Oil and Gas Market Update

VMA Market Outlook Workshop Chicago, IL

Spears & Associates, Inc. Tulsa, OK

August 2012

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Macro-Economic Outlook

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Oil Markets Worries about economic growth in the EU, US, and China pushed oil prices below $80 recently. Analysts expect oil demand to grow 1%/year in 2012 and 2013 as growth in emerging countries more than offsets lower use in developed nations. OPEC’s surplus production capacity is set to increase over the next 18 months, but most of the net gain will be held by Iran and off the market due to sanctions. Oil markets are expected to remain well-supplied over the next several years, keeping prices from rising. However, efforts to offset slow economic growth by injecting liquidity into the financial system are expected to support oil prices.

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Spot WTI Prices ($/bbl)

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Gas Markets Warm weather last winter led to record gas inventories this past spring and a 50% drop in gas prices. Near-parity with coal prices has in turn led to a large increase in gas use in the power sector this year.

The combination of rising gas demand (up 5% this year), shutting-in existing gas wells, and less new gas field development has gas storage on track to return to near-normal by the start of this winter. As excess inventories have begun to fall, gas prices have rebounded from below $2/mmbtu to over $3/mmbtu recently.

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US Spot Gas Prices ($/mmbtu)

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NGL Markets

Just as a glut of natural gas has decoupled US gas prices from oil prices, increased natural gas liquids (NGL) output has begun to depress NGL prices relative to oil. The price of an NGL “barrel” is now about 40%-45% the price of oil – down from 60%-65% the price of oil last year - as lower-value ethane has flooded the market and propane prices have collapsed. NGL production is forecast to rise about 15% year-over-year in 2012. We estimate that US NGL production will reach 3.0 million bpd in 2017, up 0.8 million bpd from 2012.

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Drilling Outlook

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Impact of Volatile Oil and Gas Prices on US Drilling Activity

Overall US rig activity has gradually slowed since peaking in late 2012 as the decline in gas drilling activity (Haynesville Shale, Barnett Shale, Marcellus Shale, etc.) has more than offset an increase in oil drilling activity (Permian Basin, Bakken Shale, etc.). Drilling in liquids-rich regions such as the Eagle Ford is just now beginning to be impacted by weak NGL prices. Despite these trends, overall US rig activity is on track to average 1,950 active units in 2012, up 5% for the year.

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Impact of the Slowdown in US Drilling Activity On Well Costs

The decline in rig activity this year has left utilization of equipment and personnel slightly lower in most regions and in most segments. Well cost components: • Rig: 25% • Pipe: 15% • Stimulation: 25% • Other: 35% We project that well costs will fall another 5% through mid-2013 before beginning to recover as utilization picks up.

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Near-Term Exploration and Production Operating Environment

Oil and Gas Operator Perspective Budget using conservative commodity price estimates ($80/bbl oil, $3/mmbtu gas) Infrastructure constraints to keep NGL prices weak Strategy

• Keep capex within cash flow • Acquire producing assets from distressed operators • Expect to reduce well costs through both operational improvements and price reductions

Oilfield Equipment and Service Company Perspective Activity to remain slow for 12-18 months Access to capital markets reduced/eliminated; primary funding source to be free cash flow Strategy

• Control costs to protect/improve margins • High-grade customers; avoid thinly-capitalized, high-cost operators • Challenge other service firms for market share • Spend for replacement but little/no growth capex • Acquisition opportunities as operators spin off in-house service firms

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US Drilling Outlook

Oil rig count price sensitivity: Oil prices below $70/bbl: down~20 rigs/month Oil prices ~$80/bbl: no change Oil prices above $90/bbl: up ~20 rigs/month Gas rig count is projected to fall 15% year-over-year in 2013. Drilling in gas regions will continue to slow over the balance of 2012, although at a slower pace, and then begin to recover in mid-2013 on the strength of a recovery in gas prices. Oil rig count is forecast to grow 15% year-over-year in 2013. Although oil prices will be little changed from this year, oil drilling in 2013 will be helped by lower overall well costs. Overall US rig activity is expected to increase 6% in 2013 to 2,075 active units.

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US Drilling Outlook

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New Wells Drilled

Vertical Horizontal

Of the 49,500 new wells to be drilled in 2012, almost 17,000 will be horizontal, up from ~8,000 new horizontal wells in 2008. The forecast calls for almost 18,000 new horizontal wells to be drilled in 2013, up 6% for the year.

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It is critical to differentiate new wells between vertical wells and horizontal wells because a horizontal well will consume ~2.5x the equipment and services of a nearby vertical well drilled into the same zone. The value or total cost of drilling & completion (D&C) is best quantified by looking at the measured depth of the well, rather than if the well is vertical or horizontal. The graphic on the left shows 2 wellbores: one vertical, one horizontal. Both wellbores have a total vertical depth of 10,000’, but the horizontal well has a 5,000’ lateral, giving it a total MEASURED depth of 15,000’. D&C cost rises approximately exponentially to measured well depth. A rough rule of thumb is that for every 5,000’ increase in depth, total D&C cost increases by 2.5x. The chart on the right shows a typical D&C cost by total well depth relationship.

Drilling and Completion Costs Versus Well Depth

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US Drilling Outlook

A small decrease in the cost to drill and complete new wells is offsetting the 5% increase in drilling activity, leaving overall US drilling and completion expenditures little changed in 2012. These trends are expected to remain in place for 2013.

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Drilling and Completion Expenditures ($ Bil)

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Canada Drilling Outlook

Canadian drilling activity is forecast to fall 5% in 2012, to an average of 400 active rigs. Oil rig count is on track to grow ~8% in 2012 while gas rig count is projected to decline over 20%. An improvement in gas prices driven by a sharp fall in gas production is expected to lift Canadian drilling activity ~5% next year. The National Energy Board (NEB) expects that over the 2012-2013 timeframe that new gas drilling will not be adequate to offset the decline in production from existing wells. In May, Canadian gas production was over 6% lower than the year-ago level. Based on current trends, Canadian gas production could drop about 1.0 bcfd to around 12.2 bcfd by the end of this year. This would be the lowest gas production rate since the early 1990s.

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Canada Rig Count

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International Drilling Outlook

International rig activity is expected to increase 5% in 2012 to ~1,200 active units, about 15,000 wells drilled and over 100 million feet of hole. Drilling activity is forecast to increase 4% in 2013 to an average of 1,250 active rigs. By region: Africa (+6%), Central and South America (+4%), the Mid East (+4%), the Far East (+3%), and Europe (+3%). Barclays Capital projects that International exploration and production spending will grow by 12% to over $450 billion in 2012. The increase is being driven by large national oil companies and North American independents that are shifting some of their natural gas spending to overseas markets. However, excluding China, no significant unconventional reservoir development is expected to occur over the next five years. 800

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International Rig Count

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Related Markets

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Oilfield Equipment Spending

The existing “stock” of specialized equipment used for onshore drilling, completion, and production – drilling rigs, pressure pumping equipment, well servicing units, etc. – has an estimated replacement value of about $120 billion. Drilling rigs represent ~50% of this figure. In the US spending on new oilfield equipment is projected to exceed $14 billion in 2012 (60% for growth capex; 40% for replacement capex), down ~8%. A sharp fall in spending for new frac equipment will drive another 15% drop in US oilfield equipment spending in 2013.

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US Oilfield Equipment Expenditures ($ Bil)

US Onshore Oilfield Equipment Stock by Type

Drilling Rigs

Frac Spreads

Cementing Units

Coiled Tubing

Well Service Units

Wireline Units

Cased Hole Units

Flowback

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Frac Horsepower Additions

During the original frac HHP ramp up in 2004-2008, demand was driven by activity in just three basins: Barnett Shale, Fayetteville Shale, and, at the end, the Haynesville Shale. From 2009 onward, the ramp up was driven by multiple stage frac jobs in every basin across the US – all the gas shales, plus the oil shales and the conventional oily plays. There is no major basin in the US where high rate multiple stage frac jobs are not done these days. But the frac fleet has now caught up with and outstripped demand. Orders for new pump trucks began to fall sharply in Q1 2012 and frac pump shipments have now begun to fall sharply as well as backlogs are worked off.

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Quarterly Horsepower Additions in North America

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Summary

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Summary

An expected combination of flat oil prices, weak NGL prices, and slowly recovering gas prices is likely to keep operators cautious about their near-term plans for capex and drilling activity through 2013. With growth and pricing constrained, operators and OFS firms alike are expected to focus on margin/share improvement, selective acquisitions/divestitures, and new market opportunities. As significant slowdown in NAM pressure pumping capex is underway as utilization and pricing weakens. Net additions to the NAM frac fleet are unlikely to take place from year-end 2012 to mid-2014. As a result, in the US spending on oilfield equipment is expected to fall ~15% in 2013.