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Industry Cautioned About Shale 'Euphoria'

While the opportunities associated with shale gas are "quite great," an executive with a leading global investment firm Thursday cautioned industry about the "current euphoria around shale," saying it could be "wrong-minded" if the challenges are not considered.

"It does seem today like we are flying in the shale sector. But that may only feel that way until the gravitational pull of reality -- the technological challenges, the capital challenges...begin to pull us all," said Marc S. Lipschultz, global head of energy and infrastructure for Kohlberg Kravis Roberts & Co. (KKR), at an energy conference sponsored by Deloitte LLP in Washington, DC.

But Gary Adams, vice chairman and leader of Deloitte's oil and gas practice, believes the euphoria over shale gas is justified. He said it's "one of the largest assets that the U.S. has ever discovered" and called it a "national treasure." He urged regulators "not to squelch" this opportunity.

In addition to the capital and technological challenges, Lipschultz said "public affairs concerns...are absolutely confronting this industry," particularly with respect to the environmental and public health risks linked to hydraulic fracturing (fracking). While environmentalists and even the press have "fanned [the] concerns" of fracking, he said that fracking has been done safely more than a million times in the U.S.

Once the challenges are met, Lipschultz believes the shale wave will have the "ability and opportunity to deliver a potential energy revolution and generate a great deal of profits for businesses."

He said the capital requirements to develop shale resources will be great. Lipschultz cited a study that found the development of six large shale resources in the United States will require more than $1 trillion in capital. "That's a lot of capital," he said, more than the entire market capitalization of the domestic oil and gas companies: $750 billion.

A lot of companies are "long [on] assets" but "short [on] capital," Lipschultz said. KKR tackles the capital shortfall by partnering with companies or investing in companies itself. "At the end of the day, we can deliver a lot of capital" and "put together the right kinds of strategic partnerships."

KKR is a player in the shale industry. In April KKR Natural Resources, a partnership of an affiliate of KKR and Premier Natural Resources, agreed to acquire certain Barnett Shale properties from Carrizo Oil & Gas Inc. for $104 million. The transaction with Carrizo Oil & Gas is expected to close this month.

The "most important near-term center of demand" for shale gas will be power generation, said Lipschultz. But he believes the real demand -- for those who want to "think big" -- will come in the transportation sector.

"I think the opportunity for export [of shale gas] is tremendous," Lipschultz said. Western Canada is advancing on it more quickly than the U.S., but "market forces dictate the U.S. will get there eventually," he said.

Current natural gas prices, which are averaging $4/Mcf, are expected to increase 50% by 2020, according to the initial results of a study released by New York City-based consulting firm Deloitte Thursday. The final results of the study -- Navigating a Fractured Future: North American Natural Gas Market Scenarios and Considerations for Strategic Planning -- are due in July.

"One of the most significant [findings] is that, despite burgeoning U.S. demand for gas-fired power generation...natural gas prices do not rebound to levels seen several years ago...Current prices and even widely anticipated future prices will likely be insufficient to incentivize the production necessary to meet the expected future demand increase," the initial findings said.

As a result Deloitte's Adams said companies that focus entirely on natural gas will have to operate "lean and mean," or there will be a wave of mergers.

"Perhaps more significant than the potential [projected 50%] price growth is the possibility that basis differentials will diverge from historical relationships as new supply basins grow in prominence, and prices will grow at different rates, altering pipeline flows and capacity values. The transformation will be most evident in the eastern U.S. where increased production from the Marcellus Shale could displace supplies from the Gulf and other regions and even reverse some regional pipeline flows. In contrast, the West will potentially be characterized by tight supplies due to an absence of significant shale gas resources.

"As a result, prices could escalate rapidly, leaving California with some of the highest prices in North America. Clearly, these potential basis shifts could have strong implications for the direction of flow and value of pipeline capacity," Deloitte said.

With the current growth in domestic supplies, "many industry participants are examining whether they should invest in liquefaction facilities to export LNG [liquefied natural gas] from North America. While exporting LNG might be profitable in this decade, [the Deloitte] report suggests it will be far less profitable after that. LNG production from other countries, many with reserves much closer to Asian and European LNG markets, is expected to expand over the next two decades. These countries also have abundant reserves, but are further supported by lower production costs and new international pipelines that allow increased access to abundant supply regions," Deloitte said.

The "changing global market dynamics also have implications for U.S. LNG importers as well, some of whom may fear that the rise of domestic shale gas production will subject U.S. terminals to low utilization levels. However, if worldwide LNG production doubles within a decade, LNG import terminals in the U.S. will eventually attract increased volumes. However, based on our analysis and the assumptions used in the scenarios, Gulf terminals are unlikely to operate at full capacity during the next two decades."

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