kohlberg kravis roberts nov. 2012 report - historic opportunities from the shale gas revolution

7/29/2019 Kohlberg Kravis Roberts Nov. 2012 Report - Historic Opportunities from the Shale Gas Revolution

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BY MARC S. LIPSCHULTZGLOBAL HEAD OF ENERGY & INFRASTRUCTURE

KKR REPORT NOVEMBER 2012

HistoricOpportunitiesfromtheShaleGasRevolution


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Table of Contents

3 Definitions

4 Executive Summary

6 Americas New Gas Supply Profile: A Doubling of Recoverable Resource

9 Will the New Supply Picture Reduce Price Volatility?

11 Economic Impact: Gass Expanded Role in the U.S. Economy

17 Managing the Environmental Impacts/Risks of Shale Gas

20 Conclusions

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KKR HISTORIC OPPORTUNITIES FROM THE SHALE GAS REVOLUTION

Definitions

Hydraulic Fracturing the process of injecting fluid and proppants

under high pressure through a [horizontal] well into a shale gas,

tight oil or other formation to stimulate production.

Horizontal Drilling the practice of drilling a horizontal section in a

well (used primarily in a shale or tight oil well), typically thousands

of feet long.

Natural Gas Liquids (NGLs) components of natural gas in gaseous

form in the reservoir, but can be separated from the natural gas

at the wellhead or in a gas processing plant in liquid form. NGLs

include ethane, propane, butane, and pentane.

Original Gas-in-Place the amount of natural gas in a reservoir

(including both recoverable and unrecoverable volumes) before any

production takes place.

Original Oil-in-Place the amount of oil in a reservoir (including

both recoverable and unrecoverable volumes) before any production

takes place.

Oil and Gas Value Chain

Upstream Oil and Gas Activities all activities and expendi-

tures relating to oil and gas extraction, including exploration,

leasing, permitting, site preparation, drilling, completion, and

long term well operation.

Midstream Oil and Gas Activities activities and expenditures

immediately downstream of the wellhead, including gathering,

gas and liquids processing, and pipeline transportation.

Downstream Oil and Gas Activities activities and expendi-

tures in the areas of refining, distribution and retailing of oil

and gas products.

Oil and Gas Resource Terminology

Conventional gas resources resources associated with

higher permeability fields and reservoirs. Usually, such a

reservoir is characterized by a water zone below the oil and

gas. These resources are discrete accumulations, typified by a

well-defined field outline.

Economically recoverable resources that part of technicallyrecoverable resources expected to be economic, given a set of

assumptions about current or future prices and market condi-

tions.

Proven reserves the quantities of oil and gas expected to be

recoverable from the developed portions of known reservoirs

under existing economic and operating conditions, and with

existing technology.

Technically recoverable resources the fraction of gas in

place expected to be recoverable from oil and gas wells with

consideration of economics.

Unconventional gas resources low permeability deposits

more continuous across a broad area. The main categories a

shale gas, coalbed methane, and tight gas, although other cat

egories exist, including methane hydrates and coal gasificati

Shale gas and tight oil gas, condensate, and crude oil pro-

duced from shale plays. Tight oil plays are those shale plays

dominated by oil and associated gas, such as the Bakken in

North Dakota.

Coalbed methane (CBM) gas produced from coal seams (a

known as coal seam gas, or CSG).

Tight gas gas and condensate produced from very low per

meability sandstones.

LIST OF EXHIBITS

1Estimated U.S. Lower-48 Recoverable Gas Re-source Base by Source

9

2 North American Shale Plays 1

3Game-changing Production Forecasts Net Surplusof Natural Gas

1

4Monthly Average Gas Prices at Henry Hub (Nom$/MMBtu)

1

5Recent and Planned Natural Gas Infrastructure Ad-ditions

1

6Supply Rationalization Process is Reflected inForward Curve

1

7 U.S. Map of Employment Gains in 2017 1

8Projected Growth in Natural Gas Consumption bySector

1

9 Natural Gas Upstream Capital Requirements 1

10 Natural Gas Infrastructure Capital Requirements 1

11Gas-fired Power Generation Employment to Doublethrough 2035

2


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4 KKR HISTORIC OPPORTUNITIES FROM THE SHALE GAS REVOLUTION

Executive Summary

Recent advances in production techniques unlocked long known

but previously untapped natural gas resources of immense scale.

We believe these newly recoverable gas resources can provide the

U.S. with at least an additional100 years of supply at current usage

levels. This presents a truly transformative change in Americas

energy supply picture, and one with potential to grow the economy,

reduce energy import dependence and enhance national security,lower household energy bills, reduce emissions, and spur a manu-

facturing renaissance. However, the ability to reap these benefits is

far from assured, and significant challenges must be overcome to

fully seize this historic opportunity.

The following white paper presents an analysis and assessment

of what brought about this revolutionary advance in recovery

techniques, the necessary conditions for full development of the

opportunity, and a view of the transformative impact it can have on

Americas energy infrastructure and economy if we successfully

harness this vital resource. It also presents a view of key challeng-

es that must be overcome, which include smoothing out the boom-

bust cycle in gas prices that undermines consumer and producerconfidence, and mitigating the environmental impacts and risks that

limit social acceptance of the resource opportunity. More broadly,

a national dialogue is needed to achieve consensus on the stan-

dards that must be met to secure and maintain the social license to

develop this critical resource.

We believe the following key points must be addressed in order to

achieve success:

First and foremost, industry must continue to proactively en-

gage with regulators, the local community, environmental and

other stakeholders to develop appropriate regulation and best

practices that reduce impacts and protect human health and the

environment, including the reduction of fugitive methane emis-

sions. For example, Anadarko, Encana, Shell, and ExxonMobil

subsidiary XTO Energys work with the Environmental Defense

Fund (EDF) on methane leakage testing to better quantify and

eliminate methane emissions from the industry. Consensus is a

necessary and desirable pre-condition for success and industry

leaders must continue to actively seek to achieve this through

open dialogue and demonstrated commitment to responsible

stewardship.

Second, expansion of natural gas-based transportation infra-

structure including mid-sized municipal and corporate naturalgas powered fleets, natural gas powered heavy duty trucks,

and consumer vehicles should be encouraged through a variety

of incentives, including where appropriate federal, state and

local policy initiatives. This infrastructure is particularly capital

intensive, but will also yield important benefits, such as reduc-

tion in oil consumption.

Third, procedures for securing permits on federal land need

to be clearer, expeditious, and more consistently applied to

provide greater certainty and transparency regarding the rules,

criteria and procedures. This clarity should expand access to

federal lands where significant oil, gas, liquids and unconven

tional gas is present and can be responsibly produced.

Finally, there must be support for, and action to encourage

development of a natural gas export infrastructure. In our vie

Liquefied Natural Gas (LNG) exports are expected to play animportant and constructive role in maximizing the domestic

economic benefits of the shale gas revolution. The U.S. now

enjoys significant comparative advantage relative to many of

our energy import dependent trading partners, and LNG expo

sales to these partners will directly reduce our trade deficit.

We believe the U.S. can capture these benefits of trade with-

out ceding its energy price advantage to purchasers of LNG

exports, as these exports will be priced significantly higher

than prices paid in the U.S. market. Additionally, because the

resource base is so large, these exports are expected to hav

only a modest impact on domestic prices while providing a

steady source of demand to support expanded production an

delivery infrastructure.

Referred to as shale gas, these newly accessible resources are

trapped deep below the surface in shale formations. As a low-

porosity rock, the shale formation must be broken, or fractured, t

release the gas trapped within. Advances in integrating two matu

exploration and production technologies, horizontal drilling andhydraulic fracturing, have progressed to the point where these

resources may now be economically recovered. While this paper

focuses on dry gas recovery from shale formations, it is importan

to note these techniques are also being used on a significant sca

to exploit natural gas liquids and oil opportunities. The challenge

hand is to successfully mobilize the financial, technical, environ-

mental risk mitigation techniques and policies necessary to bring

these gas resources online and into the economy in a manner tha

stimulates sustainable economic growth, while preserving and

protecting the environment.

This presents a truly transformativchange in Americas energy supppicture, and one with potential togrow the economy, reduce energyimport dependence and enhance

national security, lower householdenergy bills, reduce emissions, anspur a manufacturing renaissance


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The U.S. and Canada are not the only countries with significant

shale gas resources; Poland, China and India possess significant re-

sources, as do other nations. Yet, these countries currently lack the

resources, technology and infrastructure necessary to safely, effec-

tively, and efficiently extract the resource and bring it to market.

We believe successful recovery of this resource will have a tremen-

dous economic impact. It would dramatically increase gas market

share in the electricity generation sector, make inroads as a trans-

portation fuel, reduce petrochemical production costs, and improve

U.S. manufacturing and overall economic competitiveness. The U.S.would also potentially shift from being a net importer of natural gas

to a net exporter, creating a balance of trade benefits.

Tapping the full potential of this resource is not yet a given and

requires significant changes to, and investment in, our basic energy

infrastructure, including significant expansion of the U.S. natural

gas pipeline and storage system, the gas-fired generating fleet

and, potentially, development of compressed natural gas fueling

and other forms of transportation infrastructure. Transformation

at this scale will require significant capital mobilization to finance

the recovery of the resource, the expansion of gas delivery, storage

infrastructure and investment in the plant, and equipment that will

consume the growing gas supply.

As discussed below in Chapter 2, we estimate if we do what is

needed to successfully exploit the resource, gas productionshould

increase by 44% from 2011 to 2035. Developing the resource and

the delivery infrastructure to bring this new supply to market will

require:

$2 trillion in upstream investments for natural gas produc-

tion (including associated volumes of condensate and NGLs)

between 2011 and 2035, with $1.7 trillion needed for dry gas

production alone.

$205 billion in capital expenditures between 2011 and 2035 for

gas infrastructure development.

Expansion of the mainline gas transmission system by approxi-

mately 35,600 miles and an additional 589 billion cubic feet (bcf)

of working gas storage by 2035.

Similar to other recent growth opportunities in technology and bio-

tech, exploiting the opportunities presented by natural gas carries

with it tremendous basic industry and skilled-labor employment

growth potential. Extraction and delivery of natural gas requires

significant material inputs including steel and concrete, and skilled

construction workers, welders and operating engineers to build andoperate the new wells and infrastructure.

In addition to expanding the gas production and delivery system,

skilled workers, machinery and inputs will also be needed in gas-

fired power generation, construction of new ammonia, liquefaction,

methanol plants, and new transportation infrastructure. In short,

exploitation of the newly accessible gas resource holds the poten-

tial to shift us to a cleaner-energy economy and spur an industrial

and manufacturing renaissance that would provide significant new

employment opportunities for Americas skilled labor forces.

A recent study found that recent improvements in hydraulic fract

ing and horizontal drilling techniques used to produce shale gas

could lead to the creation of 835,000 to 1.6 million annual jobs

throughout the U.S. economy by 2017, due to the significant multi

plier effect associated with investment and employment in the ga

sector. To put this in perspective, the low range of this estimate

exceeds total employment in the entire U.S. auto manufacturing

industry (including parts suppliers).

If the nation joins together to make successful development of th

resource a shared national priority, even greater employment gaimay be expected over the longer term. Some projected economic

and employment gains from these new production techniques

include:

Increasing annual GDP between 1.2% and 1.7% by 2017;

Improving the U.S. trade balance by increasing net exports b

approximately $120 billion annually by 2017. This is equivalen

to nearly one-quarter of the U.S. 2010 trade deficit;

Saving consumers $41 billion in 2017 as a result of lower ga

prices, enough to cover the electricity bill of 30 million home

This figure includes direct savings to natural gas consumersindirect savings from lower electricity prices, and lower pric

for industrial products;

Creating hundreds of thousands of well-paying jobs, includin

330,000 direct jobs in natural gas, oil, and natural gas liq-

uids production;

120,000-210,000 manufacturing jobs; and,

33,000-40,000 construction jobs.

While the potential economic benefits of increased natural gas ar

hard to dispute, efficient and effective realization of these tremen

dous opportunities is not yet a given. Significant technical, marke

policy and environmental risks and challenges must be addresse

to successfully capture the opportunities presented by the shale

revolution.


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Americas New Gas Supply Profile: A Doubling

of Recoverable Resources

The ability to cost-effectively recover shale gas has dramatically

increased the amount of economically recoverable natural gas re-

sources in the U.S. With the advent of economic shale gas recovery,

the total recoverable resource base now represents over 3,500 tril-

lion cubic feet (Tcf), representing more than 100 years of U.S. gassupply at current demand levels (see Exhibit 1). Shale gas recovery

is at the heart of this increase in supply and now accounts for over

half of the recoverable U.S. resource base, whereas just a decade

ago it made up less than 5%.

exhibit 1

Estimated U.S. Lower-48 Recoverable Gas ResourceBase by Source

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2003 NPC 2012 ICF

TCF

1,147

3,572Shale Gas

Other Unconventional

Resources*

Conventional Resources

Source: ICF estimates October 2012. *Includes tight gas, associatedtight oil, and coalbed methane

This increased base has led to significant increases in domestic gas

production, and in our view shale gas produced through horizon-

tal drilling and hydraulic fracturing is the primary driver of this

increase.

An overview of the horizontal drilling and hydraulic fracturing pro-

cess is presented in the text box on the next page.

Shale Gas Recovery Process

Pioneered in the Barnett shale in Texas over the last decade,

hydraulic fracturing of horizontal gas wells has gone from beingan effective but high cost method of producing gas to the primary

source of new, low-cost natural gas production. Shale gas produ

tion today typically involves drilling vertically to 6,000-12,000 fee

below ground, followed by another 5,000-10,000 feet of lateral

(horizontal) drilling. Hydraulic fracturing fluid, or frack fluid, is

then pumped into the well at high pressure to fracture the rock a

release the gas. The frack fluid is made up of 98.0-99.5% water.

Typically sand is added to the fluids to prop open the fractures

and allow the gas and other chemicals to flow. After the fracture

is complete, 20%-30% of the frack fluid flows back to the surface

and must be disposed of. Some gas may also be released during

the flow back and can be either vented, flared (burned) or captur

for sale. Capturing the gas is the best option from an economic aenvironmental perspective. Flaring the gas is preferred to releas

the gas into the air, sinice it reduces the amount of conventional

and greenhouse gas (GHG) pollution. The illustrations below pro-

vide an overview of where these recoverable resources are foun

and how the hydraulic fracturing process works.

With the advent of economicshale gas recovery, the total

recoverable resource base nowrepresents over 3,500 trillion cubifeet (Tcf), representing more than

150 years of U.S. gas supply atcurrent demand levels.


7/22

Conventional Non-Associated Gas

Seal

Gas-rich Shale

Tight Sand Gas

Coalbed Methane

Oil

Conventional associated gas

Land Surface

Sandstone

Pumper

Blender Truck

Sand Truck

Fuid Storage Tank

Groundwater Aquifers

Additional steel casingandcement to protect ground water

Protective steel casing

Shale Fractures

Fracturescreated byhigh pressure fluid

Approximate distancefrom surface: 8,000 feet

Private Well

Municipal Water Well: < 1,000 ft.

NATURAL GAS RESOURCES

HYDRAULIC FRACTURING PROCESS

Source: Bipartisan Policy Center and American Clean Skies Foundation, March 2011


8/22


exhibit 2

North American Shale Plays

CURRENT SHALE PLAYS

Stacked plays

SHALLOWEST / YOUNGEST

INTERMEDIATE DEPTH / AGE

DEEPEST / OLDEST

* MIXED SHALE & CHALK PLAY

** MIXED SHALE & LIMESTONE PLAY

*** MIXED SHALE & TIGHT DOLOSTONE-SITSTONE-SANDSTONE PLAY

PEOSPECTIVE SHALE PLAYS

BASINS

NORTH AMERICAN SHALE PLAYS

(as of May 2011)Lower besa

river

Montney

DoigPhosphate

Niobrara*

Cody

WoodfordFayetteville

Marcellus

Tuscaloosa

Conasauga

Chattanooga

FloydNeal

Barnett

Eagle

FordHaynesville-

Bossier

Hillard-Baxter-Mancos-Niobrara

Excello-Mulky

Bend

Pierre-Niobrara

Avalon

Barnett-Woodford

Eagle Ford,

La Casita

Eagle Ford,

Tithonian

PimientaPimienta,Tamaulipas

Lewis

MontereyTemblor

Monterey

Heath**

Antrim

Utica

FrederickBrook Horton

Bluff

NewAlbany

Muskwa-Otter Park

ColoradoGroup

Gammon

Mowry

Niobrara*Denovian (Ohio)

Utica

Mancos

Hermosa

Bakken

***

Muskwa-Otter Park,Evie-Klua

Maltrata

Source: U.S. Energy Information Administration (EIA). North American shale plays. EIA, 2011: Washington, D.C. Available at:http://www.eia.gov/oil_gas/rpd/northamer_gas.jpg

Already, the growth in shale gas production has resulted in a 27%

increase in U.S. natural gas production between 2005 and 2011,

and production is expected to increase another 44% by 2035.

These production gains mean that after over two decades as a net

importer of natural gas, the U.S. is projected to become a net gas

exporter by 2017 (see Exhibit 3). It also means natural gas is poised

to expand its share of the primary energy market, becoming a more

plentiful and cost-effective feedstock for a variety of industries

(previously relocating to lower cost countries), including methanol,

Gas to Liquids processing (GTL), ammonia, and nitrogen fertilizer

plants.

Exhibit 2 shows the major shale plays throughout the U.S. and

Canada. The success with shale production in the Barnett shale,

where these techniques were advanced and costs lowered dramati-

cally, is now being replicated in shale plays across the country.

As shown in exhibit 3 below, nearly 60% of the forecasted pro-

duction in 2035 will be from shale gas. This increase in shale gas

production would enable the U.S. to shift from a net importer to a

net exporter of natural gas despite significant declines in domestic

conventional gas production (see Exhibit 3). The increased produc-

tion would serve a growing domestic demand and displace imports

of natural gas (primarily from Canada) which have been an impor-

tant part of the U.S. gas supply for the last 20 years.

After over two decades of natural gas imports, the U.S. is expected

become a net exporter in 2017, which will provide the U.S. significan

balance of trade benefits.

exhibit 3

Game-changing Production Forecasts Net Surplus ofNatural Gas

0

5

10

15

20

25

30

35

1950 1960 1970 1980 1990 2000 2010 2020 2030

TCF

Conventional Offshore

Other Unconventionals* Shale-Net Exports

Net Imports Net Exports

Source: EIA and ICF estimates, October 2012. *Includes tight gas,associated tight oil, and coalbed methane


9/22


Will the New Supply Picture Reduce Price Volatility?

Natural gas has long been recognized as a preferred fuel for

residential or commercial heating, industrial processes, and power

generation, as well as a valuable chemical feedstock. However,

despite its myriad advantages and uses, it has had difficulty reach-

ing a market share reflective of its technical potential. As discussed

throughout this section, natural gas historic underperformance

relative to potential has been driven by a variety of factors thatshould be overcome by the newly abundant resource base.

During some periods, energy policy created explicit limitations on

gas use. One such example, The Power Plant and Industrial Fuel

Use Act, of 1978, prohibited the use of natural gas for new large in-

dustrial boilers and power plants for nearly 10 years. At other times,

changing market rules or other factors resulted in price volatility,

which made natural gas uneconomic and led to economic distress

for large gas consumers.

As can be seen in Exhibit 4, natural gas prices have been volatile

during the last decade. During the winter of 2000-2001, wholesale

gas prices spiked to a level nearly four times the average gas pricesince 1993, and remained at nearly double this average for almost

a year. This run-up appears to have been caused by a combination

of factors, including declining production from conventional supply

basins, unusually low storage levels, skyrocketing demand due to

extremely cold weather, and high underlying demand due to strong

economic growth. In 2005, outages from hurricanes Katrina and

Rita resulted in another brief doubling of gas prices as a result of

damage to, and lost production from, facilities in the Gulf of Mexico.

In 2008, gas prices again doubled as part of a global run-up in

energy and other commodity prices.

Even though average gas prices were not unfavorable relative

to other fuels during this period, these price swings may have

dampened enthusiasm for major gas-based investments. The one

common thread throughout this decade of volatility is the market

was characterized by a tight supply and demand balance, resulting

in high volatility in response to even periodic market events and

disturbances. We believe this is the critical factor that is changing

as a result of the shale gas revolution.

exhibit 4

Monthly Average Gas Prices at Henry Hub(Nom$/MMBtu)

$0

$2

$4

$6

$8

$10

$12

$14

$16

Jan-00

Jul-00

Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

Source: ICF and Platts, September 2012

The new supply picture has brought not only lower prices but, in

our view, also increased confidence that the supply/demand bal-

ance permanently shifted in a way that will reduce volatility. The

geographic dispersion of shale plays also reduces vulnerability to

weather-induced supply disruptions, which may have contributed

historic volatility, as production from the Gulf of Mexico becomes

less significant source of overall supply. The key question is if th

resource base unlocked by the shale gas revolution will result in

reduced prices and volatility. We believe this is indeed the case.

Infrastructure growth is at the heart of this question. Expansion i

already well underway and we expect this trend to continue. Cap

expenditures for gas infrastructure development are forecast at

$205 billion from 2011 to 20351, which would expand the mainline

gas transmission system by approximately 35,600 miles and crea

an additional 589 billion cubic feet (bcf) of working gas storage b

2035.2 Exhibit 5 provides an overview of recent and planned natu

gas infrastructure additions.3

1 Inter-state Natural Gas Association of America (INGAA) Foundation. NorAmerican Natural Gas Midstream Infrastructure Through 2035. 28 June2011: Washington, D.C.

2 Ibid. P. 13.

3 Note that this graphic includes only certificated natural gas pipelines; it donot represent the existing natural gas transmission system or existing andplanned oil, natural gas liquids or gasoline pipelines.

The key question is if the resource

base unlocked by the shale gasrevolution will result in reducedprices and volatility. We believe

this is indeed the case.


10/22


exhibit 5

Recent and Planned Natural Gas Infrastructure Additions

MARKET RESPONSIVE

INFRASTRUCTURE ADDITIONS

Major Gas Pipeline ProjectsCertificated (MMcf/d)January 2000 To February 2011

115.00 BCF/D Total

16,178 Miles152 Projects212 Certificates

NEW ENGLAND CORRIDOR

22 Projects31 Certificates9,773 MMcf/d

COLORADO CORRIDOR


EAST TEXAS

CORRIDOR


FAYETTEVILLE

CORRIDOR


3738

4048

41

42

45

4647

49

5051 52

53

39 55

545667

6665

6463 62

61

6059

58

57

Rockies Express East (1,800)24

31

342926

3528

33 32

2325

27

30

36

RubyPipeline(1,456)

4

1915

3 218

511

17

10

13201422

168

1

12

9

6

21

Source: Federal Energy Regulatory Commission, February 2012

While we are confident that the fundamentals are in place for

sustained expansion of natural gas production and deliverability,

current historically low gas prices raise concern about the de-

velopment of the resource; persistently low prices may dampen

enthusiasm for additional production. We believe that current low

gas prices result from a perfect storm that included an histori-

cally mild winter (resulting in gas storage oversupply), slowed

economic growth and continued supply expansion. We also believe,

as evidenced by the forward curve, that these conditions are poised

to turn around.

We expect prices to firm over the near term as supply comes back

into balance and the current supply overhang is worked off. Part of

this rebalancing, we believe, comes from a shift in upstream pro-

ducers exploration and production strategies, leading them to focus

on oil and wet gas plays instead of maximizing dry gas production

gains. These wet gas plays contain natural gas liquids (NGLs)

made up of ethane, propane, butanes and pentanes-plus, and tendto provide more attractive margins given historically low natural

gas prices. This shift in development strategy, coupled with heating

season demand, should continue to work off some of the supply

overhang weighing on short-term pricing.

Exhibit 6 (right) provides a graphical representation of the supply

overhang and rationalization process as reflected in forward pricing

for NYMEX Henry Hub Futures contracts.

exhibit 6

Supply Rationalization Process is Reflectedin Forward Curve

0

2

4

6

8

10

12

2005 2010 2015

GAS PRICES AT HENRY HUB (2010$/MMBTU)

Historical NYMEX Futures (Oct. 19, 2012)

Perfect storm leads to

unsustainably low gas prices

Supply rationalization

Source: Historical: ICF estimates. NYMEX Futures: CME Group. HenryHub Natural Gas Futures. Chicago Mercantile Exchange (CME) Group,4 October 2012: Chicago, IL. Available at: http://www.cmegroup.com/trading/energy/natural-gas/natural-gas_quotes_settlements_futures.html


11/22


exhibit 7

U.S. Map of Employment Gains in 2017

U.S. MAP OF EMPLOYMENT

GAINS IN 2017

(Attributable to upstreamtechnological advancessince 2007)

2.0 - 16%

1.0 - 2.0%

0.8 - 0.9%

0.7-0.8%


12/22


Provided the necessary steps are taken to fully exploit the resource,

we project consumption will grow from 23.8 Tcf in 2010 to approxi-

mately 31.5 Tcf in 2035, or an increase of nearly one-third, driven

largely by gains in the power sector, as well as sustained industrial

consumption, LNG exports, and potentially increased use of natural

gas for transportation (see Exhibit 8). An overview of projected

growth in domestic gas consumption in key parts of the domestic

economy is presented in Exhibit 8.6 In the sections that follow we

look at the industries and investments that would create this new

natural gas demand, and the benefits these would bring to the U.S

economy if the resource is successfully developed.

exhibit 8

Projected Growth in Natural Gas Consumption by Sector

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2011 2016 2021 2026 2031

ANNUALGR

OWTH(TCF)

OtherCommercial

ResidentialPower

Industrial (others)Industrial (GTL)

Industrial (petrochems)LNG Exports

Source: ICF estimates, October 2012

Recovering the Resource: Investment andEmployment from Expanded Explorationand Production

While recovering shale gas is now economically attractive, it re-

mains a capital intensive activity, with typical horizontal wells cost-

ing $5 - $10 million depending on location, geology, and commercial

factors. Some estimates put total cumulative capital expenditure for

upstream natural gas production at over $2 trillion between 2011

and 2035.7 These upstream investments average $80 billion annu-

ally over the period, and are associated with total dry gas produc-

6 Note that power sector gas consumption is projected to decline in 2013before resuming a steady growth pattern. This is the result of projections ofpower sector gas consumption in 2012 reaching 9.5 Tcf in 2012 as comparedto 2011 consumption of 8.1 Tcf. This large increase in consumption is theresult of industry taking advantage of historically low gas prices. As pricesfirm up in 2013, power sector consumption is projected to decline as itreverts to trend in 2013 and then resumes steady growth in the comingdecade.

7 ICF estimates, October 2012, Includes production of associated volumes oflease condensate and NGLs.

tion of roughly 35 Tcf annually by 2035.8 Over one-quarter of the

upstream investments are for the incremental growth in natural g

production, which would require over $560 billion in investments

between 2011 and 2035, and support over 500,000 new upstream

production and supplier jobs by 2035.9 We believe these high-pay

ing jobs have a significant multiplier effect in the broader econom

as well.

exhibit 9

Natural Gas Upstream Capital Requirements

U.S. UPSTREAM

NATURAL

GAS CAPITAL

REQUIREMENTS

2010$ BILLION

2011-2020 2011-2035

AVG. ANNUAL

EXPENDITURE

U.S. TOTAL* $649.0 $1,993.6 $79.7

DRY GAS ONLY $544.2 $1,671.5 $66.9

INCREMENTALPRODUCTION FROM2010* BASE

$107.8 $561.2 $22.4

INCREMENTAL DRYGAS PRODUCTIONFROM 2010 BASE

$90.4 $470.6 $18.8

Source: ICF estimates, October 2012. * Includes natural gas andassociated lease condensate and NGLs. Does not include oil wells.

Bringing Gas to Market: Investment andEmployment from expansion of NaturalGas Production and DeliveryInfrastructure

Bringing this new natural gas to market would require $205 billio

in infrastructure investment, or an average of $8.2 billion annuall

between 2011 and 2035 (see Exhibit 10). A recent INGAA report

found that these infrastructure investments would support rough

105,000 jobs between 2012 and 2035.10 Because infrastructure a

deliverability are key components of gas pricing, these infrastruc

ture expansions (including transportation, storage, and processin

are essential to maintaining the long-term price stability needed f

gas to reach its potential.11

8 ICF estimates, Includes production of associated volumes of leasecondensate and NGLs.

9 The INGAA Foundation. Jobs and Economic Benefits of MidstreamInfrastructure Development. INGAA Foundation, 15 February 2012:Washington, D.C.

10 The INGAA Foundation. Jobs and Economic Benefits of MidstreamInfrastructure Development. INGAA Foundation, 15 February 2012:Washington, D.C. Available at: http://www.ingaa.org/File.aspx?id=17744

11 Inter-state Natural Gas Association of America (INGAA) Foundation. NorAmerican Natural Gas Midstream Infrastructure Through 2035. http://wwingaa.org/Foundation/Foundation-Reports/Studies/14904/14889.aspx


13/22


exhibit 10

Natural Gas Infrastructure Capital Requirements

NATURAL GAS

INFRASTRUCTURE

CAPITAL

REQUIREMENTS

2010$ BILLION

2011-2020 2011-2035

AVG. ANNUAL

EXPENDITURES

GAS TRANSMISSIONMAINLINE

$46.2 $97.7 $3.9

LATERALS TO/FROMPOWER PLANTS,GAS STORAGE,PROCESSING PLANTS

$14.0 $29.8 $1.2

GATHERING LINE $16.3 $41.7 $1.7

GAS PIPELINECOMPRESSION

$5.6 $9.1 $0.3

GAS STORAGE FIELDS $3.6 $4.8 $0.2

GAS PROCESSINGCAPACITY

$12.4 $22.1 $0.9

TOTAL GAS CAPITAL

REQUIREMENTS$98.1 $205.2 $8.2

Source: The INGAA Foundation, 2011

Electricity Generation

The electric generation sector would be the prime consumer of the

expanded gas supply, with gas-fired generating capacity capturing

the lions share of new builds in the power sector. Gas consumption

in the power sector is forecast to nearly double between 2011 and

2035 increasing from 7.5 Tcf (21 bcf/d) to 13.3 Tcf (36 bcf/d) in or-

der to serve an additional 280 GW of gas-fired generating capacity

that will be brought online during this period (see Exhibit 11). This

enormous expansion in the gas-fired generating fleet would require

$245 billion in capital investment. It would also more than double

the labor force in the sector, which is forecast to rise from 50,000

to 120,000 employees between 2011 and 2035.12 These employment

gains include operations performed at the plants, as well as servic-

es, equipment, and materials provided to maintain plant operations.

12 ICF estimates, October 2012, These jobs do not include the job attritionrelated to coal plant retirements.

exhibit 11

Gas-fired Power Generation Employment to Doublethrough 2035

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

2011 2035

EMPLO

YMENT

(NO.)

Combustion Turbine

Combined Cycle

Source: ICF estimates, October 2012. Note: Employment includesoperations performed at the plant, as well as services, equipment, andmaterials provided to maintain plant operations.

Industrial Gas Use

The industrial sector has historically been the largest natural gas

consumer in the U.S. economy. However, during the past 15 year

gas consumption in the industrial sector has declined by 20%, as

manufacturers became more efficient, shifted production over-

seas, or moved toward less energy intensive products.13 Higher g

prices and price volatility from 2000 to 2010 had a significant rol

in this decline, and a particularly negative effect on such gas-inte

sive feedstock industries as ammonia and methanol, causing plan

shutdowns and increased imports. In our view, the abundant supp

of relatively inexpensive natural gas from the shale gas revolution

has already begun to reverse this decline.

Recent lower gas prices and increased supply have resulted in a

surge in industrial gas use, allowing shuttered ammonia plants

to reopen and other plants to be built or relocated from abroad14.

States are now competing with each other to provide economic

incentives to induce construction of capital-intensive new plants

within their borders. These developments can create a large num

ber of direct and indirect jobs and significant base load demand

for natural gasone ammonia plant (producing 1,500 metric tons

of product per day) could consume 44 MMcf/d, or as much gas as

165,000 CNG cars.15,16

13 U.S. Energy Information Administration (EIA). Natural Gas Consumption bEnd Use. EIA, 2012: Washington, D.C. Available at: http://www.eia.gov/dnang/ng_cons_sum_dcu_nus_a.htm

14 American Clean Skies Foundation (ACSF). Tech Effect: How Innovationin Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012:Washington, D.C. Available at: http://www.cleanskies.org/techeffect/

15 American Clean Skies Foundation (ACSF). Tech Effect: How Innovationin Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012:Washington, D.C. Available at: http://www.cleanskies.org/techeffect/

16 ICF

Bringing this new natural gas to

market would require $205 billionin infrastructure investment, or anaverage of $8.2 billion annually,

between 2011 and 2035.


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Within the industrial sector, natural gas is used as both a fuel and

feedstock. The largest gas users are quite energy-intensive and

include the food, paper, chemicals, petroleum refining, non-metallic

minerals, and primary metals industries. These industries account

for 79% of total industrial gas consumption, while chemicals and

petroleum refining alone account for 46%. Industries that use gas

as a feedstock tend to be the most gas-intensive17; these include

ammonia, hydrogen and methanol production. The following section

discusses two important future sources of gas demandGas-to-

Liquids (GTLs) and Liquefied Natural Gas (LNG) exportsand their

potential implications for the U.S. economy.

Gas-to-Liquids (GTLs)

One high-use industrial application for natural gas is as a feedstock

for GTL facilities. These plants convert natural gas to liquid fuels,

primarily a low-sulfur diesel fuel. This is another path to apply

natural gas for transportation applications, but the investment would

be in the fuel production rather than the delivery infrastructure and

vehicles, since the fuels are compatible with conventional diesel

and gasoline engines.

GTL plants are in operation in or near large gas-producing countries,such as South Africa (using gas from Mozambique) Qatar, and Malay-

sia, allowing these countries to capitalize on gas resources and limit

dependence upon traditional diesel and gasoline fuels.18 U.S. based

GTL plants could provide similar domestic energy security benefits.

It is likely that two such plants would be built in Louisiana; a Sasol

plant is expected to come partial ly online in 2017 and fully in 2018,

and a proposed project from Shell is expected to come online in

2019. These plants would require capital investment of $27 billion

over the 20-year life of the plant, and create nearly 215,000 direct

and indirect construction and operations jobs over the 20-year

period.19,20,21

These plants would also be major sources of natural gas demand,

consuming a total of 2.6 bcf/d (949 bcf annual), or an incremental

increase in GTL gas use of 17 Tcf over an 18-year period (2018-

2035). If the two GTL plants are successful, the U.S. may experi-

17 American Clean Skies Foundation (ACSF). Tech Effect: How Innovationin Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012:

Washington, D.C. Available at: http://www.cleanskies.org/techeffect/18 Energy Technology Systems Analysis Programme (ETSAP). Liquid Fuels

Production from Coal and Gas. International Energy Agency (IEA), May 2010:Paris. Available at: http://www.iea-etsap.org/web/E-TechDS/PDF/S02-CTL&GTL-GS-gct.pdf

19 Claus, Kristian. Sasol announces gas-to-liquids complex. KPLCTV, 13September 2011. Available at: http://www.kplctv.com/story/15452188/sasol-announces-selects-calcasieu-parish-as-location-for-potential-8-10-billion-gas-to-liquids-complex

20 Gold, Russell. Shell Weighs Natural Gas-to-Diesel Processing Facility forLouisiana. Financial Times, 4 April 2012: London. Available at: http://online.wsj.com/article/SB10001424052702304072004577323770856080102.html

21 ICF estimates

ence further GTL development.22,23,24

Because the GTL product is a petroleum substitute, a GTL plants

economic viability is a function of the gas and oil prices. GTL plan

require natural gas prices around $5 to $6/MMBtu to be economi

if crude prices are $80 to $90/bbl. With gas and oil prices projec

to stay in these ranges, based on the forward curve, GTL plants m

prove to be a profitable long-term investment. That said, the capi

cost is significant, nearly $10 billion for a 100,000 bbl/day plant25

and one plant in the Middle East has gone significantly over budg

GTL plants constitute a significant capital risk in the event that thfuel price spread shifts over time.

Liquefied Natural Gas (LNG) for Export

We believe another important potential source of gas demandansignificant balance of trade benefitsis development of LNG expo

facilities. As U.S. production ramps up and we shift from being a nimporter of natural gas to a net exporter, LNG export facilities are

likely to form a crucial link to external markets. However, there issome political opposition to allowing significant exports of LNG, dto concerns that these exports may drive up domestic prices and

harm U.S. competiveness. We believe this concern is overstated afails to take account of well-understand benefits of trade based up

U.S. comparative advantage in natural gas production costs.

The U.S. has a significant trade deficit and the earnings from LNG

exports would directly benefit the U.S. balance of trade. It is also

important to recognize that importing countries would likely not

be securing gas at prices comparable to U.S. wellhead prices, an

therefore not gain energy price competiveness. Rather, they wou

likely be purchasing gas at landed LNG rates typically linked to oi

prices, and are much higher than U.S. domestic prices. And, whil

exports could exert modest upward price pressure on domestic

pricingwhich should spur production growththese impacts ar

believed to be relatively modest and more than outweighed by the

economic benefits. One study estimated that export of 6 bcf/d (2

Tcf annually) between 2015 and 2035 would increase the Henry

Hub gas price by just 10% (or $0.64 per MMBtu).26

The U.S. Department of Energy (DOE) must approve all applicatiofor projects designed to export natural gas to countries with whom

the U.S. does not have a free trade agreement, and in so doing itmust find these exports do not harm the public interest. While theare several applications pending at the DOE, only one recent appli

tion has been approved, for Cheniere Energys 2.2 bcf/d Sabine Pproject in Louisiana. DOE retained an independent third-party con

tractor to review the economic impacts of proposed LNG exports,

22 Claus, Kristian. Sasol announces gas-to-liquids complex. KPLCTV, 13September 2011. Available at: http://www.kplctv.com/story/15452188/sasoannounces-selects-calcasieu-parish-as-location-for-potential-8-10-billiongas-to-liquids-complex

23 Gold, Russell. Shell Weighs Natural Gas-to-Diesel Processing Facility forLouisiana. Financial Times, 4 April 2012: London.

24 ICF estimates

25 http://www.iea-etsap.org/web/E-TechDS/PDF/S02-CTL&GTL-GS-gct.pdf

26 ICF International. Resource and Economic Issues Related to LNG ExportsUnpublished report, August 2011: Washington, D.C.


15/22


which is scheduled for completion by the end of 2012, and is not ex-pected to act on any further applications until this report is released.27 Canada is also seriously considering LNG export facilities.

Despite the significant economy-wide benefits, opposition to natural

gas exports remains a potent political issue. and regulatory or leg-

islative actions to restrict exports could undermine this important

opportunity. The U.S. has long been a champion of free markets,

arguing that free trade agreements are imperative for economic

growth. A restriction on exports, aside from eroding the longtime

stance of the U.S. on free trade, would exacerbate the U.S. netexport deficit, adversely impact domestic producers, and limit U.S.

growth opportunities in an already tenuous economic climate. Rec-

ognition of the general benefits of trade explains why the U.S. does

not place export restrictions on other essential commodities such

as wheat or soybeans, and the same logic should hold for LNG.

A recent report from the Brooking Institution, based on a yearlong

assessment of the implications of US LNG exports, reached the

conclusion that A proscription on LNG exports would constitute a

de facto subsidy to domestic consumers at the expense of domestic

producers. History suggests that government intervention in the

allocation of rents can lead to inefficient outcomes and unintended

consequences. To avoid these outcomes, the U.S. Government

should neither act to prohibit nor promote LNG exports. 28

Notwithstanding the current regulatory impasse, we expect that

three U.S. export facilities would be constructed and brought into

operation between 2016 and 2019. These three U.S. LNG facilities,

all located on the U.S. Gulf Coast, would require over $18 billion in

capital investments and create nearly 150,000 construction and op-

eration jobs over the 20-year lifetime of the plants. With a combined

capacity totaling 1.5 Tcf annually (4 bcf/d), these facilities would

also be major sources of demand, consuming an estimated 26 Tcf

between 2016 and 2035.

29

27 US DOE. http://www.fossil.energy.gov/programs/gasregulation.

28 Brookings Institution Energy Security Initiative (ESI). Liquid Markets:Assessing the Case for U.S. Exports of Liquefied Natural Gas, ESI, May 2012.P. 47.

29 American Clean Skies Foundation (ACSF). Tech Effect: How Innovationin Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012:Washington, D.C.

These facilities also have the potential to generate attractive re-

turns. Because oil is the alternative fuel for most LNG importers,

the price of LNG in the international market is typically linked to

oil prices. An oil price of $100/bbl equates to a landed LNG rate o

$12.00 - $15.50-/MMBtu, a significant premium relative to curren

U.S. gas prices.30,31This premium has resulted in great interest in

developing LNG export facilities in the U.S. 32

LNG facilities are, however, quite capital intensive, the average co

for a greenfield 1 billion cubic feet per day (bcf/d) LNG plant is es

timated at $4.8 billion, while retrofit of an existing import terminawould cost 65% of this, or $3.1 billion. The investment risk for an

export terminal would be borne by the developer.33

Employment in the broader economy

In addition to the direct investment and employment impacts as-

sociated with increased gas production and utilization the shale g

revolution would also have significant positive spillover effects in

the broader economy. A recent study found that the new product

techniques driving the shale gas revolution could produce betwee

835,000 to 1.6 million jobs by 2017.34 The study calculated the job

along the natural gas and oil value chain as a result of the domesnatural gas, oil, and NGL supply surge and found that the upstrea

and midstream sectors (i.e., natural gas production, transportatio

and processing) together require 13,000 annualized direct and ind

rect jobs per additional 1 bcf/d of production. The study estimated

that in oil and gas production, every $1.00 of direct and indirect

economic activity generates between $1.30 and $1.90 in induced

economic activity (thereby creating between $0.30 and $0.90 in

economic activity outside the oil and gas sector and its suppli-

ers). Taken as a whole, the shale gas revolution has the potential

increase GDP by 1.2% to 1.7% per year by 2017. 35,36

30 A barrel of oil contains 5.8 MMBtu, thus $100/bbl is the equivalent of $17.2MMBtu. Landed LNG is typically priced at 70%-90% of oil, or $12.00-$15.5MMBtu.

31 ICF estimates

32 ICF estimates

33 American Clean Skies Foundation (ACSF). Tech Effect: How Innovationin Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012:Washington, D.C.

34 American Clean Skies Foundation (ACSF). Tech Effect: How Innovationin Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012:

Washington, D.C. Available at: http://www.cleanskies.org/techeffect/, Thestudy assessed the incremental annual change in GDP, employment, andtax receipts for the U.S. that is directly attributable to upstream technologgains (i.e., horizontal drill ing, hydraulic fracturing). The methodology involcomparing forecasting assumptions and results on the U.S. natural gas anoil production and consumption forecasts from 2007 (before the recenttechnology gains were realized) to those of 2012. The study then comparethe difference in production between these two results, and estimated theimpact on the aggregate economy for each time period through 2017.

35 Ibid.

36 U.S. Bureau of Economic Analysis. Gross DomesticProduct (GDP): CurreDollar and Real GDP. U.S. Department of Commerce Bureau of EconomiAnalysis, 2012: Washington, D.C. Available at: http://www.bea.gov/nationaindex.htm#gdp

The U.S. has a significant trade

deficit and the earnings from LNGexports would directly benefit theU.S. balance of trade.


16/22


Transportation Sector Potential

Natural gas is currently substantially less expensive than pe-

troleum on an energy basis, yet transportation is the one sector

of the economy where gas does not currently play a substan-

tial role. The shale gas revolution has prompted renewed and

expanded interest in transportation applications for natural

gas, which would have significant balance of trade and energy

security benefits. The major obstacle to increased gas utiliza-tion in transport is fueling infrastructure, which is highly capi-

tal intensive and presents something of a chicken and egg

challenge. Natural gas engines themselves are already com-

mercially available. They would not be produced in significant

volume however, until there is sufficient fueling infrastructure

to support more widespread production and use of gas-fueled

vehicles. Two gas fueling options have significant potential for

development and growth:

1. Compressed natural gas (CNG) is stored in high-pressure

tanks and can be delivered via compressors from exist-

ing natural gas distribution lines. However, CNG vehicles

typically have a shorter operating range than conventionalvehicles.

2. LNG is gas cooled to a liquid at -260oF. LNG allows greater

on-board fuel storage and greater range, but also requires

additional infrastructure for liquefaction, transportation and

storage.

Urban Fleet Vehicles: The most immediate opportunity for

natural gas in transportation is for urban fleet vehicles using

CNG. This market includes either public fleets (e.g., city buses,

garbage trucks, other vehicle fleets) or private fleets (urban

delivery trucks, garbage trucks, company fleet cars and trucks).

The key factors that support this market are that the vehicles

can operate within the range of on-board CNG storage and can

return to a central facility every night for refueling. Short-haul

heavy-duty trucks that can be fueled with LNG from dedicated

fueling facilities may also be in this category. The investment is

very specific to each project and uses commercially available

technology. Individual refueling stations cost from $0.3 million

to $3 million. Natural gas engines are available and several

additional manufacturers are considering the production of

natural gas vehicles.

Heavy-Duty Trucks: Long-haul, heavy-duty trucks should use

LNG in order to achieve the range required for this market. Thehigh incremental cost of natural gas engines for these trucks

requires significant fuel savings to provide a positive return

on the investment. The payback also depends on individual

company turnover policy. Some companies sell their trucks

after only a few years, leaving not enough time for the fuel

cost savings to pay back the higher cost of the natural gas

vehicle. In addition, the secondary market for LNG trucks may

be weak if the buyers of used trucks do not have the resources

to maintain and fuel LNG trucks. Additional investments may be

necessary for owners to meet specific safety requirements for

LNG use (for example truck maintenance facilities may need to

be modified to allow work on gas vehicles).

In addition, public fueling infrastructure that includes liquefac-

tion and LNG transportation and distribution would be required

to ensure adequate coverage for a viable long distance truck-ing network. Development of a national fuel infrastructure may

require public investment to establish adequate support for

long-haul trucking through LNG fueling stations that can cost

$2.5 to $5.5 million dollars each. Additional investments would

be required for liquefaction and LNG transportation equipment.

Although efforts are being made to provide LNG infrastructure

along certain main truck routes, it is not clear how much fuel

coverage would be needed to make this a fully viable option.

Dedicated fleets with known routes and short haul trucks with

central fueling facilities would be the best early option.

Consumer Light-Duty Vehicles: Development of a large con-

sumer market for CNG vehicles should address the chickenand egg fueling/ vehicle problem. All required technologies

have been available for many years but consumer percep-

tions, resale issues and hedonic characteristics (trunk space,

vehicle range, search time for fueling stations, long refueling

time) as well as fuel availability have been a hindrance to the

market for many years. There is only one automobile manu-

facturer currently producing CNG vehicles, though others are

considering adding such vehicles.

Home refueling stations connected to residential natural gas

supply are available for as little as $4,000. Refueling facilities

at service stations can cost from $0.5 million to $3 million. Lo-

cal gas distribution companies (LDCs) or gas producers might

invest in home or public fueling stations, but LDCs might also

require approval from Public Utility Commissions to make such

investments. Additional investment may be required to create

a truly national infrastructure for CNG cars, and the hedonic

issues may still be a barrier.37,38

37 GTI. Removing Technical Barriers to Refueling NGVs at Home. GTI, 25September 2012. Available at: http://www.gastechnology.org/webroot/app/xn/Removing_Technical_Barriers_NR_09_25_2012.html

38 ICF estimates


17/22


Managing the Environmental Impacts/

Risks of Shale Gas

The preceding chapters have addressed how the shale revolu-

tion came about and its potential economic impact. This chapter

addresses the principal non-financial obstacle to realization of this

potential: public resistance to the resource based on environmental

and safety concerns.

Natural gas has long been viewed as the environmentally preferred

fossil fuel and as the best bridge fuel for the long-term transition to

a low-carbon economy. In fact, the environmental community has

frequently advocated for increasednatural gas use as an alternative

to coal. Despite this relatively benign view of natural gas gener-

ally, developmentof shale gas has become a polarizing energy and

environmental issue.

The social license to develop the newly accessible natural gas

resource is already facing significant challenges stemming from

environmental concerns related to the exploration and produc-

tion process. As evidenced in the fracking moratoria in New York,western Maryland, and parts of Pennsylvania, these concerns must

be addressed. Securing and maintaining social acceptance of shale

gas development is a key ingredient to long-term success.

There are water, air quality, land use, and seismicity impacts as-

sociated with exploration and production that must be acknowl-

edged and mitigated. Improved communications and transparency,

commitment to best practices and openness to appropriate regula-

tory oversight and enforcement would be keys to securing sus-

tained public acceptance. This section discusses the main areas of

public concern, the sources of the risks and impacts, how they are

regulated, and actions underway to reduce impacts and mitigate

environmental risk.

Shale Gas Regulation Rigor

There is public concern that shale gas production lacks effective

environmental regulation and enforcement. The industry is regu-

lated under a web of federal state and local regulations, and there

is increasing attention being paid by federal, state and local officials

to the adequacy of these regulations to protect public health and the

environment. Many aspects of oil and gas operations are covered by

federal environmental regulations such as the Clean Air Act, Clean

Water Act and the Safe Drinking Water Act. While there are a num-ber of partial exemptions for various oil and gas-related operations,

in our view there is no evidence that these exemptions resulted in

any significant environmental impacts. Nevertheless, there is some

public pressure for the Administration and Congress to reconsider

some or all of these exemptions.

The absence of federal regulation does not indicate a lack of

regulation. State and local authorities in gas-producing regions

have taken the lead in implementing regulations and, in particular,

regulations specific to shale gas production. Regulation specific

to hydraulic fracturing, frack fluid handling, and some aspects of

wastewater disposal is currently being implemented at both the

federal and state level.

Water Issues

Human health and environment issues associated with shale gas

operations include ground water and surface water contaminatio

and water resource impairment or depletion.

Ground water contamination: The headline concern regarding th

water impacts of fracking is that frack fluids, produced water, andor methane would migrate from the fracturing zone into aquifers,

contaminating drinking water supplies with methane, fracking fluisalts, other minerals and, in certain cases, radiological material.There are no documented cases of migration of fracking fluid or

methane (gas) from the fracking production zone of a shale gas p(where the fracking of shale takes place) to a drinking water table

EPAs investigation into potential ground water contamination neatight gas production wells in Pavillion, Wyoming, which began in

2009, has heightened concerns over potential ground water con-tamination and chemical use.39 More recently, the U.S. Geological

Survey (USGS) released data indicating ground water contaminatat the site.40 However, the Pavillion site is not a shale gas play, bua shallow tight gas play in which drilling is much closer to ground

water than in the shale gas plays currently being developed. Fur-thermore, at Pavillion there is evidence of well construction issue

and some evidence of surface spills, indicating that poor productiopractices may have played a role in contamination, and not the fra

ing itself. While highly unlikely, the risk of pollutants migrating froa fracking zone directly to groundwater can be greatly minimizedthrough careful pre-screening of the surrounding geology, and mo

toring of the geology as fracking is performed. Testing of ground-water prior to fracking, to create a baseline against which any

future changes can be evaluated, is also a practice recommendedorganizations such as the Environmental Defense Fund.

The public perception about the nature of water contamination ri

and the fracturing zone as a pathway for potential contamination

may result in part from a different definition of the term fracking

as it has entered the public lexicon. As used in the public discour

fracking refers to the entire exploration and production process,including horizontal drilling, fracturing, and extraction of the gas

via the well, rather than an engineering process for fracturing low

permeability rock.

39 U.S. Environmental Protection Agency (EPA).Investigation of GroundWater Contamination near Pavillion, Wyoming. EPA, 2011: Washington, D.CAvailable at: http://www.epa.gov/region8/superfund/wy/pavillion/EPA_ReportOnPavillion_Dec-8-2011.pdf

40 U.S. Geological Survey (USGS). Groundwater-Quality and Quality-ControData for Two Monitoring Wells near Pavillion, Wyoming. USGS, 2012:Washington, D.C. Available at: http://pubs.usgs.gov/ds/718/DS718_508.pdf


18/22


The principal pathways for potential contact between fracking fluids

and drinking water/the water table are via the well bore/casing,

surface handling of the frack fluids before and during the frack-

ing operation, and during the flow back of fluids up the well as the

cleanout process is completed. This is where the bulk of regulatory

and industry best practice activity is and should be focused.

There have been cases where methane from gas drilling has af-

fected groundwater. These incidents are believed to result from

well casing failure near the surface, where methane from non-pay

formations in the drilling path has infiltrated the bore.41 Proper wellcasing (steel piping used in 1-3 layers down the well) and cement-

ing (applied between each layer of steel well casing) ensures that

gas and fracking fluids do not migrate out of the pay-zone.

Well casing and cementing requirements vary from state to state,

based in part on geological conditions and operating experience,

with some requiring bottom-to-top cement circulation of production

casing and other states requiring cementing of production casing to

a certain height above the production zone. In an effort to address

public concerns and ensure safe operations, states such as Ohio

and New York are implementing more rigorous state-level well

construction measures (e.g., dictating the number of casing layers).

In Pennsylvania, a group of natural gas producers, environmental

groups and other stakeholders have formed the Institute for Gas

Drilling Excellence (IGDE) to jointly develop an independent certi-

fication program for superior environmental performance in shale

gas production. Overall, best practices and potential regulation are

focusing on better benchmarking of pre-drilling groundwater condi-

tions and better well casing practice to reduce the incidence of well

casing failures.

A related concern is the composition of the fracking fluids used in

the process and their potential impact on human health and water

supplies. Although such additives typically make up less than onepercent of the fracking fluid and are often absorbed onto the min-

eral surface, disclosure continues to be an area of contention. One

response is the FracFocus database, in which companies provide

chemical disclosure through a public database. States such as Cali-

fornia, Colorado, Michigan, Montana, New York, and Texas require

disclosure of fracking chemicals to state authorities, although the

specifics of what must be reported are variable. Additional re-

41 U.S. Geological Survey (USGS). Groundwater-Quality and Quality-ControlData for Two Monitoring Wells near Pavillion, Wyoming. USGS, 2012:Washington, D.C. Available at: http://pubs.usgs.gov/ds/718/DS718_508.pdf

quirements for reporting of fracturing fluid constituents are unde

development.

Surface Water Contamination: Another area of potential risk to

groundwater and drinking water relates to safe handling, storage

and treatment of the returning frack fluids. Roughly 20%-30% of

liquid injected to fracture a well is returned and that water conta

both the fracking fluid and hydrocarbons, salts and metals from

the shale formation. Spil lage can be addressed through improved

handling practices, including use of storage tanks and properly

sealed settling ponds to capture and store the wastewater, ratherthan unlined open ponds. In our view, treatment and disposal mus

be handled in geologically appropriate manners. Injection of drilli

wastewater in deep injection wells in the southwestern U.S. has

been an effective disposal technique, but we believe this is due to

the geology of that region. The geology in parts of the East (Marc

lus shale in Pennsylvania) is not conducive for this option, thus s

cialized wastewater treatment plants are being developed and so

wastewater is being transported to injection wells in other states

(e.g., Ohio). Wastewater is increasingly being reused for future

fracking jobs, which minimizes both water use and wastewater d

posal. Some aspects of wastewater disposal are already regulate

under the Federal Clean Water Act and Safe Drinking Water Act,

and states including Michigan, New York, Pennsylvania, and WestVirginia instituted new regulations on water use and disposal.

Water use: A final water-related concern is the water intensity of

the fracking process itself. This is a highly location-specific issue

Development of a well requires 3-5 million gallons of water (for

context, 5 million gallons of water is the equivalent to the amount

water required for 7.5 acres of corn over a season, or the amount

of water New York City consumes every 7 minutes).42 This can be

significant drawdown in arid or semi arid environments and/or lo

cally sensitive areas. As one of our most precious natural resour

es, we believe fresh water usage should be managed aggressivel

and reuse of water, as well as use of brackish water instead of

freshwater, should be encouraged and pursued by industry.

Chemicals Issues

Use of chemicals in the fracking fluid is a serious public concern

While ground water contamination from fracking itself is unlikely

mentioned above the preliminary results of EPAs investigation in

potential ground water contamination in Pavillion, Wyoming, has

heightened concerns.43 While the analysis of the USGS data is un

derway, a small but more likely pathway for contamination, relati

to that of well leakage, is spillage due to accidents or improper h

dling. Chemicals used in fracturing, particularly proprietary blendare sometimes not disclosed to health officials, though organiza-

tions such as FracFocus, which has a public database online, allo

companies to report chemicals used. Disclosure requirements ar

42 Chesapeake Energy. Water Use in Deep Shale Gas Exploration. ChesapeEnergy, May 2012. Available at: http://www.chk.com/media/educational-library/fact-sheets/corporate/water_use_fact_sheet.pdf

43 U.S. Environmental Protection Agency (EPA).Investigation of GroundWater Contamination near Pavillion, Wyoming. EPA, 2011: Washington, D.CAvailable at: http://www.epa.gov/region8/superfund/wy/pavillion/EPA_ReportOnPavillion_Dec-8-2011.pdf

Natural gas has long been viewedas the environmentally preferredfossil fuel and as the best bridge

fuel for the long-term transition toa low-carbon economy.


19/22


key concern that should be addressed through both regulation and

best practices to ensure safe practices and understanding of risks

in the event of contamination.

Air Emissions

Shale gas production generates air emissions under normal condi-

tions and has the potential to create additional pollution through

spills or accidents. Emissions are generated through releases of

gas during production (called gas venting and fugitive emissions),and from the trucks or other equipment needed during production,

as explained below.

Greenhouse gas (GHG) emissions: When combusted, natural gas

has the lowest GHG emissions of any fossil fuel. However, natural

gas itself is composed of methane, which when vented to the atmo-

sphere is a potent greenhouse gas. This is an important consider-

ation because fugitive methane vented to the atmosphere during the

exploration and production process reduces the overall GHG benefit

of natural gas relative to other fuels.

The largest potential source of these fugitive methane emissions

from shale production is during the period when fracking waterflows out of the well after the fracturing process. Methane en-

trained by this water can be controlled by flaring or reduced emis-

sion completions (REC) where the gas is captured and sent to the

pipeline. A numbers of states, including Colorado, Ohio, Texas (Fort

Worth), and Wyoming, have established regulations to control well

completion methane emissions. The EPAs recently enacted New

Source Performance Standards (NSPS), under the federal Clean Air

Act, requires RECs for completion or recompletion of hydraulically

fractured gas wells.44 Producers must comply by January 1, 2015, if

not sooner. These new regulations do not cover associated gas pro-

duction or liquids unloading, leaving a fraction of fugitive methane

emissions from natural gas production unregulated. Environmental

NGOs are likely to push the EPA to address these gaps in future

rulemaking.

While fugitive methane emissions are significant, recent stud-

ies show that the lifecycle GHG emissions from gas-fired power

generation are roughly 30 to 40% lower than coal, when fugitives

are taken into account.45 The data surrounding these estimates is

uncertain, leading the Environmental Defense Fund to partner with

the University of Texas and nine major gas producers to undertake

field measurements of production emissions, in an effort to get bet-

ter data to inform emission reduction efforts and future policy.

Air emissions: The conventional air pollutant emissions from shalegas production are diesel engine NOx and PM emissions from drill

rigs, pump engines, trucks, gas compressors and flares and volatile

organic compounds (VOCs) associated with venting of gas from

various production processes. The engines are regulated under

44 U.S. Environmental Protection Agency (EPA). EPAs Air Rules for theOil & Natural Gas Industry. EPA, 2012: Washington, D.C. Available at:http://www.epa.gov/airquality/oilandgas/pdfs/20120417changes.pdf

45 Christopher L. Weber and Christopher Clavin, Life Cycle Carbon Footprint ofShale Gas: Review of Evidence and Implications, Environmental Science &Technology 2012 46 (11), 5688-5695

conventional Clean Air Act regulations, but some producers are

voluntarily updating equipment to the most recent standards, and

some states are requiring more stringent limits.

Seismic Activity and Other Issues

Earthquakes: Noticeable seismic activity, mostly very small

earthquakes, has occurred in shale gas production areas. To date

investigations have linked almost all of these events to deep well

injection of wastewater, rather than fracturing itself.46 Deep well jection of hazardous wastes is a well-established practice and ha

been shown in the past to cause seismicity. Seismic activity relat

to fracking or disposal of fracking wastewater has been reported

in Youngstown, Ohio, the Eola Field in Gavin County Oklahoma, an

also in central Arkansas, Texas, British Columbia and in Lancash

UK. Nevertheless, new regulations are being developed to regulat

the injection of wastewater in areas of known seismicity.47 Regul

tory measures include site characterization and testing before, du

ing, and after disposal well drilling to assess the full seismic impa

of the underground disposal process.

Land Use and other concerns: Other issues, including the land us

footprint, traffic and road damage, and noise and light pollution aralso concerns related to shale gas production. The land use foot-

print of shale gas operations is actually less than that of conven-

tional wells due to the high production per well (through horizont

drilling) and the practice of drilling multiple wells per pad. Traffic

and road damage can result from truck traffic to transport materi

als, water and wastewater since each well can require over 1,000

truck trips. Noise and light pollution can also be disruptive to neig

boring residents. Supplying water via pipeline and reusing waste

water can help reduce truck traffic and disruption. There is a nee

to work closely with local communities in establishing operating

procedures that minimize community impacts and that set reason

able setbacks from homes, schools, hospitals and the like.

Conclusions on Environmental Risks

As with any significant extractive process, there are environment

impacts and risks. Efforts are currently underway to better chara

terize and manage key health and safety risks, reduce the footpri

and impact of the gas recovery process and develop additional

requirements and procedures that improve safety and performan

Well casing and cementing standards, wastewater handling and

treatment and reducing fugitive emissions are among the key are

for improvement. States will likely continue to focus on tightening

flowback water disposal requirements at wastewater treatmentplants, increase requirements for water well testing, increase sto

water control measures, and site restoration procedures. Industr

should continue do its part by actively engaging in the developme

and uptake of best practices and recognizing that environmental

performance will be a key determinant of sustained support for

development of the resource.

46 United States Government Accountability Office, Information on ShaleResources, Development, and Environmental and Public Health Risks, GA12-732, September 2012.

47 Ibid.


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Closing: Leveraging Natural Gas

The more than doubling of our natural gas supply is a truly disrup-

tive change in what had been a relatively stable energy supply out-

look. Prior to this, US oil and gas production was on the decline for

decades and many associated industries and business had moved

offshore. Today, this trend is reversing thanks to the shale gas

revolution. If exploited to its potential we believe the shale gas revo-

lution would provide lasting economic benefits and drive growth inlong-dormant or declining parts of the economy including manu-

facturing and basic industry, improve our trade balance, increase

energy independence, advance U.S. national security, and spur new

technology and innovation.

This paper has sought to illuminate some of the key issues, chal-

lenges and requirements to safely capture this tremendous oppor-

tunity. We are confident that with appropriate care, oversight and

industry leadership, the underlying resource can be safely devel-

oped and integrated into the U.S. economy in a manner providing

investment opportunity, economic and employment growth and

broad based social support. We also recognize there is diversity of

opinion regarding appropriate development of the resource, as wellas genuine environmental concern and risks to address.

We need to have a national discussion and work together to captu

this extraordinary opportunity. It is our hope that this paper can

make a useful contribution to this critical dialogue, highlighting th

following three principles for inclusion in this conversation:

1. The shale gas revolution represents a critical change in our

energy resource base that should be harnessed in a responsiand sustainable manner. Shale gas is our pathway to a clean

energy future, and we must take it.

2. The revolution in supply should be accompanied by sustained

demand-side responses including use of incentives to develo

and sustain demand, particularly in the transportation sector

where gas utilization can provide important energy security a

balance of payment benefits. Prudent levels of natural gas ex

ports should also be encouraged to maintain demand and red

our trade deficit.

3. The human health and environment risks and impacts of the

shale gas revolution should be addressed thoughtfully andcomprehensively, using a scientific and risk-based approach

mitigation of risks and impacts.


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Important Information

The views expressed in this publication are the per-sonal views of Marc Lipschultz of Kohlberg Kravis Rob-erts & Co. L.P. (together with its affiliates, KKR) anddo not necessarily reflect the views of KKR itself. Thisdocument is not research and should not be treated asresearch. This document does not represent valuationjudgments with respect to any financial instrument,issuer, security or sector that may be described orreferenced herein and does not represent a formalor official view of KKR. It is being provided merely toprovide a framework to assist in the implementation ofan investors own analysis and an investors own views

on the topic discussed herein.

The views expressed reflect the current views ofMr. Lipschultz as of the date hereof and neither Mr.Lipschultz, nor KKR undertake to advise you of anychanges in the views expressed herein. In addition, theviews expressed do not necessarily reflect the opinionsof any investment professional at KKR, and may not bereflected in the strategies and products that KKR of-fers. KKR and its affiliates may have positions (long orshort) or engage in securities transactions that are notconsistent with the information and views expressed inthis document.

This publication has been prepared solely for infor-mational purposes. The information contained hereinis only as current as of the date indicated, and may

be superseded by subsequent market events or forother reasons. Charts and graphs provided hereinare for illustrative purposes only. The information inthis document has been developed internally and/orobtained from sources believed to be reliable; however,neither KKR nor Mr. Lipschultz guarantee the accuracy,adequacy or completeness of such information. Noth-ing contained herein constitutes investment, legal, taxor other advice nor is it to be relied on in making aninvestment or other decision.

There can be no assurance that an investment strategy

will be successful. Historic market trends are notreliable indicators of actual future market behavioror future performance of any particular investmentwhich may differ materially, and should not be reliedupon as such. Target allocations contained herein aresubject to change. There is no assurance that the targetallocations will be achieved, and actual allocations maybe significantly different than that shown here. Thispublication should not be viewed as a current or pastrecommendation or a solicitation of an offer to buy orsell any securities or to adopt any investment strategy.

The information in this publication may contain projec-tions or other forward-looking statements regard-ing future events, targets, forecasts or expectationsregarding the strategies described herein, and is onlycurrent as of the date indicated. There is no assurance

that such events or targets will be achieved, and mabe significantly different from that shown here. Theinformation in this document, including statementsconcerning financial market trends, is based on currmarket conditions, which will fluctuate and may besuperseded by subsequent market events or for othereasons. P

kohlberg kravis roberts nov. 2012 report - historic opportunities from the shale gas revolution

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