Natural Gas Contracts: Sale of the Product Drafting and Negotiating an Agreement for
Purchase of Natural Gas Products
Advanced Oil and Gas Short Course
Sponsored by
University of Houston Law Foundation
Houston, TX – June 11-12, 2009 – Hilton University of Houston Hotel
Dallas, TX – June 18-19, 2009 – Cityplace Conference Center
Arthur J. Wright
1722 Routh Street, Suite 1500
Dallas, Texas 75201
214.969.1303
Arthur.Wright@tklaw.com
(999905 000003 Dallas 2497293.1)
The Man - Andy Weissman
Gas Market
09/07/06 to 09/07/08
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IS GAS MARKET HEADED FOR PRICE CRASH?
Absent a Monster Hurricane – we had one
LNG Imports Up

Did not happen; US oversupplied in 2008
 Storage will be at record levels
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Record storage and production
Coldest Winter in 10/11 years
Prices headed down
2
Fracs
Time for the Fracs of Life
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

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
US Petrochemical plants dying
No consumer; Ethane rejected!
Industrial demand bottomed
Cheap oil – cheap NGLs
Frac spreads cause NGLs to go into gas
1-2 Bcfd additional supply
3
Canada

Production 2007 - 16 Bcfd
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
2010 – 10 Bcfd
2014 with unconventional gas – 16 Bcfd
Canadian potential growth
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Coalbed
Shale
Tight
Total all sources:
- 660 trillion cubic ft.
- 600 trillion cubic ft.
- 565 trillion cubic ft.
- 2,150 trillion cubic ft.
4
Canada (cont’d.)

British Columbia, Muskwa shale and Horn River
and Montreal Quebec shale may replace Alberta
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Horn River 15-150 wells by end of 2010
EOG, Nexen, Devon, EnCana and Apache are players
Montreal (tight gas) 240-300 wells by end of 2010
Issues – Pipelines, gas volatility and people to man rigs
6/30/08 – Horn River two wells produce 5 & 6 MMcfd day
5
Canada (cont’d.)

Utica Shale (4,000 ft.)
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
Triangle Petroleum:
►
►

Talisman drilled well in QuebecLorraine shale below Utica
Forrest testing wells also (269,000 acres)
516,000 acre shale play Nova Scotia
68,000 acre shale play New Brunswick
Mackenzie pipeline:
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Planned to be on-line 2009
No approvals given
Earliest date 2014
Needed? – US market supply up!
6

Marcellus
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
US Shales
8/25 Range
 100 wells drilled
 25 horizontal
 last 4 wells – 4.9 Mcft per day
 850,000 acres – reserves
 15 Tcf to 22 Tcf
Water procurement and disposal a key
2 years or longer – moratorium in NY
Atlas Energy – 580,000 acres

►
80 mostly vertical wells, 60 MMcfd production
Atlas – 2 stage vertical frac
 Doubles per well production
 Also drilling horizontal
 Atlas plans 100 horizontal wells in New Albany Shale through
2009.
CNX - Marcellus horizontal well rate of 6.5 MMcfd
7
US Shales (cont’d.)

Marcellus
►
CHK says no rapid expansion as in Barnett due to
regulatory, topographic, water and infrastructure issues

How big? Too early

Gothic Shale Colorado – Bill Barrett Corp.

Pearsall Shale in Maverick County
►

Encana, TXCO, and Anadarko hold positions
in Far West Texas Play
Equitable developing Huron and Cleveland shales
8
US Shales (cont’d.)

Haynesville
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8 weeks production – wells show no significant decline
8-11 Devon announces


Goodrich Petroleum flows
►

73 Tcf under their 483,000 acres
7 MMcfd Panola County Well
CHK – Haynesville
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has 440,000 acres
potential reserve


►
20 trillion cubic feet
Barnett is 2 trillion
Spent 2005 to evaluate

data from 450 wells studied
9
Shales

Haynesville - 12/08/08 - Exco announces 23 Mcf
well – Petrohawk announces wells 23 to 30 Mcf

Woodford 9/22/08
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production 550 Mcft (Barnett 3.6 Bcft)
Newfield – 40% of production
BP buys CHK acreage (25% - 1.75 billion)
4,100 ft. laterals
Devon (6 rigs), Continental (5 rigs), XTO (5 rigs), Antero (4
rigs), BP (4 rigs) and Newfield (12 rigs)
Woodford wells 7.1 MMcfd and 6.7 MMcfd
10
Shales (cont’d.)

North Louisiana has CBM at 2,500 ft. - 4,000 ft. that Equals to
Powder River players
►

Geomet, EnerVest, Southwestern and Samson
Fayetteville
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08/08/08 Southwest Energy – 500MMcf/d (200 in 2007)





22 rigs running
80 acre spacing
619 wells
554 horizontal
10/27/08 - Petrohawk announces S. TX play in Eagle Ford
Shale – two wells 15 miles apart over 9.1 million cubic ft
equivalent
11
Shales (cont’d.)

12/03/08 - Energen chases Conasauga and
Chattanooga shales without CHK

Tristone is assuming $8.50 gas shale production to
go from
6.8 Bcfd to 19 Bcfd by 2018
►
►
Short term Haynesville and Fayetteville will dominate
Montney, Marcellus, Utica and Horn River – thicker



may require stacked horizontal well bores
more gas per well bore
Shale production
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1998 – 1 Bcfd
Today – 5 Bcfd
Compounded rate over 20%
12
Shales (cont’d.)

Deutsche Bank-Study Shale initial 1st year
declines 65-75%
►
Flattens out in 3rd/4th year (10-15%) (MI)

2000 1 Bcfd in Antrum and Devonian Shales
 Appla - 84% of Shale
 2007 4 Bcfd Plus
 Marcellus and Horn River will trump Barnett
►
One Commentator

Haynesville to pass Barnett in 5 years
 Shale plays most significant discovery in 50 years
 21 Shale basins
13
Shales Technology
Technology – Horizontal Laterals
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Contact more shale – longer laterals
Better fracing - high frac rates and “packers” – 20 stages
Fluids out of cracks and flow back
Decrease drilling time – use of coiled tubing
Better control of pressure and tool placement
Dissolve calcite in rocks with chemicals
Williams
►
Barnett – using sequential and simultaneous fracs
 2 wells – one week job
ExxonMobil
►
30 new technologies to extract oil from shale
14
Shales Technology
(cont’d.)
6/30/08
Encana Technology
Bighorn well costs - down $2.4 Mcf per well
Haliburton “swellable packer”
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reduces frac time and costs – 2-3 days vs. 30 days
fit for purpose rigs 20%-30% faster
Multi-well pads cut cost 15%
Barnett – EOG recovery
factor:
► 10-12%
in 2004
► 20% in 2005
► 30% in 2007
► 50-55% late 2007
XTO in Barnett:
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28 days to drill well 2005
20 days to drill well 2007
16-17 wells permits per rig vs. 12
CHK
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14 days to drill well and 1.5M cost
15
Shales Technology
Breakeven
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Marcellus Haynesville Fayetteville Barnett (Core) -
$3.17
$4.73
$5.00
$5.00
(cont’d.)
Plus
$35 Billion to develop Haynesville
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Break even 10% pretax IRR
Barnett – Core $5.12;
Non-Core $6.32
Fayetteville $5.07
Haynesville $4.73
Marcellus $3.17
Woodford $6.11
16
Prices

Market supplied without Marcellus or Horn River
and

LNG to increase to avoid flooding lucrative Asian
and European markets.
17
Prices (cont’d.)
01/10/08 – Raymond James forecasts $6.50 for 2008
03/19/08 – Raymond James – says prices to fall in summer
06/09/08 – Raymond James up forecast for 2008 to 10 MMBtu vs. 8 MMBtu
08/31/08 – EIA says shale production could reduce LNG demand in US
09/10/08 Raymond James drops price projection
► for 4 Qtr. $7.50 vs. $10
► Wall Street consensus $11 plus
09/10/08 – EIA – If hurricane, onshore supply will prevent run-up in prices
10/15/08
► 50% Gulf Production shut in
► Future prices drop 50% from 7/08
► 200 Bcf goes to pipe and storage pressure
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Prices (cont’d.)

Gas Storage
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06/14/09 - Storage at 2,213 Bcf – 31% above year-to-year and normal




EIA Reserve largest gain since 1977 (year began review)
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12/22/08 – EIA by 2030:

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


Natural gas prices will allow production to equal 24 trillion Cft
Electricity production to rise by 25% and
natural gas to 22% of production
Electric growth majority gas and renewables
Hybrid vehicles 38% of market
Rex Maintenance
►

20% plus above normal injections
Start of season – 20% plus above 5 year average
Near record ’08-09 winter heating season
Rockies gas below $1.00 (45¢)
Third quarter 08 worst for commodities since 1970
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Pipelines

Rex brings gas to Mid Cont

TX / NM markets cannot go east

Haynesville shale

TX and Gulf Gas prices to drop relative to Rockies
and LA
20
Pipelines (cont’d.)

MLPs need credit
►
Model 





Cash flow to distribution
Large capital needs debt or stock (dilution)
Demand Strong for services
Producers drilling new fields not HBP
No Pipe in area
MLPs
►
Outspending Cash Flow with distributions
21
Pipelines (cont’d.)
Midstreams
 Cut backs
 Maturity of debt
 MLP’s need capital - where?
 MLP’s - who will build infrastructure?
 E&P
►
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spend drilling money on pipe?
pay private equity for pipe?
22
Pipelines (cont’d.)
2007-2008 Ziff study – Mackenzie and Alaska gas

MacKenzie
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
$33 Billion for 6 Bcfd
Alaska
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$20 Billion for 1 Bcfd vs. LNG $10 Billion for 1 Bcfd
What about $5.00 gas?
23
LNG

LNG – 4 built in ’90’s and ’80’s – Everett, MA; Cove Point, MD;
Elba Island, GA and Lake Charles, LA
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
Two idle; two little activity
US surplus supply / low prices
Freeport and Cheniere permits to export US gas
4 New US facilities in 2009 to receive gas – most without supply
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Freeport opens – no supply – one tanker scheduled – 08/09
Cheniere for sale – no dedicated supply

19 New “trains” at 12 plants to produce LNG
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Winter “world” 08-09 LNG prices 24-30 MMBtu
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Algeria outage in LNG plant
Freeport LNG – set to EXPORT!
US LNG not needed until 2012 or beyond
Wood Mackenzie says LNG could be 14% of US supply after 2012
and 20% in 2020
24
LNG (cont’d.)

LNG – 2008
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
Tankers – usually 8 built per year
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

17 counties import
29 importers – 2012 - US has storage
57 in 2008 and 42 in 2009 and 40% larger
New Exxon “QMax” Technology increases ship
capacity 80% - decrease energy consumption 40% per unit
Pritchard Capital forecasts LNG surge
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U.S. prices $3/Mcf
Qatar production cost in pennies
Plus $2 Mcf to transport
25
Production/Reserves

EIA reports: 2007 – 46.1 Tcf
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record high reserve additions doubled 19.5 Tcf produced;
highest 31 years
13% increase over 2006 reserves
2007 Shale - 9% of US reserves:




50% increase year to year
TX - 17% gain - 13.3 Tcf
Rockies - 26% gain - 6.2 Tcf
Horizontal rigs
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133 – 2005
600 - 2008
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Production/Reserves
(cont’d.)

2006 plus 2.1 Bcf/d + 4.7%

2007 plus 2.5 Bcf/d + 5.3%

2008 plus 3.5 Bcf/d + 7% (TX ½ - Barnett)

Last drop 2002 – 2 Bcf/d – 3.8% - 400 fewer rigs

US has 2,247 Tcf of gas
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118 years at 2007 demand
Every EIA projection exceeded by actual production
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World Turned Upside Down



JAPAN – Ten years from commercial production
Methane Hydrates
US Federal Waters “100s” of Tcfs of gas in
Methane Hydrates
North slope 85.4 Tcf in Methane Hydrates
28
World Turned Upside Down (cont’d.)

In 1st half 08 half of gas consumed was from wells drilled in
last 40 months

In 2006, was 48 months

US unconventional gas 10 times recoverable volume
conventional gas

Worldwide – translate US shale lessons?

Ziff forecasts
►
Unconventional Gas “53%” of production by 2020
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N.A. production 87 Bcfd in 2020 vs. 70 Bcfd in 2000
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Shales the key
29
NGLs
NGLs-the heavier components of the natural gas
stream
►
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C2
C3
iC4
nC4
C+5
ETHANE
PROPANE
ISO – BUTANE
NOR – BUTANE
COMMONLY CALLED NATURAL GASOLINE
30
NGLs (cont’d.)
Comparison of Gas and NGL Value
►
NATURAL GAS
► ETHANE
¢/GALLON
MMBTU/GALLON
$/MMBTU
--19.33
--.066320
2.022
2.91
31
NGLs (cont’d.)
Uses for Natural Gas Liquids
 Component: primary uses
 Ethane: petrochemical feedstock for the manufacture of ethylene,
which is the building block for the manufacture of polyethylene,
styrene and many other products.
 Propane: liquid fuel for homes, industry and transportation
(60%); petrochemical feedstock (23%); and farm use, exports and
miscellaneous (17%).
 Iso-butane: refinery feedstock for the manufacture of alklylates
and mtbe which are used as high-octane blending components in
motor gasoline.
 Normal-butane: refinery feedstock for direct gasoline blending or
isomerization (66%); petrochemical feedstock (24%); and fuel
(10%). Diminishing use for direct gasoline blending with EPA RVP
limitations.
 Natural gasoline: primarily used as a blending agent in motor
gasoline. Also, refinery and petrochemical feedstock.
32
NGLs (cont’d.)
Keepwhole and ‘At Risk’ Contracts
 "Producer (seller, buyer, etc.) is "keptwhole" on the
Btu valve of the gas delivered to the plant." Risk is
borne 100% by the processor.
 Processor is "at risk" as to financial relationship
between the raw material value (the keepwhole value)
and finished product value (NGL prices).
Netback Pricing
33
NGLs (cont’d.)




NGLs from crude is competition
Crude drives NGL prices
Unconventional gas fewer NGL’s
MARKET PROBLEMS
►
►

Price Fluctuations
Conflict of Interest
CONFLICT ENCOURAGES
►
►
Inefficient Plants
Low Plant Prices
34
NGLs (cont’d.)
►
REMEDIES
 "Drop out" Clause
 Look at Plant Statements
 Are fuel/shrinkage unusually high?
 Avoid processor net backs
 Or
 Conway Kansas or M. Bellview
 Avoid netback at plant or county
 Negotiate fixed charges/fuel, etc., up front.
35
NGLs (cont’d.)
Humble Oil and Refining
Humble Oil and Refining Company and Pan American Petroleum Corporation just completed an audit of
Champlin's books covering our Carthage Plant operations for the period from August 1, 1955, through December
31, 1957. Since commencement of processing at the Carthage Plant in 1946, these two companies have audited
the operation of this plant for themselves and on behalf of others four separate tines starting in the year 1950.
During this most recent audit (just completed in 1958) a question was raised for the first time as to the language
in the processing agreements as compared to the actual procedure used by Champlin for the allocation of plant
liquids which procedure was agreed upon and set forth in a letter agreement dated June 8, 1948, between the
Panola County Royalty Owners Association to The Chicago Corporation dated June 11, 1952.
The procedure used in allocating plant liquids, since this agreement was made with the Royalty Owners
Association, is fully reflected in the Gas and Liquid Production and Disposition Report. After a review of the
matter, Humble agrees with Champlin that this procedure, which has been in actual use since 1948 and as
adjusted slightly in 1952, is most equitable; and after reviewing the entire matter, Pan American expresses no
disagreement with the procedure.
Certainly, a prime requisite for a fair and equitable allocation of liquid products derived from a commingled
stream of gas is that the allocation method and procedures for each and every source of gas be identical. We
have, therefore, been employing the procedure worked out with the Royalty Owners Association consistently
during all this time, and all parties have been fully advised of the allocation through the monthly reports
mentioned above.
We take this opportunity of advising you that it will be our practice to continue to employ the aforementioned
procedure as to all producers connected to our plant. If you have any question as to the procedure as
heretofore employed, and which we propose to continue, or as to any other matters pertaining to our processing
agreement with you, we will be glad to discuss the matter with you. Unless we hear from you to the contrary
within thirty (30) days, we will consider that our suggestion for continuing this procedure meets with your
approval.
36
NGLs (cont’d.)
Plant Allocations
►
►
►
►
►
►
No formulas followed
Audit formulas for liquid downstream
Audit residue gas stream
Audit measurement
85% netback can be better than 90%
Fixed allocation -- not actual
Processing Contracts
►
Fee for Service
► Percent of Proceeds
► Fee and % of Proceeds
► Keep Whole
37
NGLs (cont’d.)
Processing Key Issues
►
Duty to Process

Uneconomic
 Unprofitable
 Good Faith
►
►
►
►
Keepwhole Rights
When is 85% of the liquids (NGLs) better than 90%
Conflict of Interest
Fuel and Shrinkage – Incentive
38
NGLs (cont’d.)
“Trigger Words”
►
►
Economic – prudent and thrifty in management; intended
to save money; efficient
Profitable – the return on a business after expenses; an
advantageous gain or return; income; payment for a
commodity in excess of cost (American Heritage College
Dictionary – 3rd Edition.)
39