Page 20 The Northeast ONG Marketplace

INDUSTRYINSIGHT

By: Rick Stouffer, Senior Energy Editor, Shale Energy Business Briefing; & Kristie Kubovic, Director of Communications, Shale Media Group Edited By: Mindy Gattner, Editor, Shale Media Group

With 2014 behind us, it’s time to take one last look back on the year that was. Some of 2014’s most newsworthy stories included: the Ebola epidemic in Africa; the rise of the new terror threat, ISIS; the disappearance of the Malaysia Airlines plane; the protests in Ferguson, Missouri; and the rise of unconventional shale oil and gas industry in the United States.

That last one may not have made the mainstream media; however, we, here at the ONG Marketplace, Shale Media Group, and Shale Energy Business Briefing recognize the impact hydraulic fracturing and horizontal drilling has had on the region, the United States and the world this past year. As a result, here are our Shale Oil and Gas 2014 Top Five stories for the industry:

#1: Ethane Cracker Takes Major Step Forward by Shell Exercising Property Option

For nearly three years, Shell Chemical has methodically plodded along concerning its proposed “world-class” ethane cracker, which has never progressed past the “may be built on land in Beaver County, PA, near Monaca,” stage.

Permits have been applied for, discussions with state Department of Transportation officials concerning possibly relocating roads to a more cracker-friendly location have been held, numerous public forums have taken place, and ethane suppliers have been secured. The list of preliminary steps taken by the Royal Dutch Shell unit is long and as one would think, expensive.

Still, no decision to break out the gold-painted ceremonial shovels for photos has been made – at least publicly.

Shell is considering construction of a cracker, which would take ethane supplied from the Marcellus and Utica Shale plays, and break it into primarily ethylene, a building block for numerous plastics.

One estimate places the need for construction workers for the complex at 20,000, with the process taking years to complete.

However, in early November, Shell took what many considered a huge step on the road to a cracker when it said it’s exercising its option on the Horsehead Corp property near Monaca.

“Shell can confirm the statement by Horsehead Corp that we are exercising our land option to purchase Horsehead’s property in Beaver County, PA, having determined the site is suitable for the potential development of our proposed facility,” Shell said, in a statement. “However, we have not made a final decision to build the project; we will make that decision when our full project evaluation is complete.”

“The land purchase is a necessary step for Shell to advance the permitting process and allows us to proceed with some preliminary site development work,” according to the Shell statement.

Several hurdles must be crossed before Shell can make a final investment decision. The company is in the engineering and design phase for the project, which also would include more than one polyethylene facility onsite.

Major regulatory permits, such as a state air permit, must also be green-lighted. Many of the permits Shell is seeking require it to be the owner of the property, officials said, explaining the timing of the land purchase.

The entire evaluation process has been slowly moving forward since spring 2012, when Shell signed the option with Horsehead on the 340-acre property. The company extended the option three times, paying $3.9 million for the extensions.

Last January, Horsehead began demolition on the former smelter site, with Shell paying for the work, slated to be completed early next year.

#2: Lower Crude Oil Prices a Stepping Stone to Idled Rigs, Possible Layoffs

This past June, the price of crude worldwide began to dip from the roughly $107/Bbl price point it had become embedded in.

Not a tremendous amount of attention was paid to what was seen by most inside and outside the industry as a slight, very temporary, blip.

Six months later, the slight blip has become a living nightmare not only for oil producers, drillers, and anciliary services providers, but soon could negatively impact businesses whose only contact with the industry are the workers who frequent their grocery stores, restaurants, and beauty salons.

The pace of issuing new permits to drill new wells has plummeted, right along with cuts in producers’ capital expenditure (CAPEX) budgets for 2015.

The next step is expected to be pulling drill bits out of the ground, aka, laying rigs down.

“We believe permitting trends are the first step in watching drilling rig/completion crew activity as CAPEX budgets in 2015 begin to take effect; this should quickly show up in the numbers of OFS [oilfield services] companies, depending on their basin exposure before impacting company, regional, and US production in late-2015/early-2016,” Irene Haas, Managing Director, and Jason Wangler, Analyst, with

SHALE OIL AND GAS 2014 TOP FIVE

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Wunderlich Securities, wrote in a Dec 22 research note.

“The hardest hit basin on the permitting side so far has been the Williston, with permits really showing the effect of low oil prices in the partial month of December,” Haas and Wangler wrote.

US producers haven’t begun laying down drilling rigs yet, but experts say 2015 capital expenditure budgets must be cut or chopped, depending on the company.

“Lower oil prices mean an individual well will turn cash flow positive much later in its life,” Kathryn Downey Miller, a Partner with the Lakewood, CO-based consulting/analytics firm BTU Analytics, said in a blog post in December.

“Why does this matter?” Miller continued. “Because the primary source of capital for new drilling is cash flow from operations. And the most difficult time to obtain capital from banks and the capital markets is when the market becomes anxious about commodity prices.”

Miller told SEBB the full impact of lower crude price is being delayed for some producers due to hedging, but smaller, more leveraged producers are already feeling the impact and announcing lower capital budgets for 2015, including on average 20% to 40% cuts.

The number of permits let falling, CAPEX plummeting, producers contemplating laying rigs on the ground – don’t forget the impact of low oil prices on the junk bond market – where many cash-starved companies went to finance their operations over the last half-decade.

Producers, midstreamers, and oilfield services firms levered up over the last few years, as money was readily available at great rates and, when drilling $8 million, $9 million, $10 million wells, cash flow assistance is a way of life.

The oil price plunge is deepening concern among bond investors that the least creditworthy oil players will have a difficult time staying current with their obligations, and prompting bankers to pull in the credit reins as revenue slumps.

“We’ve already reached the point where the public debt markets are closed to low-rated companies,” Ben Tsochanos, a New York-based Analyst with Standard & Poor’s, told SEBB.

With the market oversupplied, growth in higher-cost plays is expected to slow, resulting in lower demand for oilfield services, including rigs and completion services.

Lower demand for services and equipment will lead to cutbacks in personnel, experts say.

#3: Marcellus/Utica Production Projections Up – But Tracking can be Tricky

Natural gas production in the Marcellus Shale play can be illustrated with what some industry watchers say are whacky numbers, but all data continue trending just one way: upward.

The amount of gas pulled from the ground in the Marcellus went from near zero in 2005, to an average in 2007 of 760.06 million cubic feet per day (MMcf/d), 1.12 billion cubic feet per day (Bcf/d) in 2009, to 2.20 Bcf/d one year later, according to Denver-based consulting firm BTU Analytics.

From 2011 through 2014, average Marcellus production jumped from 4.31 Bcf/d, to a whopping 14.42 Bcf/d, BTU Analytics told Shale Energy Business Briefing (SEBB).

Where does production go from here? Speakers at two recent conferences, one held in Canton, Ohio, the other in Pittsburgh, said the Marcellus/Utica combined will be flowing 30 to 32 Bcf/d by roughly 2020.

“I have no doubt the 30-32 Bcf/d production total can be accomplished with intensive drilling over the next five years,” Penn State Professor Terry Engelder told SEBB.

Before the Tri-State area breaks into a collective “Happy Days Are Here Again,” experts say there are potentially numerous potholes that have slowed or could even stop the Bcf production march.

“Currently, it is only a lack of takeaway infrastructure that is constraining production growth and creating a large backlog of wells waiting to come online,” Erika Coombs, Senior Energy Analyst for BTU Analytics, told SEBB. “In fact, BTU Analytics estimates that in December, there are more than 1,500 wells that have been drilled, but are awaiting infrastructure build-out to begin producing at capacity.”

Cleveland State University Professor Iryna Lendel said at the recent Utica Summit II conference in Canton the Utica alone needs $30 billion in additional infrastructure to handle production needs.

Coombs said the well backlog, paired with what she called the “extremely favorable economics in the region,” support the firm’s outlook that production in the Marcellus will not be significantly impacted by the current weak oil price environment “and will grow by over 10 Bcf/d between now and the end of 2020.”

“Next year alone, we expect over 2.5 Bcf/d of growth due to continued drilling activity and the completion of several pipeline projects which will add over 3 Bcf/d of new pipeline takeaway capacity to the region,” Coombs told SEBB.

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“Four potential stumbling blocks [to reaching the 30-32 Bcf/d production mark] would be new, restrictive regulations, a significant change in political support in

PA/WV/OH, taxation implications and/or social license issues,” Tom Murphy, Co-Director of Penn State University’s Marcellus Center for Outreach and Research, told SEBB.

#4: US Becomes World’s Largest Oil Producer – But Keep an Eye on Prices

Sometime during 2014, the exact date argued over by experts, the United States recaptured a title it hasn’t held in decades: world’s largest crude oil producer.

America’s production by one estimate has climbed more than 4 million barrels per day (MMBPD) since 2008 and, at least for now, is not falling in relation to the off-the-table drop in crude oil prices worldwide within the last six months.

Since 2008, domestic crude production has jumped nearly 49%, from 5 MMBPD, to 7.44 MMBPD in 2013 and, through the first nine months of 2014, to an average 8.45 MMBPD, according to Energy Information Administration (EIA) data.

However, most of the huge production increase in the US – which should have caused crude prices to fall -- was swallowed by what was happening in other parts of the world, summed up in one word: unrest.

Since 2008, issues, including a civil war in Libya, US and European oil sanctions on Iran, and just the usual helter skelter economy in Iraq, forced crude production in those countries down.

The 4 MMBPD of crude production the US added to the world market since 2008, plus production increases in Canada and Russia, had minimal impact on global prices because the above problems took 75% of the increase off the market, Kent Moors, Founder and Editor, “Oil and Energy Investor,” told Shale Energy Business Briefing (SEBB).

The impact of the huge increase in drilling, specifically horizontal drilling and the use of hydraulic fracturing to pry the crude from its cozy stone bed, in the US has been staggering, in terms of economic impact and more specifically, employment.

Drilling proponents say hydraulic fracturing brings good jobs and prosperity. The drilling industry supported 2.1 million jobs in 2012, across all 50 states, and could support 3.9 million by 2025, according to one study.

Another study places total shale oil and gas industry-related employment in the 10-million-employee range.

So-called unconventional drilling has led to a virtual manufacturing renaissance in the US, with companies actually bringing manufacturing back to this country from overseas due to the inexpensive oil and natural gas here.

The chemical industry alone has announced more than 100 projects worth tens of billions of dollars under construction or planned due to low-cost natural gas.Since June, crude prices have sunk by more than 40%, to roughly $60/Bbl, causing much gnashing of teeth inside and outside the industry.

The recent drop in crude prices won’t kill off the US shale oil industry, experts say, it’ll just make it more efficient.

“The party the shale plays have been having is gridning to a halt,” Irene Haas, an energy Analyst in Houston with Wunderlich Securities, told Shale Energy Business Briefing (SEBB). “Numerous companies are cutting CAPEX because they have to. Production will drop in the second half of 2015.”

Profit margins and break-even points are relative not only to the price of oil, but also to the cost of doing business, experts said. As oil prices drop, producers will renegotiate expensive oil service contracts, slash wages for their workforce, and cut perks to bring their costs in line with the depressed price for crude.

The demand for oil remains strong, which should provide an adequate floor for producers in the long run, but only after they get their finances in order, industry experts said.

#5: MLPs End 2014 with Flourish; Kinder Morgan Taking a ‘Breather’

Publicly-held master limited partnerships (MLPs) solidified their hold on the US energy industry, as more and more companies saw the financial pluses associated with the 33-year-old investment vehicle.

Shale oil and gas industry players such as Consol Energy, EQT, Rice Energy, Shell, and Antero Resources, to name just a few, sold units (as opposed to shares in a C corporation) earlier in 2014.

A total of 18 MLPs offered shares via initial public offerings this year, with more than a dozen more filing the necessary paperwork with the US Securities and Exchange Commission, waiting on better economic conditions to pull the proverbial trigger. In 2013, 21 energy-related MLPs went public. MLPs aren’t a new investment vehicle – the first MLP, Apache Oil, was launched in 1981 – but they do represent a different investment type to many investors and financial advisors.

Basically, a MLP is a publicly-traded limited partnership, recognized for their tax benefits since they are pass-through entities that generally avoid corporate income tax at both the state and federal levels since they’re classified as partnerships. MLPs must derive at least 90% of their income comes from “qualified sources” as per Internal Revenue Service guidelines.

MLP unitholders receive income distributions which are taxed at his or her tax rate.

MLPs are controlled by a general partner, which typically holds a 2% general partner interest in the MLP, plus additional partnership units. The general partner

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generally receives a percentage of the MLP’s cash flow off the top. Called incentive distribution rights, or IDRs, the percentage varies and may start low, but can quickly increase as distributable cash flow grows.

Today, there are roughly 90 oil and gas-related MLPs traded on public stock exchanges.

With interest continuing to grow in MLPs, a very unexpected turn of events occurred this past August, which caught many MLP-interested investors by surprise.

Richard Kinder, one of the pioneers in the MLP movement, CEO of MLP general partner Kinder Morgan Inc, and head of two of two huge MLPs, Kinder Morgan Energy Partners and El Paso Pipeline Partners, announced the master limited partnership format no longer fit Kinder Morgan’s purposes.

The former Enron executive said he wanted to buy the two publicly-trade partnerships that Kinder Morgan Inc had been managing – for $70 billion.

Kinder saw the future and the future was, in a GP-MLP arrangement, in which the general partner is offered unlimited units as compensation, the general partner can virtually suck the economic life out of its charges.

In Kinder Morgan’s case, after 17 years, the GP was getting 45% of the MLPs’ income. Kinder and his executives realized the structure had to change to lower the cost of capital and allow the MLPs to invest in more projects.

While Kinder appears to have left the MLP structure, at least one MLP expert says

that’s not exactly the case.

“Rich Kinder didn’t exit MLPs, he took a detour,” Ethan Bellamy, Managing Director at RW Baird & Co, told Shale Energy Business Briefing (SEBB). “I expect he will remain a key player in the MLP sector, either through a carve out of a new MLP from the new Kinder Morgan Inc, or the acquisition of an existing MLP’s general partner that would allow him to drop in assets over time.”Bellamy expects MLPs to be challenged in 2015 by what he called a “flagging oil price and overall lackluster performance from the energy complex.” “Think of them as the best house in a bad neighborhood,” he told SEBB.

Looking Toward 2015

While cracker plants, dropping crude oil prices, Marcellus production, US becoming the world’s largest oil producer, and MLPs may have taken the top spots for the shale oil and gas industry in 2014, only time will tell what 2015 will bring. Politics and short term oil and gas prices will surely play pivotal roles in 2015, along with the accelerated midstream construction and the increased talk of exporting. Whatever the case, the shale oil and gas industry has altered the regional and national outlook in just a few short years and looks to continue doing so in 2015.

Shale Media Group (SMG) is the news, information, and education resource dedicated to the shale oil and gas industries by messaging across video, Internet, publications, events, and radio. For more, check out ShaleMediaGroup.com to access all platforms, including SMG’s latest news delivery system - Shale Energy Business Briefing (SEBB), an ad-free subscription based service, where subscribers receive a real-time, daily email, featuring concise, hard hitting shale news 7 days/week, 365 days/year. To sign up, go to sebb.us. In addition, join us on January 22 for our next Elite Energy Event in at the Holiday Inn in Monroeville, PA from 5-8pm. Rick Stouffer is the Senior Energy Editor at Shale Media Group. Contact him at RStouffer@ShaleMediaGroup.com. Kristie Kubovic is the Director of Communications at Shale Media Group. Contact her at Kristie@ShaleMediaGroup.com.