienced a well blowout in the Marcellus shale in early June, but had it fully contained and over with in less than a day.

Onshore drilling is a completely different operation from offshore. However, expecting the public or the media to appreciate the distinction is pretty naïve. Meanwhile, the other obvious fallout from the Gulf disaster is a broad loss of credibility for the oil and gas production industry among those who do not know the indus-try – such as landowners in areas that have no experience with natu-ral gas development. That credibility has to be restored one company and one project at a time, often by dem-

there is a pair of elephants in the living room, one real and one questionable

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onstrating the success achieved in the many areas that have experienced widespread natural gas development.

Then along comes Gasland. This film, styled as a documentary wherein the film maker traveled across the coun-try to learn the “truth” of natural gas development, showed up at the Sundance Film Festival a while back, then – in the furor around Deepwa-ter Horizon – finally found a home at HBO. The film is a focused, relentless attack on the industry, alleging un-bridled environmental abuse, water pollution, and lack of regulation.

Needless to say, (a) the film maker is very popular on NPR’s Fresh Air and Comedy Central’s Daily Show with Jon Stewart, and (b) the industry has strongly criticized the accuracy of his film. An industry website, Energy in Depth, posted a point-by-point refuta-tion of the factual allegations in the film (http://www.energyindepth.org/2010/06/debunking-gasland/). Naturally, the film maker and his supporters voiced skepticism as to anything the industry might say in rebuttal. Why? Well, because it’s “the Industry,” of course. In an interview, the film maker was asked point-blank about the industry’s claim that he had massive numbers of inaccuracies in his film. He answered, “The facts speak for themselves. Look it up.”

Based on a cursory review of the references from Energy in Depth, the film maker has a strong expecta-tion that no one actually will “look it up.” Without going into all of the detail of the Energy in Depth rebut-tal, it is worth noting the most dra-matic piece, the one that is shown over and over in the trailer, is a guy setting his kitchen sink water on fire in Colorado. There is no question this is impressive, adding to a whole new definition of carbonated wa-ter and ideally getting everyone to quit smoking. But the allegation that methane in the water supply came from natural gas development has been investigated multiple times by the Colorado Oil and Gas Conserva-tion Commission, which found a cou-ple of years ago that the methane was naturally occurring, not the result of drilling. Naturally occurring methane has been a fact of life in many areas of the country for as long as water wells were drilled—in fact, in some regions, shallow gas drilling has actu-ally reduced the problem by pulling the methane out of the ground and thus reducing the levels pushing on the water.

The Energy in Depth rebuttal does not have to be taken at face value with-out any questions – it does have a particular pro-industry point of view, but it also has numerous detailed references that do allow one to “look it up.” The bottom line is that the film is indeed extremely slanted and misleading, and not at all helpful in that it acts to polarize a debate that was already ongoing – the continued development and improvement of

best practices to support respon-sible growth in this critical national resource. In particular, the storage, handling, and treatment of produced water, the hydraulic fracturing water that comes back out of the well, is a very important issue getting a lot of attention, and one where innovation in water-treatment technology can ultimately make a huge difference.

The industry has known very well that water supply, handling, and dis-posal issues are critical to the contin-ued development of shale, and so far, across the industry and the environ-mental community, there has been a strong, collaborative approach cen-tered around the notion that the na-tion can gain a great deal of benefit in terms of air quality, carbon emissions, and national security if we can main-tain a healthy pace of development of our vast natural gas resource. For the promise articulated in the MIT study to play out, this collaborative approach has to continue. It would be good for the name-calling to stop, for the actual, balanced facts to be out in public, and for the national ben-efits of shale development recognized last year by President Obama in his climate-change agreement with China to be fully weighed in on the positive side of the scale.

—Rick Smead

The opinions expressed in this article are those of the authors and do not necessarily represent the views of Navigant Consulting, Inc.

AbouttheAuthor»RickSmeadisaDirectorinNavigantConsulting’sEnergyPractice.

so far, across the industry and the environmental community, there has been a strong, collaborative approach

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Natural Gas Market Charts

MONTHLY GAS INDEX PRICE

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A E C O-C S o C a l Ga s H e n ry H u b S o urc es : NCI/G as D aily

MonthlyspotpricesshowedlittlechangeforJune,buthavecomeupasweapproachJuly.Storageinjectionshavebeguntolagprioryearsduetoverywarmtemperatures,whichareforecasttocon-tinuethroughSeptember.

NYMEX FUTURES SETTLEMENT PRICES AT CLOSE

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DailyindexesreflecttheupwardtrendofpricesintoJuly.

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Natural Gas Market Charts

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Natural Gas Market Charts

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U.S.drygasproductionremainsstrongfor2010,althoughshowingasmallrecentdecline.

U.S. TEMPERATURE OUTLOOK

July,August,andSeptemberareexpectedtobewarmerthannor-malintheGreatBasin,thedesertSouthwest,Texas,theSoutheast,andtheEasternSeaboard,whichmaycausestorageinjectionstofallshortofprioryearrates.

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Legislative and Regulatory Highlights

California

Sacramento Natural Gas Storage EIR ReleasedA.07-04-013

On June 11, the California Public Utilities Commission released its Environmental Impact Report on the Sacra-mento Natural Gas Storage project, which is to be located in the City of Sacramento. The EIR covers all aspects of the project including biological, noise, health, hazardous materials, and community consistency issues. The report was prepared by Dudek, an environmental and engineer-ing firm.

Seventy-nine different areas were reviewed, and the proj-ect was found to conform to standards in all but night-time construction noise and the potential for gas migra-tion into fresh water aquifers. It is expected that these remaining issues will be found to be of limited signifi-cance and as a result will be overridden.

The project will likely have a brief hearing on the subject of alternatives after which it will proceed to a proposed Final Decision the end of the summer.

The full EIR can be viewed at http://www.cpuc.ca.gov/environment/info/dudek/sngs/SNGS_Final_EIR.htm

Pacific Northwest

Complaints About Oregon LNG DismissedCP09-6-000 and CP09-7-000

FERC found that landowner complaints of illegal ac-tions by Oregon LNG were unfounded. Oregon LNG had been accused of trespassing, unauthorized rerouting of the pipeline, and invasion of landowner privacy, among other charges.

Oregon LNG’s application to construct the regas plant at Warrenton and the associated pipeline to Molalla remain under consideration at FERC.

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National Energy Board

Invitation Issued to Participate in Public Review of Arctic Safety and Environmental Offshore Drilling RequirementsFile OF-EP-Gen-AODR 01

On June 10, 2010 the NEB issued a letter inviting public participation in the indicated review under the Canada Oil and Gas Operations Act in compliance with the Canada Oil and Gas Drilling and Production Regulations. The letter also outlined the scope of the review. The results will be incor-porated in the examination of future applications for off-shore drilling in the Arctic. Those who wish to participate in the review are invited to register by July 16, 2010.

The review will address how best to drill safely while pro-tecting the environment, including: the hazards and risks; the effectiveness of measures employed to prevent and mitigate such risks; the existing state of knowledge on the Arctic offshore including the physical environment, bio-logical environment and geosciences; and the effectiveness of available well control methods. It will also examine appropriate responses when things go wrong including: the state of preparedness to respond to drilling accidents and malfunctions in Canada’s Arctic offshore; options for

regaining well control; the effectiveness of available spill containment and clean up options; financing spill clean-up, restoration and compensation for loss or damage; and the state of knowledge of long-term impacts of oil spills on the environment, way of life, and communities in the Arctic. Finally, the review will look at lessons learned from major drilling accidents around the world.

Alberta

ATCO Gas Natural Gas System Settlement Code RevisionDecision 2010-260; Application No. 1605983

On June 8, 2010 the Alberta Utilities Commission (AUC) is-sued a decision approving the application filed on March 12, 2010 by ATCO Gas, a division of ATCO Gas and Pipe-lines Ltd., requesting approval of revisions to the ATCO Gas Natural Gas System Settlement Code (NGSSC) in order to reflect changes that the AUC made to the electric system settlement code (AUC Rule 021) in November 2009. The NGSSC documents standards for determining and communicating load settlement procedures between ATCO Gas, as a gas distribution company, and gas retailers and default supply providers in the company’s service territory.

In its decision, the AUC noted that considerable duplica-tion of effort was involved in the process to revise Rule 021 and the ATCO Gas NGSSC. For this reason, the Com-mission indicated that it will initiate a consultation pro-

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cess on the development of a generic AUC Rule pertain-ing to natural gas settlement system codes with a view to harmonization of changes to Rule 021 and the ATCO Gas NGSSC in the future.

Alberta Reserves and Supply/Demand Outlook UpdateERCB Publication ST98-2010: Alberta’s Energy Reserves 2009 and Supply/Demand Outlook 2010-2019

This annual report by the Energy Resources Conservation Board (ERCB) was released on June 5, 2010. It is available online at http://www.ercb.ca/docs/products/STs/st98_ current.pdf. Highlights of interest in relation to Alberta natural gas reserves and the updated supply/demand outlook in this year’s report include:

» Remaining established reserves of coalbed methane in Alberta as of December 31, 2009 were estimated at 2.3 trillion cubic feet. This is 2.3 times greater than the December 2008 estimate. The sharp increase is due to a re-evaluation of gas content and recovery factors. Production of CBM during 2009 totaled about 229 billion cubic feet, slightly more than in 2008.

» The description of Alberta’s shale gas resource has been expanded in this year’s report, but reserves have not been estimated. Shale gas produced 2.8 Bcf of gas from 250 well connections in 2009.

» As of December 31, 2009, the estimate of established reserves of conventional marketable natural gas in Alberta stood at 36.4 Tcf, a decrease of 1.4 Tcf since

December 2008. The sizeable drop is the consequence of gas reserve additions being insufficient to fully replace 2009 conventional natural gas production of 4.0 Tcf.

» Conventional natural gas production in Alberta has been declining since 2001. Since 2006, the drop has accelerated due to declines in productivity and fewer new connections. Production declined a further nine percent during 2009.

» Based on its remaining established and yet-to-be-established reserves estimates and on the assumptions explained in the report pertaining to the price of natural gas, the number of new gas well connections, initial productivity rates from new wells, and decline rates, the ERCB is forecasting conventional gas production to fall from 4.0 Tcf in 2009 to only 2.1 Tcf in 2019. These volumes are substantially lower than previous estimates as a result of lower expectations for new conventional gas connections.

» If conventional natural gas production rates follow the latest ERCB projection, Alberta will have recovered 77 percent its ultimate gas supply potential by 2019.

» In 2009, Alberta domestic gas demand of 1.6 Tcf constituted 36 percent of total Alberta natural gas production. By the end of the forecast period, Alberta demand is projected to reach 1.9 Tcf or 71 percent of total production. This increase is seen to come from increased gas demand for electric power generation and from continued strong growth in gas requirements for oil sands bitumen production and upgrading.

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Fuels PracticeGordon Pickering, Director 916.631.3249 gpickering@navigantconsulting.com 3100ZinfandelDriveSuite600Sacramento,CA95670

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