Gas Price Risk for the State of Alaska in the North American Gas Market Edward M' Kelly Vice Preside

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Gas Price Risk for the State of Alaska in the
North American Gas MarketEdward M. KellyVice
President, North American Natural Gas and
PowerWood Mackenzie, for The State of Alaska
Joint Legislative Hearing on Gas Pipeline
IssuesSeptember 1, 2004
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Agenda

• Introduction
• Oil Supplies - OPEC and the Spare Capacity Build
  
• Domestic Natural Gas Supply - Running Fast,
  Falling Behind
• LNG - A Slow and Partial Solution to the Gas
  Problem
• Implications for Demand and Price
• The Long Term Dynamic
• Strategic Implications Conclusions
• Discussion, QA

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OPEC Production Capacity - Tight Now, but Set to
Grow
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Wood Mackenzies WTI Oil Price Outlook The
Market Slowly Stabilizes, but Politics Still Rules

• Nominal 2004
• 2003 31.01 31.63
• 2004 39.96 39.96
• 2005 35.75 35.05
• 2006 28.00 26.91
• 2007 28.00 26.39
• 2008 28.00 25.87
• 2009 28.00 25.36
• 2010 28.00 24.86

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North American Supply The Worst Fears are
Unfounded

• US Supply rebound in 2004 and 2005 driven by
  Deepwater and Rocky Mountains increases
• Maintaining US supply becomes a challenge as
  Deepwater supplies decline from 2006

• US support from higher cost unconventional
  supplies
• Continued technology improvement crucial to
  realizing potential

US Unconventional Supplies
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United States Supply (excl. Alaska)

• In the US, an overall flat supply profile through
  2010 masks significant regional change
• Gulf of Mexico, Gulf Coast and Mid-Continent all
  exhibit marked production decline...
• but offset by strong growth from the Rocky
  Mountains

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US Unconventional - The New Conventional

• In the US, the threat posed by declining
  Production from mature basins is partially offset
  by increasing, higher-cost unconventional
  supplies
• Gas production from tight sands and coalbeds
  shows strong growth

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Rocky Mountains - Key to US Supply Support

• Focus area for many companies for a variety of
  reasons
• Highest production growth potential in US Lower
  48 - but not without risks
• Expect more proactive pipeline development in
  contrast to boom/bust 1990s

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Rocky Mountains - Unconventional Once Again Key

• CBM and tight gas plays will drive production
  growth in the region

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Canada and Mexico Supply

• Holds up despite decline in traditional Alberta
  supplies
• Following a rebound in production during 2004 and
  2005, production flattens as increased activity
  is only sufficient to offset declines in existing
  production
• CBM and development of deeper gas prospects in
  north and west of Basin plus British Columbia

• Mexican supply is an important wild card
• Without change in constitution and limited
  success on the MSC program, gas to market is
  expected to reach around 3.8 bcfd in 2010
• This supply growth slightly outpaces demand
  growth after 2005
• By 2010, LNG imports of 900 mmcfd (main grid)
  lead to exports to US of more than 500 mmcfd

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LNG Arctic Projects - will not materialize
quickly, and will lag demand pressure, not
relieve it. Any phase of price weakness likely
transitory

• Mackenzie Delta supplies are expected to connect
  to the Alberta gas grid in 2009, building to
  flows of 800 mmcfd by 2010.
• By 2005, summer LNG deliveries are constrained by
  available regas capacity.
• The first greenfield US LNG regas facilities are
  expected to come online in 2007. One Gulf Coast
  facility and one Baja facility should begin
  importing LNG that year.
• LNG regas capacity and liquefaction capacity grow
  in step, with capacity increasing to 6.1 bcfd in
  2010
• Alaskan supplies could still reach the North
  American gas grid in 2013, but that date is now
  slipping, and delays could push in-service back
  years.

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Agenda

• Introduction
• Oil Supplies - OPEC and the Spare Capacity Build
  
• Domestic Natural Gas Supply - Running Fast,
  Falling Behind
• LNG - A Slow and Partial Solution to the Gas
  Problem
• Implications for Demand and Price
• The Long Term Dynamic
• Strategic Implications Conclusions
• Discussion, QA

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Delivered Costs Influence Destinations, But Other
Factors Play Major Roles
Cove Point DES
Source Wood Mackenzie Global LNG ON LINE
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Increased Imports of LNG into North America
Forecasted deliveries bcfd (Excluding Altamira
Lazaro Cardenas)

• 2003-2004 Increase
• No New Major Upstream Projects
• Increases due to Trinidad supplies and weather
  conditions globally (more spot gas)
• 20042005
• Egypt, Nigeria, Qatar come on line
• 2008-2009 New Regas Capacity Needed
• Delays will be problematic
• Additional supplies into Mexico will account for
  almost 1 bcfd of further supply
• 500 mmcfd into Altamira
• 400 mmcfd into Lazaro C.

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LNG into North America will not
LNG into North America will

• Set the US Gas Price
• Provide a ceiling for US gas prices
• Flood the US gas price
• Single handedly address the US gas supply
  shortfall

• Be somewhat responsive to the US market price.
• ...but spot cargoes will be a function of global
  weather trends
• Baseload Supplies will provide a critical
  increment to US supply
• Dampen basis in areas on both coasts

Canaport, NB, Irving Oil Bear Head, NS
Long Beach, CA Mitsubishi
Sears Point, ME
Oxnard,CA BHPB
Providence, RI Somerset, MA Weavers Cove, MA
Crown Landing, NJ BP
Baja,California CVX (Chevron)
Bahamas Tractebel
Bahamas AES
WC 182 Shell
Costa Azul, Baja CA Shell/Sempra
Port Pelican CVX (Texaco)
Lazaro Cardenas, MX Repsol (Tractebel)
Cameron, LA Sempra
Corpus Christi Cheniere
Rosarito, Baja CA ConocoPhillips
Golden Pass ExxonMobil
Altamira, MX Shell, Total
Source Wood Mackenzie
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Agenda

• Introduction
• Oil Supplies - OPEC and the Spare Capacity Build
  
• Domestic Natural Gas Supply - Running Fast,
  Falling Behind
• LNG - A Slow and Partial Solution to the Gas
  Problem
• Implications for Demand and Price
• The Long Term Dynamic
• Strategic Implications Conclusions
• Discussion, QA

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Electricity Sales and Economic Growth

• Electricity sales growth is closely linked with
  overall economic growth.
• Efficiency gains over the past 25 years have had
  a significant impact on electricity sales.
• Total electricity sales increase slower than the
  real GDP.

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And Total US Gas Demand Increases by 7.4 bcfd
from 2003 - 2010
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Change in US Gas Demand by Region (2004 to 2010)
Total -0.40
Total 0.37
Total -0.22
Total 0.75
Total 0.14
Total 0.43
Total 0.51
Total 1.43
Total 2.22
Source Wood Mackenzie Ltd, RDI Platts POWERmap
2004
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US Demand Seasonality
Gas Demand (mmcfd
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Slow Declines in Industrial Sector Driven by
Global Challenges, Intensified by North American
Energy Price Pressure
US Industrial Gas Use 2003 Total 7,557 bcf
Annual Change in Industrial Gas Demand and
Cumulative Change Relative to 2000
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Henry Hub Spot Price Outlook
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The High Plateau North America Sustains New
Heights
Henry Hub Price US/mmbtu (2004 dollars)

• LNG Development
• Mexico Reversal
• Mackenzie Delta

Oil Price Declines
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The Gas/Oil Price RelationshipLinkages Continue
2004 dollars per mmbtu
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Agenda

• Introduction
• Oil Supplies - OPEC and the Spare Capacity Build
  
• Domestic Natural Gas Supply - Running Fast,
  Falling Behind
• LNG - A Slow and Partial Solution to the Gas
  Problem
• Implications for Demand and Price
• The Long Term Dynamic
• Strategic Implications Conclusions
• Discussion, QA

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US Production Outlook 2000 to 2020

• The main driver will be price
• The main thrust will be the move from
  conventional to unconventional gas plays
• Alaska and other key projects will be needed
  toward the middle of the next decade
• Materiality will determine the role the majors
  play
• Onshore
• Offshore
• Import/LNG

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Canada Production Outlook 2000 to 2020

• Similar story to the Lower 48 in a switch from
  conventional to unconventional resources
• Pipeline build for the Arctic and Mackenzie Delta
  projects will help determine the impact
• Opening of Offshore BC is expected toward the end
  of the decade
• East Coast success could have a profound impact
  on prospectivity, but results thus far have been
  poor

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Mexico Production Outlook 2000 to 2020

• Will revised terms inspire interest from the
  outside?
• How quickly can PEMEX tap underexploited basins?
• What political elements will drive the import of
  LNG into Mexico?
• How will the pipeline system be built out and
  could there be greater impacts on overall NA
  pricing?
• How will the offshore play out over time?

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Key Uncertainties in Long-Term Supply Development

• Price
• Where will it go and how high?
• Will price purely be a function of demand
  destruction - will demand always be on the
  margin?
• How do the basis dynamics play out?
• What price deck will companies use as a long-term
  hurdle?
• How will companies choose to manage through
  boom-bust cycles ?
• Land Access / Exploration
• Federal permitting, at what pace and to what
  extent?
• How much opposition to CBM and what other surface
  issues will be encountered on the State level?
• Will offshore reserves ever become accessible -
  West Coast Canada, Eastern Gulf, Mexico GoM, East
  Coast US?
• How large a drilling portfolio will independents
  work up?
• Exploration vs Exploitation Who will be the
  explorers Entrepreneurs, Small EP, New Capital?
• Competition
• Will LNG force the upstream to become even more
  reactive?
• Threat from Alaskan Pipeline - will drillers
  alter investment plans?
• Consolidation continuing - will it solve the
  cyclical drilling patterns/exposure to weather
  downturns?
• What will the now larger independents do with the
  lesser plays - recycle into the small EP firms,
  or hold on for peak pricing value capture?

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Key Uncertainties in Supply Development -
Continued

• Integration
• Is greater participation in the midstream
  necessary for the long term (production area
  storage, marketing)?
• How will upstream firms market gas--- Or are
  Anadarko, Encana, Apache and Devon simply the new
  majors in a non-refining sense?
• Who will drive pipelines forward proactive or
  reactive?
• Storage Who, What and Where?
• Financial
• Continued innovation on the financing end, with
  continued potential for the upside (VPP, NPIs,
  etc...)
• When will the forward market recover, and become
  affordable to even the smaller players?
• Access to capital for the smaller players?
• Better use of portfolio optimization of physical
  assets?
• Low hurdle rates to consolidate plays?
• Other Constraints
• Existing Land Rigs how many more will we need
  and at what cost?
• The margin-push by service providers?

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US LNG Supply Outlook 2000 to 2020

• Near term supply problems
• Long term need to sign and underpin long term gas
  agreements?
• How many facilities can one area bear?
• What price will be used to evaluate projects?
• Where will the next resources come from?
• How will LNG react to Alaska and other pipes?
• How will niche players evolve
• demand aggregators
• shipping optimizers
• fuel load managers

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US Demand Outlook by Sector 2000-2020

• Power remains the major driver long term
• Efficiency gains limit long-term growth in
  residential and commercial sectors
• Industrial demand declines slowly as
  energy-intensive processes move to lower-cost
  markets
• Demand remains constrained by available supply
  Alaska does not alter long-term decisions

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Canada Demand by Sector 2000 to 2020

• Oil Sands development major driver
• technology change is a wildcard
• oil price will effect development
• Commitment to renewables reduces power growth
  over time
• Coal is a viable alternative to gas long term

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Demand Issues - Key Drivers to 2020

• Growth in gas demand for power sector remains the
  key driver through 2020
• Changes in new generation build shift growth
  trends over time
• Coal and oil capacity additions anticipated, but
  efficient combined cycle baseload and simple
  cycle peaker build will drive gas demand
  increases in the US
• Industrial demand trends down slowly
• US traditional advantage as a low cost energy
  market is gone
• Much of the most cost-sensitive demand is now out
  of the system, but structural change will reduce
  production, or energy consumption from energy
  intensive industries over time
• LDC demand will remain constant to slightly down
  as efficient unit penetration increases over
  time.
• Demand is more likely to change shift price
  levels beyond 2010 than supply

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Power Sector - Long Term Driver of Gas Demand

• Over 200,000 MW of new generation will be needed
  between 2010 and 2020 to serve peak demand
  growth.
• Retirements of existing capacity can easily add
  another 100,000 MW of new generation
  requirements.
• Fuel and technology choices remain limited for
  power generation.
• Each technology has potential problems
• Gas technologies - Fuel price and availability
• Coal technologies - Environmental issues, capital
  costs
• Nuclear - Public opposition, capital costs, lead
  times
• Renewables - Feasibility
• Gas technologies remain economically viable.

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GDP and Electricity Growth
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Potential Retirements of Existing Capacity
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Requirements for New Coal Build

• Baseload generation need
• Cost-of-service regulatory treatment
• Expectation that high gas prices are here to stay
  (4 and above)
• Regional Differences
• Construction near coal sources - greater
  requirement for transmission infrastructure
• Political opposition higher in some markets (e.g.
  New England, California)

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New Build Assumptions - 2010-2020
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Power Sector Wildcards

• Higher Gas Demand
• Increasingly stringent environmental legislation.
  GHG legislation.
• Existing nuclear fleet - An accident or terrorist
  attack causes a shutdown of some of the fleet.
• Regulatory uncertainty delays future build. As
  shortages develop, lead times favor gas peaking
  build.
• Lower Gas Demand
• Re-regulation. Cost-of-service build favors coal
  development.
• New nuclear plant construction.
• Capital cost reductions make IGCC competitive.
• Efficiency gains limit electricity peak demand
  and sales growth.
• Renewable Portfolio Standards drive development
  of alternatives.

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Henry Hub Price Outlook to 2020

• Costs of supply development create a long term
  floor on US gas prices. Reliance on
  unconventional supply keeps that floor above
  3.50 per mmbtu.
• Price must be high enough to encourage LNG
  development
• Incremental development of LNG capacity means
  that LNG remains an intramarginal supply source.
  Post-Alaska is the only possible exception
• Price must remain high enough to encourage
  development of coal-fired generation capacity
• Oil and gas linkages remain strong, but in a low
  price oil environment, gas supplies reduce
  downward pressure on gas prices. Gas market
  fundamentals can shift the oil-gas relationship
  through time.

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Agenda

• Introduction
• Oil Supplies - OPEC and the Spare Capacity Build
  
• Domestic Natural Gas Supply - Running Fast,
  Falling Behind
• LNG - A Slow and Partial Solution to the Gas
  Problem
• The Long Term Dynamic
• Strategic Implications Conclusions
• Discussion, QA

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How Knowable are Future Prices? - Critical
Uncertainties

• Supply Development
• Pace of technological advance pace of decline in
  marginal price floor
• Reserves uncertainties - still some possibilities
  in N America
• Upstream development in Mexico
• Federal drilling permitting - at what pace and to
  what extent?
• How much opposition to CBM and what other surface
  issues will be encountered on the State level?
• Offshore issues - West Coast Canada, Eastern
  Gulf, Mexico GoM, East Coast US?
• New Supply Sources - hydrates?
• Demand
• New technologies altering the competition
• between fossil and nonfossil energy sources
  (hydrogen, renewables for example)
• among fossil fuels
• New power generation technologies (?)
• Pace of growth in consumption efficiencies
• Competition
• The oil market dynamic - oil prices
• Effects of Alaskan pipeline on LNG development

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How Knowable are Future Prices? - Near Certainties

• Supply Development
• US supplies will decline - the pace is the
  question
• LNG imports will build - the pace is the question
• Demand
• Gas will supply the majority of power demand
  growth for the next decade next 2 decades likely
• Material growth in coal and nuclear generation
  base will take time (well into next decade), if
  it is even allowed
• Consumption efficiency will increase, at an
  accelerating pace
• Competition
• Gas prices will react to oil price movements.
  Until fundamental shift in competitive dynamic,
  gas will largely remain in the resid-distillate
  price range.

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The Gas/Oil Price RelationshipLinkages Continue

• Steady growth in supply keeps pace with demand
  through 2010
• Residual fuel oil serves consistent share of
  generation requirement, in certain markets,
  distillate outcompetes gas for peaking loads
• Oil price declines through 2007 allow declines in
  gas prices relative to current levels
• Storage fills near capacity every year to handle
  winter demand pressure storage levels creep up
  over time with development of new storage
  capacity
• Mackenzie Delta and wave of LNG build, as well as
  reversal of Mexican flows allow slight decline in
  gas prices for 2009, 2010. Price trend up
  starting in 2011.

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Wood Mackenzies Base Case Henry Hub Outlook -
With Oil at 22.75 Real 2012 and Beyond, Alaskan
Gas (2015) Lowers Price to 3.50
2004 dollars per mmbtu
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Wood Mackenzies Low Case Henry Hub Outlook -
With Oil at 18, Henry Hub Prices Remain Near or
Above 3.00
2004 dollars per mmbtu
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The Wood Mackenzie Bottom Line With a
Transport Contract at 2.50 or less, and Absent
Major Technological Shifts in the Energy Market,
the States Actual Cash Risk from a Pipeline
Contract is Minimal
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