Building Value from Shale Gas:

Building Value from Shale Gas: The Promise of Expanding Petrochemicals in West Virginia December 2013 Author Tom S. Witt, PhD Managing Director and Chief Economist Witt Economics LLC Referenced Authors Dr. Thomas Kevin Swift, American Chemistry Council Martha Gilchrist Moore, American Chemistry Council 1

This study was supported by funding from Braskem America. The opinions herein are the opinions of the author and do not necessarily represent those of Braskem America. SUMMARY Book 1 provides an overview of the study, issues addressed, economic drivers and associated economic impacts of a potential petrochemicals expansion in West Virginia. Book 2 gives an overview of the shale gas industry. In collaboration with the American Chemistry Council and reproduced with permission, this section is an excerpt from the recent report, Shale Gas, Competitiveness, and New US Chemical Industry Investment: An Analysis Based on Announced Projects by Dr. Thomas Kevin Swift and Martha Gilchrist Moore (May 2013, pp. 10-22). Figure numbers and figure references have been renumbered to be consistent with this overall report. Book 3 discusses the ethylene value chain, including a review of the world market supply and demand for ethylene, which is used as a raw material for a wide array of consumer packaging, transportation, and construction industry products. Book 4 reviews how West Virginia oil and natural gas production contributed to the development of the regional chemicals industry. At one time, the chemicals industry was a bedrock of the West Virginia economy but has declined in recent years. Yet the extraction of natrual gas liquids (NGLs)-rich shale gas in the Appalachia region could serve as a catalyst that renews the chemicals industry, resurrects the region s manufacturing sector, bolsters the state s economy, and creates an important new pool of jobs for the region. Book 5 focuses on the opportunity that shale gas development presents to the West Virginia economy. Specifically, it addresses how the development of an ethylene industry, and its application in the polyethylene industry, would enhance the local industrial and employment base of West Virginia. It assesses how recent investments in natural gas infrastructure enable producers to move natural gas and NGLs to markets outside the state, as well as provide an opportunity to revitalize the petrochemical industry inside the state. Book 6 evaluates the positive economic impacts associated with the construction and operation of a world-scale ethane cracker and polyethylene plants in West Virginia. It examines a generic, integrated plant complex, including associated pipeline infrastructure, on-site ethane storage and rail/truck terminals, with an assumed cost of approximately $4 billion. Copyright 2013 by Witt Economics LLC and Braskem America Inc. All rights reserved.

01 BOOK Economic Opportunities for West Virginia Overview Development of Ethane Crackers and Associated Petrochemical Plants

Overview of Economic Opportunities for West Virginia: Development of Ethane Crackers & Associated Petrochemical Plants Introduction The advent and development of natural gas produced from shale rock formations create a new dawn for the oil, gas and petrochemicals industries in the United States, particularly in West Virginia and the Appalachia region. This region sits atop two of the most prolific shale deposits in the country, namely the Marcellus and Utica shale formations. The technological advances of horizontal drilling and hydraulic fracturing, combined with almost a decade of shale gas production experience, have unleashed a tremendous new set of natural resources and a rebirth of the natural resource economy in Appalachia and the wider United States. Existing shale gas regions, as well as ones yet to be explored, are groundbreaking for the US economy. Natural gas production from shale that is rich with associated natural gas liquids (NGLs), such as ethane, propane, butane, and natural gasoline, presents new opportunities for the regional petrochemical industry. This research provides a detailed study of the economic impacts associated with the potential construction of new petrochemical facilities in West Virginia, including an ethane cracker and downstream polyethylene manufacturing plants, as a means to better understand how such an investment would impact the state economy. State government, local manufacturers, and the oil, gas and chemical industries are all excited about the potential expansion of manufacturing in natural-resourcerich places like West Virginia. This report builds on the 2011 American Chemistry Council study Shale Gas & New Petrochemicals Investments in West Virginia using new data and a deeper analysis of the economic impacts associated with the creation of an ethane cracker and downstream polyethelene plants. Study Organization Book 1 provides an overview of the study, issues addressed, economic drivers and associated economic impacts of a potential petrochemicals expansion in West Virginia. Book 2 gives an overview of the shale gas industry. In collaboration with the American Chemistry Council and reproduced with permission, this section is an excerpt from the recent report, Shale Gas, Competitiveness, and New US Chemical Industry Investment: An Analysis Based on Announced Projects by Dr. Thomas Kevin Swift and Martha Gilchrist Moore (May 2013, pp. 10-22). Figure numbers and figure references have been renumbered to be consistent with this overall report. Book 3 discusses the ethylene value chain, including a review of the world market supply and demand for ethylene, which is used as a raw material for a wide array of consumer packaging, transportation, and construction industry products. Book 4 reviews how West Virginia oil and natural gas production contributed to the development of the regional chemicals industry. At one time, the chemicals industry was a bedrock of the West Virginia economy but has declined in recent years. Yet the extraction of NGLrich shale gas in the Appalachia region could serve as a catalyst that renews the chemicals industry, resurrects the region s manufacturing sector, bolsters the state s economy, and creates an important new pool of jobs for the region. Book 5 focuses on the opportunity that shale gas development presents to the West Virginia economy. Specifically, it addresses how the development of an ethylene industry, and its application in the polyethylene industry, would enhance the local industrial and employment base of West Virginia. It assesses how recent investments in natural gas infrastructure enable producers to move natural gas and NGLs to markets outside the state, as well as provide an opportunity to revitalize the petrochemical industry inside the state. Book 6 evaluates the positive economic impacts associated with the construction and operation of a worldscale ethane cracker and polyethylene plants in West Virginia. It examines a generic, integrated plant complex, including associated pipeline infrastructure, on-site ethane storage and rail/truck terminals, with an assumed cost of approximately $4 billion. 1

Executive Summary Shale-gas-based petrochemical development offers tremendous opportunity to West Virginians and others in Appalachia. The advent of ready access to globally competitive, low-cost ethane feedstock in the United States is fueling a renaissance in the US chemicals industry. Already, the chemicals industry has announced over 10 million tons of new ethylene capacity investments in North America by 2018 with more expansion being considered over the coming decade. Thus, the conditions are ripe for Appalachia to redevelop a regional petrochemicals industry that uses locally available, high-value raw materials from the Marcellus Shale formation, which is the most prolific natural gas play in the United States. Policy Considerations The key policy question facing West Virginia is: How do we best capture the full value of local raw materials to stimulate, develop, and sustain the local economy? With North America becoming a focus region for natural resources and petrochemical expansion due to the discovery of significant new hydrocarbon reserves and given the state s proximity to critical feedstock, the opportunity exists for West Virginia to re-emerge as a center of chemical manufacturing. Figure 1-1 The Ethylene Chain ETHYLENE CHAIN and converted into intermediate products such as polyethylene and then further converted into consumer products. These products ranging from food and product packaging, textiles, automobile components and appliance parts, to construction materials and industrial machinery use polyethylene as a major raw material. Manufacturers rely on competitively priced polyethylene to thrive. The ethylene market is extremely competitive with access to cost-competitive feedstock being the primary cost driver. The pervasiveness of polyethylene products in the world economy is growing, with per-capita use rising globally, particularly in the developing world. The strongest demand growth will continue in the Asian region, where high GDP growth rates drive increasing consumption by populations with increasing disposable income. Furthermore, as polyethylene capacity around the world continues to grow in the Middle East and Asia, North American feedstock competiveness, with its more than 10 million tons of new North American polyethylene capacity on the horizon, will drive increased exports from North America to other regions. West Virginia could participate in this tremendous expansion. Building an ethane cracker and associated polyethylene (PE) manufacturing facilities is a watershed economic opportunity for the state and region. This opportunity would expand a high-value manufacturing industry that creates high-wage jobs, new technologies, and the prospect for expanding downstream plastics industry investments. Natural Gas Ethane Cracker Significant New Investments in the Region to Move Natural Gas and NGLs to Market Pool Liners Window Siding Trash Bags Sealants Carpet Backing Insulation Detergent Flooring Pipes Food Packaging Bottles Cups Housewares Crates Intermediate Products PVC Vinyl Chloride Ethylene Glycol Styrene Polystyrene Polyethylene Footwear Clothes Diapers Stockings Toys Textiles Source: American Chemistry Council Tires Sealants Paint Antifreeze Adhesives Coatings Films Paper Coatings Models Instrument Lenses Natural resources support the manufacture of consumer goods through the ethylene value chain (See figure 1-1). Investment in natural gas processing and in natural gas liquids (NGLs) fractionation facilities drives followon investments in pipeline and storage infrastructure. This can enable further investment in value-capturing chemicals manufacturing plants that use NGL products as raw materials. Chemicals like ethylene are manufactured In response to the growth in both reserves and production, significant investments have been announced in the Marcellus and Utica shale plays to process and deliver natural gas and NGLs to markets inside and outside the region. While West Virginia has existing gas processing and fractionation capacity, the growth of the Marcellus and Utica Shale plays has dramatically increased regional gas production and, consequently, investments in gas processing and fractionation. Bentek Energy forecasts gross natural gas production in the Appalachian Basin, which includes both shale plays and extends from New York to Tennessee, to increase from an anticipated 10.9 billion cubic feet per day (Bcf/d) in 2013 to 19.4 Bcf/d in 2023, an 8.4 Bcf/d increase. This growth is largely being driven by the liquids-rich plays in the Marcellus/Utica region. Adequate processing capacity will be built to accommodate this increase. In fact, approximately 5 Bcf/d of incremental processing capacity is slated to come online by the end of 2016, for a total regional capacity exceeding 8 Bcf/d. 1 1 BENTEK Energy. Son of a Beast: Utica Triggers Role Reversal, Oct 2013, p.20. 2

In addition, moving NGLs to market requires infrastructure to connect gas processing and fractionation facilities to manufacturing facilities. NGL pipelines are being developed to carry NGLs from the Appalachia region to established markets in the US Gulf Coast, Ontario, and Europe. Local opportunities exist as well in West Virginia, which has had a heritage of and appreciation for the chemicals industry since the 1930s. A strategic effort on the part of the state and local government to promote the physical and social infrastructure required for a renewed local petrochemicals industry would be a signal to investors that the state looks to once again become a serious player in the US chemicals manufacturing sector. Without it, these high-value raw materials would find alternate markets. Economic Impacts Associated with Petrochemical Industry Development Economic Impacts of an Ethylene Cracker and Associated Polyethylene Plants The study evaluates the economic impacts associated with the construction and operation of a world-scale ethane cracker and associated polyethylene plants in West Virginia. 2 A generic integrated plant complex is examined with an assumed start-up date in 2018 and an assumed cost of $3.8 billion, with an additional $150 million in pipeline infrastructure, $20 million in on-site ethane storage, and $20 million in rail and truck terminals. The economic impacts are estimated using the IMPLAN inputoutput modeling system (IMPLAN Group LLC, implan.com). Table 1-1 summarizes the construction impacts. Table 1-1 One-Time Economic Impacts Associated with Construction of New Ethane Cracker and Associated Polyethylene Plants in West Virginia ($2012) Impact Type Employment (job-years) Employee Compensation (million) Output (million) Direct Effect 18,156 $893 $1,346 Indirect Effect 976 46 134 Induced Effect 5,087 178 563 Total Effect 24,118 $1,116 $2,043 Note: The economic impacts from construction are spread over the construction period and are one-time impacts. For example, the direct employment of 18,156 full- and part-time jobs are spread over a fouryear construction period and would be at multiple locations within the state. Table totals do not add due to rounding. Table 1-2 Annual Economic Impacts Associated with Operation of an Ethane Cracker and Associated Polyethylene Plants in West Virginia at Full Operation ($2012) Impact Type Employment (job-years) Employee Compensation (million) Output (million) Direct Effect 325 $35 $585 Indirect Effect 1,229 62 196 Induced Effect 534 19 59 Total Effect 2,088 $116 $840 Note: Totals may not add due to rounding. The study found that the development of an ethane cracker and associated polyethylene plants in West Virginia would have a multibillion dollar positive impact on the state s economy in both the short and long terms by employing an estimated 325 full-time staff annually and generating hundreds of millions of dollars in annual economic output over a 40+ year operating period. In addition, the project is expected to generate at least $36 million in state and local taxes, exclusive of property taxes and government incentives, when at full operation and for each year thereafter. Economic Impacts of Additional Downstream Product Manufacturing Plant Development The positive economic impact of building a worldscale ethane cracker and associated polyethylene plants also brings with it a significant opportunity to advance and expand the regional industrial base by attracting new polyethylene product manufacturers to the state. Ethylene is one of the primary building block chemicals in the chemicals industry, and its primary end-use product sector is for conversion into polyethylene (PE). From PE pellets, PE converters create an array of manufactured products across the spectrum of consumer products, as shown in figure 1-2. Figure 1-2 Types of Polyethylene Products Produced by Converters The study also examines the economic impacts associated with the yearly operation of the plant complex. Table 1-2 reports the annual economic impacts from the plant complex at full operation. Source: Data from American Chemistry Council, Plastics Industry Producers Statistics (PIPS), 2012. 2 All costs and impacts are presented in 2012 dollars. 3

Building a profitable PE industry can also contribute to building a successful product manufacturing industry. The major drivers of profitability in end-use polyethylene converter plants are: 1. The price of delivered polyethylene raw material 2. The cost of electricity 3. Proximity to product distribution and retail centers for finished goods 4. The availability of a skilled workforce The presence of an ethane cracker and polyethylene plants, local raw material advantage, competitive electricity rates, and a skilled workforce would place West Virginia in a position to attract downstream polyethylene converters. Beyond the tremendous economic potential, the study recognized and analyzed the value-added downstream opportunity that a polyethylene manufacturing complex presents to consumer products manufacturers using plastics. The report further studies the economic impact associated with an ethane cracker and polyethylene complex seeding the creation of downstream manufacturing in consumer and industrial products made from plastics. While it is challenging to estimate the pace and scope of downstream development, the study estimated two potential scenarios to gauge the range of potential economic impact associated with PE product manufacturers moving to West Virginia. Downstream investments have the potential to create upwards of over 900 jobs and $280 million in output annually. Attracting such polyethylene product manufacturers could be a tremendous opportunity for West Virginia and surrounding region to further capture the downstream value-added benefits of its NGL resources. Creating the conditions for manufacturers to thrive would drive significant economic impact in the years following the startup of an ethane cracker and polyethylene plants. Non-quantifiable Economic Impacts Associated with Construction and Operation of an Ethane Cracker and Associated Polyethylene Plants In an effort to be comprehensive, the study recognized that many important economic impacts are challenging to quantify, yet vitally important contributions to the local economy. The project analyzed in this study would also create the following non-quantifiable impacts: The presence of a cracker complex sends a signal to other chemical and manufacturing companies to make similar investments in ethane crackers or downstream plants using the petrochemicals produced at this complex. Out-of-state suppliers to the new plant may perceive expanded economic opportunities and may relocate operations within the state. 3 The increased demand for ethane may necessitate considerable expansion in natural gas drilling plans, resulting in additional lease acquisition, permitting, drilling, and natural gas production. The resulting increases in natural gas supplies may be attractive to firms using a significant amount of natural gas in their production processes. This increased supply might also necessitate development of more midstream processing and pipeline extensions in the state. Expanded economic activity rooted in the sciences should reinforce the teaching of science, technology, engineering, and mathematics in public schools, community colleges, and colleges and universities. The additional economic activity will probably result in more charitable giving and volunteering with nonprofit institutions, thereby adding to the quality of life of the communities impacted by the plant and its employees. Consistent with other petrochemical plants within the state, considerable investment in maintaining a safe operating environment will result in employees being trained on fire-safety and suppression procedures. Some of the trained employees may also be members of volunteer fire and ambulance organizations. The resulting expansion of economic activity should generate more deposits in regional and state financial institutions, increasing the latter s ability to provide loans and support to families and businesses. Consistent with bringing technologically advanced industry to the state, the demand for a highly skilled workforce will attract a population with advanced science and mathematics skill levels and drive educational advancement. Finally, the resulting chemical industry renaissance will provide an endorsement of the state s economic viability to global markets. 3 Similar phenomena occurred when Toyota announced its engine (and now transmission assembly) plant in Buffalo, West Virginia. The Toyota Manufacturing facility has undertaken considerable expansion since 1996, and its success has attracted other automotive equipment manufacturers to the state, including NGK Spark Plugs, Diamond Electric, K.S. West Virginia, and Hino Motors. 4

Figure 1-3 Appalachia Regional NGL Infrastructure Map Source: BENTEK Energy. Map by Maria Majia, Energy Analyst. December 16, 2013. Additional Considerations Optimizing the Opportunity in West Virginia Promoting an Industry Cluster: The Ohio River Basin as a geographic center for interconnected businesses A geographic cluster of businesses can increase productivity, drive innovation, and stimulate new businesses. Collaborative links with regional universities, leveraging human and social capital, and incentives to magnet investors who, in turn, attract other business can facilitate the transition from an extractive economy to a manufacturing and innovation economy. In the chemicals industry, feedstock hubs are important. A feedstock hub usually requires close proximity to feedstock sources, pipeline infrastructure, storage capabilities, and access to a ready market for feedstock consumption. As such, focused regional investment in storage and pipelines is critical to establishing a feedstock hub because any one entity would be hard-pressed to bear the cost of this infrastructure alone. Hubs tend to grow incrementally over time, as they achieve the economies of scale needed for the industry to thrive; potentially, they can become a catalyst that creates a petrochemical industry business cluster. West Virginia and the greater Ohio River Basin, stretching from Pittsburgh to Kenova and beyond, have the advantage of being at the center of NGL-rich shale gas development, but they face the challenge of building a well-established storage capability and product pipeline network. Fortunately, the region already has the beginnings of a robust natural gas and ethane pipeline network as established players like MarkWest Energy, Blue Racer Midstream, Williams, and M3 Midstream have each grown their respective gas processing networks over the last ten years. Figure 1-3 shows a partial map of the Appalachian regional NGL infrastructure. What the region lacks is a unifying strategy for focusing these disparate private sector developments on establishing a high-value local market for NGL products in the form of a regional petrochemical manufacturing hub. 5

Developing the right workforce: Availability of skilled labor and educational programs West Virginia has a strong history of petrochemicals production in the Kanawha Valley and Charleston area, as well as in the Mid-Ohio Valley. The state also has a strong industrial base and with it, an existing labor pool capable of fielding many of the required skill sets needed for an expanding petrochemical sector. Innovative programs within West Virginia s Community and Technical College System for the training of chemical plant operating personnel already exist and have the capacity to be expanded as the petrochemical and related industries come online. For example, the Associated Construction Trades assessed the Parkersburg and Wood County region to have over 34,000 total skilled workers available in the immediate vicinity, as shown in figure 1-4. Figure 1-4 Local Skilled Workforce Profile - Wood County Enabling the growth of an educated workforce with the requisite skill sets needed to construct, operate, and maintain a new world-scale petrochemical industry will require collaboration with local high schools, colleges, and trade schools during the years leading up to construction and continuing on well after the complex is operating. Developing a robust market: Promoting incremental value in petrochemical production Producing ethylene through cracking produces coproducts that are part of the conversion process. These co-products include: hydrogen, methane, propylene, butadiene, butylene, pyrolysis gas, benzene, toluene, C8 aromatics, and fuel oil. While the majority of the output stream of an ethane cracker is ethylene, significant coproducts are produced. The sale of those co-products into the chemicals market is an important factor in business sustainability. In addition, many of these co-products are volatile materials that are expensive to transport, so selling them to users in the market region has tremendous value. The Appalachia chemicals industry needs to identify market opportunities for selling cracker co-products such as butadiene, pyrolysis gas, and other potentially high-value products. The ability to market those products to downstream customers and optimize economic value is a strategic priority. The Importance of transportation: Getting products to market Source: Associated Construction Trades, ACT Parkersburg Maps, 2013. While no one project would ever employ an entire region s skilled labor force, the availability and diversity of a skilled labor pool are critical for the development of large scale capital projects. The labor pool of skilled trades required to build and operate petrochemical facilities particularly for the thousands of craft workers, such as welders, pipe fitters, carpenters, electricians, iron workers, scaffold builders, and construction hands will be crucial. Supporting the development of an ethane cracker and downstream industries will require a volume of workers and a myriad of skill sets that may not all be present in the Ohio River Basin. Thus, significant workforce training programs will also be needed to be effective. It will take a strong commitment from government, industry, unions, and the public to develop the workforce and attract the vendors needed to develop, build, and operate a petrochemical cluster. The majority of polyethylene pellets are delivered to market using either railroad transportation (for domestic consumption) or waterborne vessels (for export). Furthermore, polyethylene is priced on a delivered basis, meaning that the polyethylene producer is responsible for paying to transport the finished goods to its customers. Hence, cost competitive logistics proves very important when selecting the site location for an ethane cracker and polyethylene complex. Generally, waterborne and rail transportation are the least expensive forms of bulk transportation. Furthermore, geographies with competitive rail transportation markets generally have more competitive freight rates. West Virginia has a mix of opportunities and challenges with respect to logistics. West Virginia may have a regional advantage because of its proximity to the eastern US markets, where a significant portion of US national demand for polyethylene products resides. Shorter domestic transportation logistics may give a petrochemical company developing a West Virginia ethane cracker and polyethylene complex advantaged delivery times in serving major polyethylene markets, provided the company has well-negotiated, cost competitive rail and truck contracts. That said, being inland with river access but no ocean access, a cracker in West Virginia would be challenged with a potential transportation 6

cost disadvantage to serve export markets where ocean freight is often favored. In addition, West Virginia suffers from elevated railroad freight rates due to limited railroad infrastructure and a lack of railroad competition; 93% of all West Virginia rail stations are captive to one Class I railroad. 4 Yet, given the opportunity that a local cracker and polyethylene complex represents, it would certainly be in the best interest of the state and the region for West Virginia to consider employing policy tools to mitigate high local rail transportation rates and unlock the latent potential of an industry serving regional markets. Investments in additional rail, port, and truck infrastructures would create greater competition in intermodal transportation and expand options to local industry for shipping locally produced products to other regions. Strategies for success: Progressive policy and selective economic development tools The state of West Virginia has a tremendous set of tools at its disposal to close the competitive gap that may exist as industry players consider building new petrochemical facilities. Targeted tax incentives, workforce training incentives, and infrastructure incentives can be deployed to address and mitigate the types of challenges that the state faces to make West Virginia a competitive center for petrochemicals, as is done for other core industries in the region. Applicable state programs that could be considered for such a project include, but are not limited to: Five for Twenty-five Program: Program to provide special salvage-value property tax valuation, which applies to a certified facility with a capital investment of over $2 billion. The special tax valuation for real and personal property lasts for a period of 25 years and was designed specifically to attract large oil, gas, and petrochemical facilities to the West Virginia economy. Five for Ten Program: Program to provide salvagevalue property tax treatment on a certified addition to facilities with initial capital investment of at least $100 million. The certified capital addition must be at least $50 million. In the case of natural gas-related manufacturing, the addition must be at least $410 million to an existing facility with an original capital investment of at least $20 million. Manufacturing Investment Tax Credit: 5% of capital investment for new and existing businesses pro-rated over 10 years. Tax credit may offset up to 60% of state corporate tax liabilities. Manufacturing Property Tax Adjustment Credit: Non-refundable 100% state tax credit equal to the amount of local property tax paid on manufacturing inventory. Economic Opportunity Tax Credit: Investment tax credit for those who create new jobs. Tax credit may offset between 80% and 100% of state business tax liability directly attributable to new employment created. Strategic Research and Development Tax Credit: Credit that can offset up to 100% of corporate net income tax and business franchise tax, based on qualified expenditures for R&D projects with the goal of attracting high-value R&D jobs and programs to West Virginia. Governor s Guaranteed Workforce Program: Flexible, customized training program under the West Virginia Development Office; offers assistance to eligible companies and businesses by providing funding that directly supports the transfer of knowledge and skills to new employees. Developing infrastructure and the necessary business environment to seize opportunities takes time and resources. Transforming West Virginia from a region focused on resource extraction to one focused on chemical manufacturing requires West Virginia to become a hub for petrochemicals with key assets like NGL storage, pipeline connectivity, and expanded transportation corridors. Working together, West Virginia s government and workforce can partner with the business community to invest in the growth of an entire petrochemical industry in the mid-and upper-ohio valleys. As this study shows, such development can yield billions of dollars in ongoing economic impact for West Virginia and its extended regional economy. However, this requires a long term commitment to expand the petrochemical industry and revive the manufacturing sector of West Virginia s economy. As the petrochemical industry enters its next period of growth, there is tremendous promise for the United States and potentially for West Virginia. The time is right for West Virginia to re-invest in the petrochemical industry. 4 Rail Price Advisor. Volume 22, Number 8. August 2013, p.1. 7

02 BOOK The Development of Shale Gas & Energy Use and the Chemical Industry

The Development of Shale Gas & Energy Use and the Chemical Industry The Development of Shale Gas One of the more interesting developments in the last five years has been the dynamic shift in natural gas markets. Between the mid-1960s and the mid-2000s, proved natural gas reserves in the United States fell by one-third, the result of restrictions on drilling and other supply constraints. Starting in the 1990s, government promoted the use of natural gas as a clean fuel, and with fixed supply and rising demand from electric utilities, a natural gas supply shortage occurred, causing prices to rise from an average of $1.92 per thousand cubic feet in the 1990s to $7.33 in 2005. The rising trend in prices was exacerbated by the effects of hurricanes Katrina and Rita in 2005, which sent prices over $12.00 per thousand cubic feet for several months due to damage to gas production facilities. Shale and other non-conventional gas were always present geologically in the United States. Figure 2-1 illustrates where shale gas resources are located in the United States. These geological formations have Figure 2-1 Shale Gas Resources Source: Energy Information Administration based on data from various published studies; updated May 9, 2011. 8

been known for decades to contain significant amounts of natural gas, but it was not economically feasible to develop, given the technology available. However, uneconomic resources often become marketable assets as a result of technological innovation, and shale gas is a prime example. Over the last five years, several factors have combined to stimulate the development of shale gas resources. First was a new way of gathering natural gas from tightrock deposits of organic shale through horizontal drilling combined with hydraulic fracturing. Horizontal drilling allows producers to drill vertically several thousand feet and then turn 90 degrees and drill horizontally, expanding the amount of shale exposed for extraction. With the ability to drill horizontally, multiple wells from one drilling pad (much likes spokes on a wheel) are possible, resulting in a dramatic expansion of shale available for extraction, which significantly boosts productivity. A typical well might drill 1½ miles beneath the surface and then laterally 2,000 9,000 feet. The second innovation entailed improvements to hydraulic fracturing (or fracking). This involves fracturing the lowpermeability shale rock by using water pressure. Although these well stimulation techniques have been around for nearly 50 years, the technology has significantly improved. A water solution injected under high pressure cracks the shale formation. Small particles, usually sand, in the solution hold the cracks open, greatly increasing the amount of natural gas that can be extracted. Fracturing the rock using water pressure is often aided by chemistry (polymers, gelling agents, foaming agents, etc.). A typical well requires two three million gallons of water and 1.5 million pounds of sand. About 99.5% of the mixture is sand and water. 5 Figure 2-2 provides a simple illustration of these technologies. Another important technology is multi-seismology that allows a more accurate view of potential shale gas deposits. Figure 2-2 Geology of Shale Gas and Conventional Natural Gas Source: US Energy Information Administration and US Geological Survey 5 Report Note: While this water consumption is significant, it is important to put it in perspective. Nationwide, the EPA estimates that landscape irrigation consumes about nine billion gallons of water a day, which is 20 times the highest estimate for the amount of water used annually in fracking. See Water for Fracking, In Context, Forbes, July 7, 2013. 9

With these innovations in natural gas drilling and production, the productivity and profitability of extracting natural gas from shale deposits became possible. Further, unlike traditional associated and nonassociated gas deposits that are discrete in nature, shale gas often occurs in continuous formations. While shale gas production is complex and subject to steep production declines, shale gas supply is potentially less volatile because of the continuous nature of shale formations. Many industry observers suggest that the current state of shale gas operations is more closely analogous to manufacturing operations than traditional oil and gas exploration, development, and production. These new technical discoveries have vastly expanded estimates of natural gas resources and will offset expected declines in conventional associated-gas production. Estimates of technically recoverable shale gas were first assessed by the National Petroleum Council (NPC) at 38 trillion cubic feet (TCF) in 2003. More recently, the Potential Gas Committee (PGC) estimated US shale gas resources of 1,073 TCF at the end of 2012. The United States is now estimated to possess nearly 2,700 TCF of potential (or future) natural gas supply, 40% of which is shale gas that could not be extracted economically as recently as eight years ago. This translates into an additional supply of 47 years at current rates of consumption of about 23 TCF per year. Total US natural gas resources are estimated to be large enough to meet over 115 years of demand. Due to the emergence of new shale gas supplies, the US sharply reduced gas imports from Canada and liquefied natural gas (LNG) receipts over the past several years. Higher prices for natural gas in the last decade (especially after hurricanes Katrina and Rita) and the advances in horizontal drilling and hydraulic fracturing (i.e., chemistry in action) changed the dynamics for economic shale gas extraction. These technologies allowed extraction of shale gas at about $7.00 per thousand cubic feet, which was well below the historical trend. With new economic viability, natural gas producers have responded by drilling, setting off a shale gas rush. As learning curve effects took hold, the cost to extract shale gas (including return on capital) fell, making even more supply (and demand) available at lower cost. Moreover, natural gas liquids have become paramount in changing the economics of shale gas production. It is the sales of ethane and other liquids that have enabled producers to extract and sell natural gas at less than $3.50 per thousand cubic feet. Although the path was irregular, average daily consumption of natural gas rose from 60.3 billion cubic feet (BCF) per day in 2005 to 62.0 BCF per day in 2009. Figure 2-3 The Advent of Shale Gas Resulted in More, Less Costly Supply of US Natural Gas Moreover, since the mid-2000s, US-proved natural gas reserves have risen by one-third. In economists terms, the supply curve has shifted to the right, resulting in lower prices and greater availability. As a result, average natural gas prices fell from $7.33 per thousand cubic feet in 2005 to $3.65 per thousand cubic feet in 2009. In 2010 and 2011, a recovery of gas-consuming industries and prices occurred. Average daily consumption rose to 66.9 BCF and prices strengthened to $4.12 per thousand cubic feet. But the mild winter of 2011-12 resulted in a record level of stocks and pushed prices even lower to $2.79 per thousand cubic feet. Figure 2-3 illustrates how this new technology s entrance into the market expanded supply and pushed prices lower. Before the development of shale gas, the US was a gasimporting nation. The US is now a gas-surplus nation and has become the leading global producer. Shale gas is thus a game changer. In the decades to come, unconventional gas could provide half of US natural gas needs, compared to only 8% in 2008. The US s favorable position is illustrated in figure 2-4. As natural gas prices have fallen in the US in wake of the emerging shale gas revolution, prices in other major nations have risen. Figure 2-4 Trends in Natural Gas Prices across the World $ per million BTUs $18.00 $16.00 $14.00 $12.00 $10.00 $8.00 $6.00 $4.00 $2.00 $0.00 02 03 04 05 06 07 08 09 10 11 12 United States Belgium Germany Japan Brazil China India Source: EIA, Petrobras, IMF, World Bank, various national statistical agencies 10

Figure 2-5 Average Natural Gas Prices by Nation 6 By 2012, North America featured some of the lowest cost natural gas in the world. Figure 2-5 illustrates this. Prices in Russia and Iran have appreciated beyond that of the United States. Prices in Saudi Arabia are set at $0.75 per million BTUs by government decree. These prices were originally due for adjustment in 2012, but a decision on this has been delayed. Prices at this level are artificial and would actually be around $3.00 per million BTUs if a free market existed. The availability of low-priced natural gas improves US industry competitiveness. Lower natural gas prices mean lower input prices for major US manufacturing industries. Leading industries, including aluminum, chemicals, iron and steel, glass, and paper, are large consumers of natural gas and, thus, benefit from shale gas developments. Lower input costs have boosted capital investments and expanded output. These manufacturers add a great deal of value to the natural gas they consume. Manufacturers in these industries compete globally, and small cost advantages can be all it takes to tip the balance for some companies. In their recent study U.S. Manufacturing Nears the Tipping Point: Which Industries, Why, and How Much? the Boston Consulting Group uncovered a tipping point in costrisk among seven key industries (computers and electronics, appliances and electrical equipment, machinery, furniture, fabricated metal products, plastic and rubber products, and transportation goods). They found that as these industries re-shore to the US, the US economy will gain $80 billion $120 billion in added annual output and two million to three million jobs. With a growing and increasingly affluent population and economic growth, demand for electricity will rise in the US. In addition, clean air regulations are promoting natural gas use in electricity generation. This will increase natural gas demand, and economic theory suggests that barring any increase in supply, market prices will rise. There is a risk that higher gas prices could partially offset some of the positive gains achieved during the past five years. Further technological developments in drilling and fracturing, however, could generate additional low-cost natural gas supplies. The use of hydraulic fracturing in conjunction with horizontal drilling has opened up resources in low permeability formations that would not be commercially viable without this technology and has led to many positive gains in US industry and the economy. However, there are some policy risks as there is public concern regarding hydraulic fracturing due to the large volumes 6 Note: Prices generally reflect domestic wellhead/hub process or imported prices via pipeline. Some nations (e.g., Japan and Korea) import LNG; thus, the higher prices. Other nations import LNG if it is a minor share of demand, but the graphic does not generally reflect these prices. 11

of water and potential contamination of underground aquifers used for drinking water. 7 The concern exists even though fracturing occurs well below drinking water resources. Limiting the use of hydraulic fracturing would impact natural gas production from low permeability reservoirs. Ill-conceived policies that restrict supply or artificially boost demand are also risks. Local bans or moratoria could present barriers to private sector investment. A final issue is the need for additional gathering, transport, and processing infrastructure. The Marcellus and some other shale gas deposits are located outside the traditional natural gas supply infrastructure to access the shale gas. The United States must ensure that our regulatory policies allow us to capitalize on shale gas as a vital energy source and manufacturing feedstock, while protecting our water supplies and environment. ACC supports state-level oversight of hydraulic fracturing, as state governments have the knowledge and experience to oversee hydraulic fracturing in their jurisdictions. Furthermore, ACC is committed to transparency regarding the disclosure of the chemical ingredients of hydraulic fracturing solutions, subject to the protection of proprietary information. Energy Use and the Chemical Industry Excluding pharmaceuticals, firms in the $587 billion chemical industry produce a variety of chemistry products including chlorine, caustic soda, soda ash and other inorganic chemicals, bulk petrochemicals and organic chemical intermediates, industrial gases, carbon black, colorants, pine chemicals, other basic chemicals, adhesives and sealants, coatings, other specialty chemicals and additives, plastic compounding services, fertilizers, crop protection products, soaps and detergents, and other consumer chemistry products. Although pharmaceuticals are classified by the government as part of chemicals, for the purposes of this analysis, pharmaceuticals were excluded because of the different industry dynamics. The chemical industry transforms natural raw materials from earth, water, and air into valuable products that enable safer and healthier lifestyles. Chemistry unlocks nature s potential to improve the quality of life for a growing and prospering world population by creating materials used in a multitude of consumer, industrial, and construction applications. The transformation of simple compounds into valuable and useful materials requires large amounts of energy. The business of chemistry is energy-intensive. This is especially the case for basic chemicals, as well as certain specialty chemical segments (e.g., industrial gases). The largest user of energy is the petrochemical and downstream chemical derivatives business. Inorganic chemicals and agricultural chemicals also are energyintensive. Unique among manufacturers, the business of chemistry relies upon energy inputs, not only as fuel and power for its operations, but also as raw materials in the manufacture of many of its products. For example, oil and natural gas are raw materials (termed feedstocks ) for the manufacture of organic chemicals. Petroleum and natural gas contain hydrocarbon molecules that are split apart during processing and then recombined into useful chemistry products. Feedstock use is concentrated in bulk petrochemicals and fertilizers. Petrochemical Feedstocks There are several methods of separating or cracking the large hydrocarbon chains found in fossil fuels (natural gas and petroleum). Natural gas is processed to produce methane and natural gas liquids (NGLs) that are contained in the natural gas. These natural gas liquids include ethane, propane, and butane, and are produced mostly via natural gas processing. That is, stripping the NGLs out of the natural gas (which is mostly methane) that is shipped to consumers via pipelines. This largely occurs in the Gulf Coast region and is the major reason the US petrochemicals industry developed in that region. Ethane is a saturated C2 light hydrocarbon, a colorless and odorless gas. It is the primary raw material used as a feedstock in the production of ethylene and competes with other steam cracker feedstocks. Propane is also used as a feedstock, but it is also used primarily as a fuel. Butane is another NGL feedstock 8. The revolution in shale gas has pushed ethane prices down from a peak of 93 cents per gallon in 2008 to an average of 41 cents per gallon during 2012. That is a 56% decline. In recent months the price fell to as low as 23 cents per gallon. Petroleum is refined to produce a variety of petroleum products, including naphtha and gas oil, which are the primary heavy liquid feedstocks. Naphtha is a generic term for hydrocarbon mixtures that distill at a boiling range between 70 C and 190 C. The major components include normal and isoparaffins, naphthenes and other aromatics. Light or paraffinic naphtha is the preferred feedstock for steam cracking to produce ethylene, while heavier grades are preferred for gasoline manufacture. Gas oil is another distillate of petroleum. It is an important feedstock for production of middle distillate fuels kerosene, jet fuel, 7 Report Note: Numerous studies are underway to study the environmental impact risk related to hydraulic fracturing with varied results. At the request of the U.S. Congress, the U.S. EPA is conducting a study to better understand any potential impacts of hydraulic fracturing on drinking water resources that is expected to be released in 2014. http://www2.epa.gov/hfstudy 8 Report Note: NGL feedstock includes ethane (C2), propane (C3), butane (C4), natural gasoline (C5), and condensate (C6+), all of which can be used as feedstock for manufacturing petrochemicals. 12

diesel fuel, and heating oil usually after desulfurization. Some gas oil is used as olefin feedstock. Naphtha is the preferred feedstock in Western Europe, Japan, and China. The price of naphtha is highly correlated with the price of Brent oil. As a result, naphtha prices in Western Europe rose from an average of $793 per metric ton in 2008 to $942 per metric ton in 20[12]. That is a 19% increase. Petrochemical Products and Their Derivatives Naphtha, gas oil, ethane, propane, and butane are processed in large vessels or crackers, which are heated and pressurized to crack the hydrocarbon chains into smaller ones. These smaller hydrocarbons are the gaseous petrochemical feedstocks used to make the products of chemistry. In the US petrochemical industry, the organic chemicals with the largest production volumes are methanol, ethylene, propylene, butadiene, benzene, toluene and xylenes. Ethylene, propylene, and butadiene are collectively known as olefins, which belong to a class of unsaturated aliphatic hydrocarbons. Olefins contain one or more double bonds, which make them chemically reactive. Benzene, toluene, and xylenes are commonly referred to as aromatics, which are unsaturated cyclic hydrocarbons containing one or more rings. The figures in the Appendix A illustrate supply chains of several building block chemicals from feedstock through intermediates and final end-use products. Ethane and propane derived from natural gas liquids are the primary feedstocks used in the United States to produce ethylene, a building block chemical used in thousands of products, such as adhesives, tires, plastics, and more. While propane has additional non-feedstock uses, the primary use for ethane is to produce petrochemicals, in particular, ethylene. Ethane is difficult to transport, so it is unlikely that the majority of excess ethane supply would be exported out of the United States. As a result, it is also reasonable to assume that the additional ethane supply will be consumed domestically by the petrochemical sector to produce ethylene. In turn, the additional ethylene and other materials produced from the ethylene are expected to be consumed downstream, for example, by plastic resin producers. Increased ethane production is already occurring as gas processors build the infrastructure to process and distribute production from shale gas formations. Chemical producers are starting to take advantage of these new ethane supplies with crackers running at 95% of capacity, and several large chemical companies have announced plans to build additional capacity. And because the price of ethane is low relative to oil-based feedstocks used in other parts of the world, US-based chemical manufacturers are contributing to strong exports of petrochemical derivatives and plastics. Another key petrochemical feedstock methane is directly converted from the methane in natural gas and does not undergo the cracking process. Methane is directly converted into methanol. Methanol is generally referred to as a primary petrochemical and is the chemical starting point for plastics, pharmaceuticals, electronic materials, and thousands of other products that improve the lives of a growing population. Methane is also directly converted into ammonia. Ammonia is a starting point for a variety of chemical intermediates used in manufacturing synthetic fibers used in apparel, home furnishing, and other applications. Ammonia is also the starting point for a variety of nitrogenous fertilizers used to enhance crop growth and feed a growing population. The Shale Advantage Energy represents a significant share of manufacturing costs for the US business of chemistry. For some energyintensive products, energy for both fuel and power needs and feedstocks can represent 85% of total production costs. Because energy is a vital component of the industry s cost structure, higher energy prices can have a substantial impact on the business of chemistry. Figure 2-6 illustrates the energy intensity of some of these products. Figure 2-6 Fuel, Power, & Feedstock Costs as a Percentage of Total Costs for Selected Chemical Products Chlorine/Caustic Soda (Sodium Hydroxide) Sodium Carbonate (Soda Ash) Acrylonitrile Adipic Acid Aniline Benzene Butadiene (1,3-1) Cumene Ethylbenzene Ethylene Ethylene Dichloride (EDC) Ethylene Glycol Ethylene Oxide Methanol Phenol Propylene Styrene Terephthalic Acid Vinyl Acetate Polyethylene (LDPE) Polyethylene (LLDPE) Polyethylene (HDPE) Polypropylene (PP) Polystyrene (PS) Polyvinyl Chloride (PVC) Anhydrous Ammonia Urea 20 Energy Costs 40 60 80 100 Other Costs 13