# Presentation: 409752

## Natural Gas Price Volatility: 

**Natural Gas Price Volatility: **
**Causes, Implications and Solutions**
**DOE/EIA NEMS Conference****	****March 12, 2002**

**Volatility Has Been Increasing**
**	****40% (****annualized monthly****) in 1990**
**	****Over 60% in 2001**
**Major Drivers**
**	****Shifting supply/demand fundamentals**
**	****Market deregulation; Politics**
**	****Volatility in other fuels and weather**
**	****Speculative activity**
**Implications**
**	****Impacts financial performance**
**	****Boom-bust cycles; Hinders planning **
**Offsets**
**	****Size; Integration; Operational Flexibility**
**	****Hedging; Contracts; Improved Information**

**Adam Sieminski (410) 895-3347**** **adam.sieminski@db.com

-      Photo Credit::  BBC News - Deutsche Bank trader

**Notes:**
Oil and gas prices from 
g/energy/adam/2_tables/prices.xls

refining margins from o/weeky energy wire/ refin2.xls
tab:  margin forecasts

## A New Trading Range for U.S. Natural Gas?...still expecting prices to settle at low-end of $3-4 range

**A New Trading Range for U.S. Natural Gas?**...still expecting prices to settle at low-end of $3-4 range

**Deutsche Bank estimates:**
**2002       $3.00    2003       $3.15**

**Notes:**

energy/adam/3_tables/spotgas.xls

numbers come from Weekly Natural Gas newsletter, monthly

## Importance of Gas Price Volatility...complicates ability to plan and budget

- Affects the financial performance of producing companies and stability of income of producing governments
- Accentuates upstream boom and bust cycles, resulting in over-investment and under-investment
- Hinders the ability of industrial users (fertilizer, petrochems, metals, paper etc.) and electric generators to plan purchases, thereby slows the corrective mechanism for pricing

- Source: Deutsche Bank (after Edward Morse, Hess Energy Trading)

## What Is Natural Gas Price Volatility?...a measure of historical variability and risk

- A combination of
- Magnitude
- Duration
- Common Sense Notion:  rapid and radical price changes, as occurred in the run-up from $2 in early 1999 to $10 in late 2000, and back to $2 in 2001
- Technical Definition:  the annualized standard deviation of percentage changes in daily futures prices

- Source: Deutsche Bank (after Edward Morse, Hess Energy Trading)

## U.S. Crude Oil and Natural Gas Prices 1990-2002...oil:  volatility at the start and end of the decade;...gas:  unprecedented volatility in 2000-2001

- Source: Nymex; Bloomberg; Deutsche Bank (YTD March)

- Saudi Arabia as a buffer?

- US FERC as a buffer?

**Notes:**
G/energy/adam/2_tables/pricehilow.xls
info from Bloomberg
CL1 [commodity] gp [go] 01/01/01 to ytd
NG1 [commodity] gp [go] 01/01/01 to ytd

## Natural Gas Wellhead Prices (Real $)...spike surpassed the mid-1980s peak

- Source:  U.S. DOE/EIA; Deutsche Bank estimates

**Deregulation**

**Notes:**
G/energy/adam/2_tables/oil1860.xls

## Natural Gas Prices 1990-2002...since the start of gas futures trading in April 1990 

**Notes:**
G/energy/adam/3tables/gas/db gas volatility calculation.xls

## Natural Gas Price % Changes 1990-2002 ...monthly volatility appears to be rising

**Notes:**
G/energy/adam/3tables/gas/db gas volatility calculation.xls

## Natural Gas Historical Volatility 1990 - 2002 ...technical definition clearly on the rise

**Notes:**
G/energy/adam/3tables/gas/db gas volatility calculation.xls

## Absolute Monthly Gas Price Change- Log Scale	...under 10¢ in the 1980s to almost 50¢ now

## Root Causes of Gas Price Volatility...changing fundamentals and changing markets

- Fundamentals
- less production surplus
- shift in demand to more inelastic users
- greater variability in temperatures / rainfall
- more dependence on storage
- less storage relative to demand
- Market liberalization, deregulation and “politics”
- More volatility in competing fuel prices
- Dynamics of the futures markets

- Source: Deutsche Bank (after Robert Mabro, Oxford Energy)

## U.S. Gas Well Completions vs. Gas Production...production lag suggests shrinking supply surplus after 1994

- 5500

- 10500

- 15500

- 20500

- 25500

- 1985

- 1986

- 1987

- 1988

- 1989

- 1990

- 1991

- 1992

- 1993

- 1994

- 1995

- 1996

- 1997

- 1998

- 1999

- 2000

- 2001

- 2002E

- 15000

- 16000

- 17000

- 18000

- 19000

- 20000

- 21000

- Source: DOE/EIA, Deutsche Bank estimates

- Well completions (left axis)

- Production (bcf, right axis)

- Linear Trend wells

## Rig Count and Production Are Related...individual years differ, but trend lines match 

**Notes:**
G/energy/3tables/gas/coalbed methane.xls

## Supply Impacted by Shifts in the Rig Count...lower US gas rig count may constrain supply in 2002-2003

**Notes:**

energy/adam/2_tables/rigcount.xls

info comes from Baker Hughes website:  www.bakerhughes.com

Rig Count tab

International rig count excel spreadsheet

## U.S. Gas Demand and Supply ...supply up and demand rebalance in 2002...focus shifts from NUGs to base industrial use

**Notes:**

energy/adam/2_tables/table5.xls
worksheet: summary

## New Baseload Electric Plant Costs...long run with $3.20 gas and $1.20/mmBtu coal 

## More New Baseload Electric Plant Costs...combined cycle gas technology is still the preferred choice

## Incremental Natural Gas Demand for Electricity Generation...huge growth in capacity for gas non-utility generation...but not all of it shows up as consumption

**Notes:**
G/energy/adam/2tables/

## Value of Natural Gas as a Percent of GDP...importance jumped in 2000-01-- settling back down?

**Notes:**
G/energy/adam/2tables/gdpworksheet.xls

##    A Recent Warm Winter Trend?

- ...followed by a reversion to cold?

- Source:  NCDC, Deutsche Bank estimates

*The Economist *Magazine, November 18-24, 2000

**Notes:**

energy/adam/2_tables/heating.xls
worksheet:  hdd trends

##  ENSO Index for the Seven Strongest El Ninos	...often brings warm winters and cool summers

## Sources for Gas Distribution at Peak Demand...price volatility increases as firm contracts decline and dependence on storage rises

- Source:  American Gas Association

## Natural Gas Inventories vs Prices...prices increasingly determined by storagedue to lower surplus production

## Natural Gas Inventory Cover of Demand...the trend since 1983 has been down

- Source: DOE/EIA, Deutsche Bank

## Total U.S Natural Gas Storage...warm weather keeping storage full...uncertainties in NUG and industrial demand

- Source:  AGA; Deutsche Bank estimates

## Major Factors Driving Natural Gas Demand...the economy and weather with some price impact

-    %Δ Gas Demand  =  1.0 x %Δ Real GDP
- 			+ 0.250 x %Δ HDD
- 			+ 0.075 x %Δ CDD
- 			+ 0.075 x %Δ Real Oil Price
- 			-  0.100 x %Δ Real Gas Price (lag)
- 			- 0.300  (constant)

- Source: Deutsche Bank

## GDP Forecasts Are Volatile...slowdown presents a major downside risk to demand

**Notes:**

energy/adam/2_tables/table12.xls
worksheet:  trends

## Gas Storage Net Withdrawals vs. Heating Degree Days...a month with 800 HDDs suggests a 500 bcf net draw from storage

**Notes:**
G/energy/adam/2_Tables/heating.xls

## Gas Storage Additions and Cooling Degree Days...additions slow when the weather is hot...and the wide scatter suggests predictability was lowbut CDDs are more important in recent years

- Note: Data covers May-September, 1993-2000
- Source: NOAA/NCDC and DOE/EIA

**1993-2000**

**1999-2001**

**Notes:**
For 1999-2000 graph
G/energy/adam/2-tables/cooling.xls

##   Natural Gas Prices Are Influenced by Crude Oil Prices...oil/gas ratio reverts to “normal” level of 8:1

- Source:  Nymex, Bloomberg

**Notes:**

G/energy/adam/spreads.xls

tab:  wti v. gas

## Speculative Position of Gas Traders...gas price falling in line with greater speculative selling

## Can New Supply Sources Help Offset Volatility?...long-distance gas, coalbed methane, deepwater

- New LNG terminals
- West Coast / Baja, Mexico?
- US GOM?
- Pipelines from the Arctic
- Alaska gas to Chicago?
- Mackenzie gas to fuel Alberta tar sands?
- More eastern Canadian gas to New England?
- Coalbed methane?
- Mexican gas to Texas?

- Source: Deutsche Bank

## Potential “Long Distance” Supply Projects into U.S.

- Alaska Highway route... the original gas proposal

- Canada’s  Mackenzie Delta route... opposed by Alaska politicians...          but soaks up more gas

- Japan

- LNG into the West Cost is economically compelling... but twenty years of pursuit have yielded only failure.

- Australia

- Bolivia/Peru/Argentina

- Key Mid-West markets

- Algeria/Trinidad/Nigeria/Qatar/Malaysia/Australia

- Trinidad expansion, Nigerian expansion, Nigeria II, Egypt

- Russia

**Potential “Long Distance” Supply Projects into U.S.**

- Source:  DOE/IEA; Deutsche Bank comments

## Where is LNG? Global supply: two regional basins

**USA Alaska**

**Kenai**

**Trinidad**

**Atlantic**

- Venezuela

**Nigeria**

**Bonny **

- Angola

**Algeria**

**Arzew,Skikda**

**Abu Dhabi**

**Das Island**

**Qatar**

**North Field**

- Yemen

**Libya**

**Marsa-el-Brega**

**Arun**

**Indonesia**

**Australia-**

**North West Shelf**

- Australia

- Darwin

**Brunei - Lumut**

**Malaysia - Bintulu**

**Indonesia Bontang**

- Russia

- Sakhalin

- Indonesia

- Tangguh

- Egypt

**Oman**

- Snøhvit

- Australia
- Gorgon

- Iran

- Probable Greenfield Projects

- Possible Greenfield Projects

- Existing LNG Plants/Expansions

- Source: DB estimates, Company Data, Wood Mackenzie

- 0

- 20

- 40

- 60

- 80

- 100

- 120

- 140

- 160

- Atlantic Basin Demand

- Pacific Basin Demand

**Mt**

- 1990

- 1995

- 2000

- 2005

- 2010

- 2015

- 6% AAGR

- 2000-2005

- 17% AAGR

- 2000-2005

## Kings of the Wild Frontier...pricing parameters for long distance US gas

- LNG Mix: At delivered to pipepline cost of $2.00-$3.50/mmBtu (with a 15% project return) we estimate that some 1,000 tcf of gas could ultimately access the US as LNG. The project range encompasses the world-class Trinidad (BP, BG, Repsol), Shell-dominated Nigeria (Eni, TOTAL) and US-run Qatar (ExxonMobil). Gas from Libya and Venezuela could also make the hurdle, suggesting a major benefit for the company that resolves the US domestic politics.
- Giant Pipelines: Current indications for the capital cost of the proposed Alaska gas pipeline (ExxonMobil, BP, Phillips) suggest that it requires a price of at least $3.80/mmBtu. Without lowering the cost, we doubt that this gas will access Chicago before 2010, despite the extremely low upstream gas cost and huge reserves. However, the returns from Sable Island (Exxon, Shell) are set to rise the longer the gas price remains over its estimated breakeven of $2.30/mmbtu.

- Source: Deutsche Bank estimates

## Capacity of U.S. LNG Regasification Terminals

## LNG Delivery Points...need to boost capacity into California  

- Cabot/Tractebel has exclusive access to the merchant (i.e. not open access) Boston terminal.

- Owner:
- BG has committed to Lake Charles for the next 22 years.  Duke has access to 2005.

- Owner:
- BP, Coral (Shell) and El Paso have secured long-term capacity through auction process.

- Californian market ideal for LNG: end of infrastructure, same size as Japan, lack of indigenous supply.

- Regasification terminal

- Owner:
-  Long term agreements with BG (T&T) and Enron and Shell.

- Source: DOE/EIA; Deutsche Bank comments

**LNG Delivery Points**...need to boost capacity into California

## West Coast LNG Routes...longer hauls = higher costs

- Source: Deutsche Bank

**West Coast LNG Routes**...longer hauls = higher costs

## Delivered LNG Costs to Los Angeles...plenty of projects for less than $4/mmBtu

**Delivered LNG Costs to Los Angeles**...plenty of projects for less than $4/mmBtu

- Source: Deutsche Bank estimates

## Delivered LNG Costs to Lake Charles...plenty of projects for less than $3.50/mmBtu

**Delivered LNG Costs to Lake Charles**...plenty of projects for less than $3.50/mmBtu

- Source: Deutsche Bank estimates

## LNG Tankers on Order or Option

- 27 on option

**LNG Tankers on Order or Option**

- Source: Deutsche Bank estimates

## LNG Constrained by Pace of Regasification Additions...West Coast by 2007-2008?

- Everett

- LNG's US Market Share (Right Scale)

- Source: Deutsche Bank estimates

## Coalbed Methane Reserves and Production...small but important at the margin

- Source:  Energy Information Administration, Office of Oil and Gas

## Deepwater Gas Production ...big and continuing to compete effectively with LNG

**Notes:**
G/energy/adam/4tables/gomdeepwaterprod.xls

## What Do Energy Investors Really Want? ...volatility might not matter if goals are met

- Return on Capital - the ultimate measure of cost and growth 	performance... more emphasis on the bottom line
- Quality of Earnings - consistency & above the cost of capital
- Sustainable Growth at low cost - getting the timing right on 	when to drill, when to deplete, and when to buy
- Quality of Reserves and time to first production - 			Why should investors pay up for long reserves lives or 	inventories) and long lead times?
- Disciplined Spending - only accretive acquisitions.

- Source: Deutsche Bank

## What Can Be Done to Offset Price Volatility?...strategies to reduce risk

- Scale, Integration, Diversification, Liquidity
- Increase operational and contractual flexibility
- Minimize project lead times
- Lower costs
- Fuel switching
- Hedge price risk;  Storage to manage volume risk
- Long-term (or levelized) contracts
- 	 (accepting larger credit and business risks)
- Obtain authoritative and credible market information

- Source: Deutsche Bank

## Deutsche Bank

**Adam Sieminski  ** (410) 895-3347
**Jay Saunders   **(410) 895-3341
**Paul Sankey**   (44 131) 240-7646
**U.S. Majors**
**David Wheeler **  (212) 469-7885
**Mohan Mandrekar**   (212) 469-5073
**U.S. Exploration & Production**
**David Bradshaw   **(212) 469-8143
**John Bailey   **(212) 469-4616
**Oil Services & Equipment**
**Arvind Sanger  **(212) 469-2998
**Michael Urban   **(212) 469-3113
**Marketing Analysts**
**Sam Fennell   **(44 207) 547-5528
**Jennifer Gordon   **(44 207) 547-5527
**Mark Hastings**   (212) 469-8636

**European Majors**
**JJ Traynor**   (44 131) 240-7648
**Caroline Cook**   (44 131) 240-7642
**Nick Griffin  ** (44 131) 240-7645
**Pan Europe E&P**
**Caroline Cook**   (44 131) 240-7642
**Al Stanton**   (44 131) 240-7647
**Australia/Asia**
**John Hirjee**   (61 39) 270-4318
**Huw Williams   **(8 52) 2203 6177
**Latin America**
**Carlos deLeon   **(44 207) 545-7855
**Emerging Europe**
**Krisztina Kovacs   **(44 207) 547-7905
**Leonid Mirzoyan   **(7095) 797-5196

**Deutsche Bank**
**Global Oil & Gas Research**

## Always Read the Fine Print...accurate forecasting is a tough business

- The information and opinions in this report were prepared by Deutsche Bank AG or one of its affiliates (collectively "Deutsche Bank").  This report is based upon information available to the public.  The information herein is believed by Deutsche Bank to be reliable and has been obtained from sources believed to be reliable, but Deutsche Bank makes no representation as to the accuracy or completeness of such information.  Deutsche Bank  may be market makers or specialists in, act as advisers or lenders to, have positions in and effect transactions in securities of companies mentioned herein and also may provide, may have provided, or may seek to provide investment banking services for those companies.  In addition, Deutsche Bank or its respective officers, directors and employees hold or may hold long or short positions in the securities, options thereon or other related financial products of companies discussed herein.
- Opinions, estimates and projections in this report constitute Deutsche Bank's judgment and are subject to change without notice.  Prices and availability of financial
- instruments also are subject to change without notice.  This report is provided for informational purposes only.  It is not to be construed as an offer to buy or sell or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy in any jurisdiction in which such an offer or solicitation would violate applicable laws or regulations.
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**Additional information available upon request.**

## Slide 49