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Acknowledgments
Mike BodellAllen Brooks
Perry Fischer
Robert Gray
Jim Halloran IHS
Lynn Pittinger
Keith Shanley
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Lessons Learned from Unconventional Gas Plays Unconventional gas is increasingly important in global energy supply mix
Two play types for tight sandstone gas plays in Rocky Mountains (Shanley)Widespread producing complexes (true resource plays) where trap definition is less
important than focus on pilot development projects & establishing an economic threshold
Unconventional reservoir plays where trap definition is critical and development areas
are more restricted (conventional trap plays)
Both involve large gas volumes & require a realistic assessment of charge potential but
require different approaches for commercial success
Drilling and fracturing methods differ & are critically important
Seismic is fundamental
Geology matters!
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4
Widespread belief that shale plays have ensured an
abundant supply of inexpensive natural gas
Little is known about the plays on which this belief is based While there is little doubt about the resource size, the cost
to produce it is probably much higher than assumed
ExxonMobil acquisition of XTO Energy makes shale players
feel they are on the right track
Why There is a Problem
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Exxon Mobil-XTO Energy Merger
Most analysts believe acquisition represents a dramatic shift bypremier global E&P company
Taken as a validation of shale plays
It is neither
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It is mostly about reserves
Consistent with the companys retreat from the international arena
A validation that natural gas is the short-term basis for North Americas
energy future: shale gas is an important component
Gas price will increase
An act of quiet desperation
Exxon Mobil-XTO Energy Merger
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Energy Realities: the resource pyramid Unconventional gas plays became
important as better plays wereexhausted
Tight sandstone, coal-bed
methane, & shale at the bottom
Economics are marginal
Mean & modal single-well
performance need to be placed in
context of Minimum Economic
Threshold (MET)
Companies whose stated strategy is
to find oil reserves onshore North
America dont understand the
resource pyramid or history
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Shanleys synthesis of tight-gas experience in the U.S.
Producing complexes like Piceance Basin Mesaverde (Williams Fork): true
resource play
Conventional fields with low-quality reservoir like Green River Basin Almond:
conventional trap play
Both have very large resource volumes
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Green River basin: conventional fields, tight reservoirs Gas ubiquitous but only commercial where traps can be
defined High net-to-gross, low permeability, marine sandstone
Emphasis on discrete development areas
Petroleum system risk is important
3-D seismic driven: pilots have limited value
Minimum Economic Threshold >> background resource
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Piceance basin: tight sandstone producing complex Development across 100s-1000s of
km2
Non-marine, low net-to-gross
sandstoneidentification of traps not
critical
Little petroleum-system risk
Reservoir characterization based on
areas and pilots
Manufacturing model
Minimum Economic Threshold ~=
background resource
From Shanle 2010
From Shanley 2010
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Shale Manufacturing Paradigm born in the Barnett Shale play:
Shoot, ready, aim!
Indiscriminate leasing in anacreage rush
Announce success & resource
size
Lease-driven drilling campaign
Find the sweet spot by the
Braille Method after 12,000
wells drilled
Do the hard science
CHK has spent $1.2 MM/well
on acreage for shale plays
(Bernstein Research, January2010)
"There was a time you all were told that any of the 17 counties in the BarnettShale play would be just as good as any other county," McClendon said. "Wefound out there are about two or two and a half counties where you really wantto be. --Bloomberg News October 14, 2009
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It is unlikely that most operators will reach their claims for average well EUR in a time frame
in which NPV10is meaningful
Many operator EUR is based on assumption of 40-65 years of well life with terminal decline
rates of 4-6%
The main difference between our EUR and the operators is the time required to reach that
EUR
We do not feel there is much NPV in about of operator EUR We also suspect that liquid loading will limit well life to far less than 40-65 years!
Reserves are overstated
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Most Likely Horizontal Barnett EUR is 1.1 Bcf (0.09 P75 -1.1 P50 - 1.4 P25)
0%
20%
40%
60%
80%
100%
120%
0
20
40
60
80
100
120
140
160
0 .0.
4.0.
8
1.
2.1.
6. 2 .
2.
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3.
2.3.
6. 4 .
4.
4.4.
8
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2.5.
6. 6 .
6.
4.6.
8
7.
2.7.
6. 8
CumulativePercent
Frequency(NumberofWells)
Bins of EUR
Barnett Shale Horizontal Well P50 EUR Histogram
Frequency Cumulative %
Mean EUR = 1.1 Bcf
Mode = 0.40 BcfMET = 1.5 Bcf @ $6.50 gas
Based on individual decline-
curve analysis of 1977
horizontal wells
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Barnett Type WellIncremental Net Present Value Added
by Time Periods of Production10% Discount Rate
How Important Is Assumed Well Life?
Used the CHK Type Curve for the Barnett Play
IP 2 MMscfd
D = 2.974/yr, b = 1.61
70% of Value produced in 1st 5 yrs
85% in 1st 10 yrs
Negligible value added after 20 yrs (
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Devon is the leading operator in the Barnett Shale with almost 4,000
wells (1/3 of all producing wells & dominates mid-stream)
Devon was first mover with Mitchell acquisition & later Chiefacquisition
"2009 was a pivotal year for Devon as we began repositioning the
company to focus entirely on our high-return, North American onshore
natural gas and oil portfolio."
--Larry Nichols, chairman and CEO of Devon Energy
How are we doing in the Barnett Shale?
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How are we doing in the Haynesville Shale?
Mean EUR = 2.6 Bcf, Mode = 2.0 Bcf
Minimum Economic Threshold = 5.0 Bcf: 10% of wells
Best wells are 8-9.5 Bcf EUR
A conventional trap play
Not a manufacturing play
MET
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14,000 wells to Cotton Valley before Haynesville Play began
Traps well defined by legacy production
Where to buy leases?
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Fallacy of the Manufacturing Modeltraps matter!
Haynesville Shale
structure map
Fayetteville Shale
structure map
Traps are critical and best production is in discreet areas
Similar to Green River Basin Almond
Pilots appropriate to characterize reservoir and best-practice
completion methods
Southwestern Energy did extensive pilot work in Fayetteville Shale
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Fallacy of the Manufacturing Model.
Operators represent shale plays as low- to no-risk ventures
Gas is ubiquitous & success can be achieved and repeated thru horizontal drilling &fracture stimulation
Pilot programs were few and late in Barnett Play, were used in Fayetteville, not in
Haynesville
Fundamental elements of petroleum geologytrap, reservoir, charge, sealare not
critical
An appealing model not supported by results to date Over-riding problem with shale plays is lack of reservoirno effective porosity &
permeabilities 100s-1000s times lower than tight gas plays
Artifical reservoirsmust be created by engineering brute force
Much progress with completion methods, but long-term production is elusive
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Fallacy of the Manufacturing Model: Barnett Shale
Barnett may be a true manufacturing play
Problem: Minimum Economic Threshold is above most
wells
Mode is 0.4 Bcf, Median is 0.8 Bcf, Median is 1.1 Bcf
Late results are better but a lot of capital has been
destroyed in the process
Early pilot programs might have been a good idea!
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
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6.0
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8.0
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9.0
1
181
361
541
721
901
1081
1261
1441
1621
1801
EstimatedUltimateRecovery(Bcfg)
Order of First Production
Barnett Shale Horizontal Well EUR by Order of First Production
Minimum Economic Threshold (MET) = 1.5 Bcf
Mean EUR = 1.1 Bcf
Mode = 0.4 Bcf
Median = 0.8 Bcf
MET
Barnett Shale Structure Map Showing
Horizontal Wells Above MET (< 30% of total)
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Pitfall: non-comparable analogues with dissimilar permeabilities
(0.00005-0.0003 millidarcies) & completion methods
And all have orders of magnitude better reservoir quality than current shale-play reservoirs: range of
permeability for shale plays is 0.00005-0.0003 md!
Few wells with > 10 years of production, none with 40-65 years, & few total wells Water-free production characterizes these examples but is a rare phenomenon
Shale that produces from natural fractures,
drilled vertically & not fracture-stimulated.Permeability range is 200-15,000 times
greater than current shale plays.
Sandstone that is drilled vertically & fracture-
stimulated. Permeability range is 100-167
times greater than current shale plays.
Limestone that is drilled vertically & not
fracture-stimulated. Permeability range is
1,000-1,667 times greater than current shale plays.
Chalk that is drilled horizontally & not
fracture-stimulated. Permeability range is
200-333 times greater than current shale plays.
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Operators claim that shale plays are low cost compared to conventional plays
Costs stated in investor presentations are less than those in public filings
Typically exclude sunk costs like land expense & geophysics, interest expense
Dont include dry holes (15% according to Bernstein)
Pitfall: Costs are understated
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Unit costs are understated
Companies state shale profitability at less than
$5/Mcf gas price, but their average unit cost ismore than that
Hedging has helped minimize losses since price
collapse, but difficult to find attractive hedge
prices for significant volumes in low-cost
environment
If the plays are so profitable, why cant thecompanies pay for drilling & leasing out of cash
flow? What about paying down debt?
Were losing money but making it up on
volume!
Company Market Cap $B EV $B Debt to Total Cap Capex to Cashflow
PetroHawk $7 $9 44% 385%
Range $8 $10 42% 163%
Chesapeake $17 $30 50% 161%
Devon $30 $37 32% 78%
XTO $28 $38 38% 52%
Southwestern $15 $16 30% 42%
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Pitfall: Higher gas prices will save the dayAverage inflation-adjusted
gas price since 1995 is
$5.50/Mcf Gas prices necessary to
make shale plays profitable
have only existed for brief
periods since deregulation
All previous gas price
spikes because of storage
shortfalls/decreased gas-
directed drilling
Opposite is occurring now:
storage surplus
If shale gas development
continues at current pace,
unlikely to get a new spike
to save the day
Why should the market
reward the lack of drilling
discipline by the shaleoperators?
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What is the premise of 100 years of natural gas supply? Potential gas committee report: 1,836 Tcf technically recoverable resources (P3) + 238
(P1) Tcf proved (~90 years supply @ current demand of 23 Tcf/year)
616 Tcf (about 1/3) is shale gas (27 years of supply @ current demand)The probable component (P2) of total resource is 441 Tcf (~ 19 years supply)
About 147 Tcf (1/3) of that is shale gas
Approximately 6.5 years of P2 shale gas supply at current consumption rates
Thats a lot of gas from shale, but not what is generally perceived
Operators claim more than that in both the Haynesville and Marcellus plays
Shale gas is 15-20% of total U.S. supply
Reserve Category Definitions
Proved P1 - reasonable certainty
Probable P2 - more likely than notPossible P3 - less likely than probable
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ExxonMobil Acquisition of XTO Energy
$31 billion in stock & assumption of $10 billion of debt--25%
premium above XTO stock price (XTO P/E ratio =12.8) Condition that Congress does not restrict hydraulic fracturing
Viewed as a dramatic shift by premier IOC to bet on U.S.
unconventional gas
Taken as a validation of shale gas plays
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2007, 2008, & 2009 were the companys worst years ever for reserve additions
2008 additions reported as 103% Without Canadian oil sands, replacement would have been less than 100%
2/3 of 2009 reserve additions are from gas discovered in Australia & Papua New
Guinea years ago
Just added because processing facilities completed in 2009
Unconventional gas represents the only remaining scalable resource
SEC revisions more liberal & allow appropriate technology for proved reserves
Acquisition driven by XOMs need to add reserves
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XTO has gas production and positions in many plays
XTO has great representation in the shale plays, but 83% of production is from
tight gas, conventional gas, and coal-bed methane
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Long-term natural gas price will rise Price will accommodate marginal cost of production eventually
Energy demand will grow & natural gas will fill a larger proportion ofenergy mix
Percent of unconventional gas will increase compared to conventional
Shale gas the best of a bad lot for majors
XOM is betting that technology, efficiency, & increased demand & price
will lead to commercial success
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Only a dramatic shift to those not paying attention
Winners Curse speech by Kurt
Rudolf at AAPG Annual Meeting inLong Beach, 2007-- few new
opportunities not already captured
in international arena
XOM applied petroleum
system/basin analysis methods toNorth American basins
XTO positions were a good fit
Opposite approach to Gold Rush
Showcased Piceance Basin tight
gas sand play: Multi-zonestimulation technology
Most resources currently in
Americas
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Only a dramatic shift to those not paying attention
Tight gas play in Hungary (Pannonian Basin Mako Trough)
Shale play in Horn River Basin (Canada) Leased 20,000 acres in Pennsylvania Marcellus in August, 2008
290,000 acres in Marcellus with Pennsylvania General Energy
Ongoing commitment to Canada oil sands
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Unlocking Tight Gas
Use technology to crack the code first with tight sandstone reservoirs,
then with shale
Use the Multi-zone stimulation technology to produce shale in vertical wellsthat cost less
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Conclusions
Approach to shale plays in U.S destroys capital
Reserves are overstated Costs are understated
Why it is important
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Implications Shale gas plays will be a permanent & important part of the E&P landscape
They require peak market conditions to be commercial based on historical
gas prices
Companies that bet everything on shale plays (or any single play-type) will
have a competitive disadvantage through 80% of the price cycle
Tight sandstone plays are preferable because of better reservoir & matrix
storage capacity: shale players should learn from 3 decades of experience
Focus on trap definition (seismic) and best fracture technology for the play Seismic attribute mapping to define optimum reservoirs
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Troubling implications Massive capital investment & debt load in projects that have not yet
demonstrated sustainable value Undisciplined drilling & resulting over-supply keeps prices low
Ongoing asset sales, share offerings & new debt: present level of
drilling & leasing cannot be paid from cash flow
High decline rates mean the drilling treadmill must continue
A potential bubble when the music stops: tighter credit, higher interest
rates
4 16 44185
392
769
1325
2330
2669
0
500
1000
1500
2000
2500
3000
2000 2001 2002 2003 2004 2005 2006 2007 2008
NumberofWellsCo
mpleted
Horizontal Barnett Wells Completed
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Closing thoughtsXTO approached XOM about merger
implications about cost, competitiveness,environmental & legal battles pending
Hungary play failed & XOM exited
Piceance basin play is non-commercial to date
XOM feels that it needs to learn from XTO, but
may not be able to retain employees
ExxonMobil came late to the shale party & paid
a high price of admission (diluted shareholders)
May have overvalued high-decline rate wells
XOM overhead structure and cost may not fit
with operating 1000s of low-rate gas wells
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Closing thoughts ExxonMobil understands the technical risks &
uncertainties in unconventional plays Made realistic projections about reserves and
costs
XOM bet is that efficiency, science & technology
will bring commercial success
Bring abundant capital and little debt to plays
dominated by highly leveraged companies
Bet is based on assumption that price will rise
Less clear that XOM appreciates the business
risks from undisciplined competitors who over-
produce and keep prices low as long as the
market provides capital
We are awash in gas today because the market continues to distribute funds to companies
that destroy the capital they are given. There is no type of skillful way to differentiate a
positive shale well from a negative one. I believe this is the dilemma you should focus on.
CEO of a public gas E&P company, personal communication (January 2010)
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Lessons from North American Unconventional Gas Plays
Ohi Oil & G A i i
Thoughts about ExxonMobilsacquisition of XTO Energy