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State of the Industry, GasMart 2008

North American drilling, production, costs and prices are trending up as shale gas takes center stage. Forget liquefied natural gas (LNG) in the near term and maybe longer; and be glad you're not tied to the world oil market. For the future, think Alaska. And for gas users: conserve, hedge, plan, stick to your strategy and keep good records.

It's all about the exploding demand and prices for energy, and for all natural resources around the globe. "Natural gas prices are 50% higher at the Henry Hub today than they were when we met at GasMart 2007. That is what has spurred the industry into higher cost discovery ventures; they're drilling all over the continent. This resurgence of North American natural gas is what is partially protecting us from the even higher price of global natural gas, which is tracking the oil price into orbit around the world," said Ellen Beswick, publisher and founder of Intelligence Press Inc., which has hosted GasMart for 22 years.

The GasMart 2008 program "draws on the talents of the hands-on experts in the natural gas business, who are going to be laying out the situation for natural gas, doing their best to project into the future and helping all of us plan and strategize for that future," Beswick said.

"Gas drilling has more than doubled" in North America in the past seven years, with 31 Tcf of gas reserves added, Will Hussey, senior vice president of origination for ConocoPhillips Gas & Power, told the GasMart 2008 audience meeting in Chicago. But that's not the whole story. "When you look at shale, you don't look at it in the same way as conventional gas. There's a lot of shale gas out there, but you can't book the reserves until it's producing. So that [reserves] number is probably understated...A year ago I said that the United States was on the decline, but I am happy to say that people proved me wrong." Hussey said, displaying a map of the U.S. with 20 different developing shale gas areas.

In the Western Canadian Sedimentary Basin "drilling is picking up again," said David Slater, managing director of Nexen Marketing U.S.A. Inc. Spurred by the success in unconventional plays in the United States and driven by higher prices, Nexen and others have staked out their own shale gas find in the Horn River Basin in northern British Columbia. Slater also has hopes that Canadian development of coalbed methane will revive in response to higher prices.

Costs to develop these more difficult plays can average $6-7/MMBtu, so it's not your old natural gas market, Hussey said. The costs of steel, rigs, engineering, labor and equipment all have gone up since 2000, some of them by as much as three and a half times.

Huge Competition For LNG To Continue

But it's better than the $15-25/MMBtu contracts for LNG delivered in Asia, where contracts are usually tied to the price of oil, said Kathleen Eisbrenner, Shell Gas and Power International executive vice president for global LNG.

If anything, the competition for LNG could get worse. "Many countries are now planning to import LNG for the very first time. Countries as diverse as Brazil, Chile, Germany and Singapore, just to name a few," she said. "China has entered the global LNG market in a big way, moving quickly from acquiring its first spot cargo in 2006 to signing up for several large long-term contracts in 2007 and into 2008."

Currently there are 17 LNG importing countries and 15 exporters. By 2012 there are expected to be 29 importing countries around the world and 18 exporters. Eisbrenner noted that peak winter demand in Brazil, Argentina, Uruguay and Chile, for instance, would be competing for LNG that might otherwise find its way into U.S. storage during the North American summer.

So back in North America, it's not just developing indigenous resources, it's storing them and getting them to market. Porter Bennett, president of Bentek Energy, described it as "replumbing" the natural gas industry to better connect new production with demand centers. Using the vantage point of his firm's data gathering and analysis, Bennett stressed that production is growing dramatically -- a 4 Bcf/d increase in one year at the beginning of this year when it hit 60 Bcf.

"The story isn't how much gas is being produced, but where it is being produced," Bennett said. A lot of the growth today comes from producing areas that didn't exist 10 years ago, and he noted the large number of pipeline and storage projects under way. And while the connections are being made there are likely to be continuing price disconnects.

Abundant New Pipe Projects

Robust domestic gas demand from population centers to the east and west of the fast-growing Rockies production area has sparked a number of pipeline proposals in addition to the new Rockies Express Pipeline (REX) led by Kinder Morgan with partners ConocoPhillips and Sempra. Chicago is a natural draw for the added Rockies supplies, according to John Eagleton, Kinder Morgan Energy Partners vice president for business development, who discussed Kinder Morgan's latest "bullet" pipeline proposal.

"Once completed, the Chicago Express/NGPL pipeline project will have the capability of delivering 1.2 Bcf/d directly into the Chicago market," Eagleton said. "Why Chicago? After we had a number of discussions with our shippers, they identified Chicago as being a very liquid, very attractive market" with declining Canadian supplies, average daily demand of nearly 4 Bcf, peak-day demand of 10 Bcf and 500 Bcf of storage. To the Northeast two other expansions of REX are being contemplated in the same 2010-11 time frame as the Chicago Express, Eagleton said.

Among the other pipe projects out of the Rockies are the Pathfinder and Bison pipeline proposals going to the northeast, put forth by TransCanada and its subsidiaries. Ultimately, the lines will feed into TransCanada's Great Lakes Gas Transmission and its Canadian mainline. Gas production across the spectrum of Rockies sub-basins shows a rising curve through 2020, said Dean Ferguson, vice president of marketing for TransCanada's U.S. Pipeline Central unit.

Also high on the list of pipeline prospects for TransCanada are the emerging shales -- a list that just keeps growing and growing and growing. Even fairly "new" maps of North America's shale gas resources detailing the Barnett, Woodford, Fayetteville, New Albany, Marcellus, Montney, Horn River and others are outdated from a year ago because of the continuing success by producers in other basins, Ferguson said.

The Calgary-based company also has its hand in southern pipeline projects to help carry gas from the Barnett and Fayetteville areas, along with the growing output from East Texas and along the Gulf Coast.

Meanwhile, Al Musur, director of global energy management for the Abbott pharmaceuticals company, questioned federal policy that restricts access to oil and gas drilling off the East and West Coasts. "There are so many rules about what you can't do with natural gas it's insane," he said.

Further, the policy of promoting the use of corn-based ethanol is driving up the cost of natural gas and of food. "Even cavemen knew that it is a bad idea to burn your food for fuel," Musur said.

'Hope Is Not A Strategy'

Veteran energy marketer Val Trinkley, general manager of EnergyUSA, told the 500 GasMart attendees, including more than 200 buyers, that whatever the approach or "philosophy" they adopted for buying gas, stick to it. That goes for both aggressive and conservative buyers. Those buyers can be sure that volatility and demand in the gas markets are going to stay high, and the hedge funds -- like it or not -- are going to add to the volatility, he said.

Trinkley advocates an elaborate, disciplined and broadly communicated approach to buying that ties it from the organization's bottom line to the external players such as producers and local distribution utilities. Warning that second-guessing within organizations is always rampant, Trinkley encouraged everyone to keep close track of what they do, why they do it and when they did it.

"Hope is not a strategy," Trinkley said. "We might hope for $7-8 gas, but reality shows we are going to be paying $9-10." He emphasized that the market has changed dramatically just in the last year when it is considered that 12 months ago oil was selling for $62/bbl and now it's more than $130/bbl.

"One thing that I have learned over my career is you have to focus on the entire pricing equation of natural gas," said Integrys Energy Services' James Stewart, director of energy consulting. He recommended a comprehensive program approach, advising middlemen to consider natural gas cost components -- Nymex commodities (80%), transportation from producing region to citygate (10%) and utility distribution and fixed fees (10%) -- as well as a series of inputs, including facility characteristics, budgets and utility tariffs to help manage energy dollars.

As for industrial natural gas users, "let's face it; it's all about the hedge. If you don't have risk characterized correctly, you don't have proper procedures in place, if you don't get that hedge on, all is lost. You can't make it up on little incremental savings on your pipeline transportation contracts, your balancing contracts. It's all about the hedge," said Guy Ausmus, ArcelorMittal USA Inc.'s manager of base metals and energy. Also, a successful program that encourages conservation and efficiency can pay lasting dividends to an industrial consumer, particularly if natural gas prices remain high, as Ausmus expects. "My market view is this thing still has legs. I think it's young and we've got a long way [for prices] to go."

Noting the rising prices of his own products, Ausmus said, "Cheaper always makes me look better to my boss, but on a spread basis we're OK."

Craig Jimenez, president of Oklahoma City-based OGE Energy Resources Inc., said a variety of marketers serving the industry and its customers will be a key part of how the new gas infrastructure is utilized, providing what he called a "sustainable business" that combines transportation/storage services with a strong balance sheet and "fair dealing." Infrastructure development, such as Kinder Morgan's projects, depend on long-term shipping commitments, and the marketers help make that happen, said Jimenez, whose firm is a regional marketer.

"A subset of the marketing community -- our company among them -- is willing to step up and make financial commitments for long-term capacity," Jimenez said. "Increasingly we're willing to take a risk on capacity. Ultimately, this helps reduce the net cost of transportation. So one area where marketers make a difference for the ultimate end-users is in supporting the building of new infrastructure. The other side is offering a variety of financial structures for selling the gas."

Wachovia's Janelle Scheuer, director of commodity derivatives, said that when choosing an energy supplier or marketer to help manage risk, "you want to make sure that your counterparty is going to be there for you, they have strong credit strength, they're going to be customer-focused -- that everything that they can do to make you look smart in front of your boss is going to be happening."

Alex Strawn, energy purchasing manager for Procter & Gamble, speaking on behalf of the Process Gas Consumers Group, noted the big jump in natural gas prices. "We've never seen price gaps this large year to year," Strawn said, urging efforts by the middle men, pipelines and marketers, to continue to be relevant and dynamic business partners to industrial end-users -- given an almost unpredictable and fluid market environment."

BP Investing In North America

The robust development of the North American market is occurring as global commodity costs are going up across the board, Brian Frank, president of BP Energy Co., North America Gas & Power told the GasMart audience. "We are in a period of unprecedented commodity values with crude trading over $130/bbl and June natural gas trading [above $11.00]. We are seeing all commodities -- not just energy commodities -- at record levels. It doesn't matter whether it is agricultural products, steel products, cement or lumber. All commodities are at levels that are unprecedented...probably levels that none of us predicted four or five years ago."

BP over the last five years in the United States has made about $35 billion. "As you probably know, oil company profits are the subject of quite a bit of political discussion these days. What they don't talk about is that over the last five years we have invested $35 billion in the United States in supply and infrastructure," he said. "There is an enormous amount of investment that needs to be made."

The expanding world economy is demanding more and more energy, and where is it coming from? Hussey displayed a chart showing that in the 1960s independent oil companies (not controlled by a country) had access to 85% of the world's oil and gas reserves. Today they have full access only to 7%, while national oil companies dominate their own territories, the ConocoPhillips executive said.

"As for producers, is it time to sit back and wait for prices to settle down or keep marching? We see them continuing to march," he said. "We have a lot of confidence there. That's why people are coming into the United States, why they spend here, even with costs so high."

And that's why there is a natural gas pipeline from Alaska to the Lower 48 in North America's future. BP's Frank pointed out that Alaska gas is "baseload supply" while LNG terminal construction is a gamble because of the uncertainty of receiving cargoes in a competitive global market. "We are working to bring Alaska gas supplies to the North American market," he said, noting that in early April BP partnered with ConocoPhillips to move the Alaska gas pipeline project forward. "With Alaska gas, we've always said [it will be operating] 10 years from when we say 'go.' We said 'go' about a month ago, so that is probably the best case scenario," even though the project has "a lot of challenges and a lot of risks."

This report will be continued next year at GasMart 2009 in Chicago (watch gasmart.com for dates).

©Copyright 2008 Intelligence Press Inc. All rights reserved. The preceding news report may not be republished or redistributed, in whole or in part, in any form, without prior written consent of Intelligence Press, Inc.

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