Shale Gas and Its Implications for U.S. Energy Markets. Seven Ways Shale Production Is Reshaping Commercial and Industrial Energy Purchasing

Shale Gas and Its Implications for U.S. Energy Markets Seven Ways Shale Production Is Reshaping Commercial and Industrial Energy Purchasing

2 Shale Gas and Its Implications for U.S. Energy Markets Introduction Direct Energy Business is more than just a supplier. We have a distinct focus on helping to make your business better by providing straightforward guidance and an exceptional customer experience to help you make the most of the energy opportunities available to you. We are excited to share our expertise and help make smart energy choices easy and clear. We ve created this guide to help you understand how shale gas production has reshaped the energy markets and explore its impact on commercial and industrial energy purchasing. Shale gas has dramatically transformed U.S. energy markets in recent years In the 2004 edition of its Annual Energy Outlook, the U.S. Energy Information Agency (EIA) presented a less-thanpromising picture for the nation s natural gas industry. Sustained high prices in the early half of the decade prompted the agency to change its long-term forecast for the industry, predicting slower growth for domestic production and much stronger reliance on higherpriced, imported liquefied natural gas (LNG) and remote resources in Alaska and Canada s Mackenzie Delta, to meet U.S. demand. Tellingly, the term Marcellus is not mentioned once in the 278-page document. 1 Flash forward to 2014: the state of the U.S. natural gas market has changed completely. The surge in shale gas production since the mid-2000s has led to a sharp increase in domestic supplies, with the EIA projecting that the U.S. will become a net exporter of natural gas by 2018 2 and that prices will remain relatively stable in the long term. 3 Much of this change can be attributed directly to the rise in shale gas production, particularly in the Mid-Atlantic s Marcellus shale region, where output has risen from essentially zero in the mid-2000s to more than 15 billion cubic feet per day as of mid-2014, or about 5.5 trillion cubic feet (Tcf) annually. 4 While the EIA did not even track production data on shale gas before 2007, by 2012, the unconventional resource accounted for 40 percent of total U.S. production and that growth is expected to continue. In its 2014 Annual Energy Outlook, the EIA projects that shale gas production will account for 53 percent of overall U.S. output by 2040 5 (see chart below). U.S. natural gas production by source, 1990-2040 (trillion cubic feet) 40 HISTORY 2012 PROJECTIONS 30 20 Shale gas 10 0 Alaska Tight gas Lower 48 onshore conventional Lower 48 offshore Coalbed methane 1990 2000 2010 2020 2030 2040 Source: EIA, 2014 Annual Energy Outlook

Shale Gas and Its Implications for U.S. Energy Markets Geologists and energy industry officials have long known that natural gas was trapped in the porous shale formations that can be found under many regions of the U.S. Until recently though, no economically-feasible method existed to separate the natural gas from the shale and bring it to the surface. Now, the widespread adoption of innovative production technologies, like horizontal drilling and hydraulic fracturing in particular, has lowered the cost of production and sent output from U.S. shale formations soaring. Nowhere has this transformation been more pronounced than in the Marcellus Shale region that sprawls deep underground, across some 95,000 square miles in the Mid-Atlantic principally in New York, Pennsylvania and West Virginia. Although the first productive Marcellus well wasn t drilled until 2005, producers there are now pumping out more than 15 Bcf per day.6 Not surprisingly, the Marcellus boom has benefited the region s economy. According to Pennsylvania s Department of Labor & Industry, in the first quarter of 2014, there were an estimated 228,930 employees in jobs directly or indirectly tied to the development of Marcellus Shale up more than 30,000 from just four years earlier. In addition, the department points out, these employees get paid well. The average wage in the core industries in the Marcellus region is about $93,000 a year, while the average in related industries totals an estimated $65,000 both significantly higher than the statewide industry average of $49,600.7 The Marcellus Shale Coalition, which represents producers in the state, also estimates that each well drilled in the state represents an investment of $5 7 million.8 With almost 9,000 active wells9 across the state, that adds up to a substantial amount of money. We tg as Dr yg as The Marcellus Shale Formation Marcellus Shale Extent Wet/Dry Gas Boundry* Source: Pennsylvania State University, Marcellus Center for Outreach and Research * Wet/dry gas boundary denotes the area that yields methane only (dry gas) versus that which yields methane, as well as liquid natural gasses, such as ethane, butane and propane (wet gas). 3

4 Shale Gas and Its Implications for U.S. Energy Markets As natural gas output has climbed and producers have gained more information about the region, estimates of the potential size of the Marcellus shale play as a natural gas resource have increased as well. The Potential Gas Committee (PGC), an independent industry analytical group that compiles a biennial assessment of U.S. natural gas resources, reported that, as of year-end 2012, the Atlantic area accounts for some 33 percent of the nation s total gas reserves, putting it ahead of the Gulf Coast region as the largest single source of natural gas in the country. The PGC states that Atlantic-area natural gas resources which are composed primarily of the Marcellus shale play, but also include several other areas now likely total more than 740 trillion cubic feet. This is a 110 percent increase from the group s previous assessment in 2010, when it said that the area held some 353 trillion cubic feet. To put that into perspective, total U.S. consumption in 2013 was 26.1 trillion cubic feet. The surge in shale gas output has had broad implications for both the natural gas and electricity markets, particularly with regard to prices. While demand has steadily increased since 2010, prices have remained relatively stable, according to EIA data. Pricing at Henry Hub in Louisiana, the trading point for New York Mercantile Exchange (NYMEX) natural gas contracts, shows that prices have averaged at just under $4 per million cubic feet a price that the EIA expects to remain essentially unchanged through 2015. 11 TOTAL U.S. CONSUMPTION IN 2013 MARCELLUS AND OTHER ATLANTIC-AREA NATURAL GAS RESOURCES As pipeline capacity is increased, markets in the Northeast gain greater access to Marcellus Region gas, which can result in stabilized or decreased prices. The Mid-Atlantic has benefitted noticeably from the rise in Marcellus output, with prices at a number of the region s trading hubs now frequently below those posted at Henry Hub. For example, the EIA noted in an August 2014 report that prices at the Dominion South hub in Southwestern Pennsylvania have gone from being marginally above the Henry Hub price in 2010 and 2011, to rough parity with Henry Hub prices in 2012 and 2013, to sharply lower than Henry Hub in 2014. 12 Three other trading hubs in northern Pennsylvania Dominion North, Leidy and Tennessee 4 have been similarly below Henry Hub prices for much of 2014. 13 These price declines are not a fluke. Due to the sharp increase in shale production, natural gas prices have been flat or falling since a commodities run-up in 2008 that drove prices up across all U.S. markets just prior to the recession. 14 The Northeast has not seen the same benefits yet, but this is due largely to pipeline constraints that the EIA says will be reduced in the years ahead, as soaring production in the Mid-Atlantic changes supply patterns. As pipeline capacity increases, markets in the Northeast will gain greater access to Marcellus Region gas, which can result in stabilized or decreased prices. 15 Instead of relying on gas transported via intercontinental pipelines from the Gulf Coast to the New York and Northeast regions, the two regions have benefitted from that fact that pipelines are being filled locally from shale production, which helps drive down prices mainly in the off-peak months. The agency pointed out in the same brief that Marcellus gas production likely will soon top the combined winter peak demand in Pennsylvania, West Virginia, New York, New Jersey, Delaware, Maryland, and Virginia. In other words, the gas is available, now it is just a question of getting it to markets that need it via the pipeline infrastructure.

Shale Gas and Its Implications for U.S. Energy Markets 5 Shale s Electrifying Impact on Power Markets The increases in shale gas production have also had an impact on U.S. electric generation and wholesale electricity prices. As natural gas production has climbed and prices have remained stable, the use of natural gas for electricity production has risen climbing from 20 percent of the total production in 2008 to 27.4 percent in 2013. And, the EIA expects the use of gas to continue, projecting in its latest Annual Energy Outlook that natural gas could overtake coal as the nation s principal source of electric power generation as early as 2019, if the trend toward early nuclear and coal plant retirements accelerates. 16 Overall, the rising percentage of electricity generated nationally from natural gas, coupled with natural gas relatively stable prices, has helped keep national electricity prices relatively stable since 2008 even as a number of coal and nuclear plants have been retired and/or required to install expensive environmental retrofits. Specifically, the EIA reports that national industrial electricity prices, which averaged 6.83 cents per kilowatt-hour (kwh) in 2009, fell by the smallest of margins, to 6.82 cents per kwh at the end of 2013. Commercial sales were almost as flat, ending 2013 at 10.29 cents per kwh a slight increase from the 2009 average of 10.16 cents per kwh. 17 As natural gas production has climbed and prices have remained stable, the use of natural gas for electricity production has risen climbing from 20 percent of the total production in 2008 to 27.4 percent in 2013. The polar vortex that settled over the Eastern U.S. in the winter of 2014 had predictable impacts on natural gas prices they climbed sharply as heating and electricity demand soared simultaneously. But the markets worked, and the lights and heat stayed on. And, shortly after temperatures warmed, prices began to fall. For the year, Henry Hub prices still are expected to post an average of just above $4 per Mcf. This pattern could repeat itself if extreme cold weather returns to the East, but government and private forecasters expect overall volatility, as well as long-term price increases, to remain in check largely due to the continued development of new shale gas resources. For example, the EIA estimated in its 2014 Annual Energy Outlook that Henry Hub prices would average $4.37 per Mcf (in 2012 dollars) in 2020 18 essentially unchanged from current levels.

6 Shale Gas and Its Implications for U.S. Energy Markets What s next for shale production? One of the next likely development targets is the Utica Shale formation. This shale play lies under the Marcellus rock at depths of up to 14,000 feet at least 5,000 feet deeper than Marcellus and spills out further to the west, particularly into Ohio, where much of the early exploratory work has occurred. Though it is not as large as the Marcellus formation, the Utica formation is still abundant. The U.S. Geological Survey first estimated that the Utica formation likely contains 38 Tcf of natural gas the equivalent of almost one billion barrels of unconventional oil and more than 200 million barrels of unconventional natural gas liquids. With the ability to economically tap into these natural gas sources and the estimated availability of the gas contained within them, it is likely that natural gas from shale will continue to play an important role and have a strong impact on the U.S. energy markets. What does this mean for you, the energy customer? The federal government estimates that commercial and industrial entities spend just over $400 billion annually on energy,19 so any downward price movement is good news. While there are regional differences, EIA data shows that the average national price of electricity in the commercial sector ($10.29 cents/kwh in 2013) is essentially unchanged from 2008, when the average price ended the year at 10.26 cents/kwh. The same holds true for the average national price for industrial customers, which stood at 6.82 cents/kwh in 2013, down slightly from the 6.96 cents/kwh that prevailed in 2008.20 The Utica Shale Formation Utica Shale Extent Source: Pennsylvania State University, Marcellus Center for Outreach and Research

Shale Gas and Its Implications for U.S. Energy Markets 7 Implications for Immediate Energy Purchases In light of the downward pressure that shale production has put on energy prices, consider how changes in the market will shape your buying strategies in the near term: 1. Abundant supply provides opportunities for savings. While increases in domestic natural gas production can drive down prices or mitigate increases that can come when production is down, your supply price can still be affected by regional pipeline constraints and increased demand due to seasonal and weather-related events. Please be sure to check with your supplier to identify the most lucrative timing for supply purchases. Considerations for Long-Term Buying Strategies While natural gas supplies have been plentiful and prices have remained relatively low when compared to historical prices, energy markets seldom stand still. Businesses should be aware that there are a number of long-term issues that may affect future energy prices, even given the surge in production of domestic natural gas. 1. Exports cut into domestic supply surpluses. The EIA projects that the U.S. will be a net exporter of natural gas by 2018 and could be shipping as much as 5 Tcf per year overseas by 2040. Natural gas prices have remained particularly high outside of the country, so many developers are exploring the possibility of converting existing, no-longer-needed liquefied natural gas (LNG) import facilities into export terminals to take advantage of those higher overseas prices. While these plans are unlikely to lead to domestic shortages, a tightening of the balance between supply and demand could easily lead to higher prices down the road. 2. Infrastructure expansion shifts regional demand. Plans to expand pipeline infrastructure, particularly into the constrained New England region, could add demand and pull supply from the heart of the Marcellus, putting upward pressure on prices. 3. The transportation industry finds new applications for natural gas. Yet another potential use for natural gas is the transportation market. With crude oil, gasoline and diesel prices expected to remain high, there is significant incentive to use compressed natural gas (CNG) to power vehicles, such as long-haul trucks, light-duty fleet vehicles and buses. The added natural gas demand from the transportation industry could cause prices to rise. 4. Coal-fired electricity generation declines. There is much uncertainty around the number of coalfired electric generation plants that will be closed due to new clean air rules set forth by the Environmental Protection Agency (EPA). The EIA reported in its 2014 Annual Energy Outlook that it now expects 60 gigawatts of coal-fired capacity to be retired from commercial service by 2020 to comply with new and pending EPA regulations about half of which serves the Mid-Atlantic region, which has long relied on coal for its baseload electric generation. This means that significant new generator capacity will have to be built in the years ahead. Much of that new generation will probably be from natural gas-fired plants that are relatively cheap to build and can be completed quickly. This would add more new demand for natural gas, which could push prices upward. 5. Pipeline infrastructure surrounding the Utica Shale. There is also uncertainty around how the pipeline infrastructure will be built to distribute the gas from the still-developing Utica Shale formation. The Marcellus resource is largely underneath an existing natural gas distribution network, which has made it easy to gather the gas and get it to market via existing pipelines. The Utica area, on the other hand, is much less developed. As such, when the pipelines will be built to transport this gas and which direction they will flow remain unanswered questions, leaving the impact of natural gas from Utica on prices an unknown.

8 Shale Gas and Its Implications for U.S. Energy Markets Looking Ahead Though natural gas prices have declined from historical levels and plentiful supplies should keep an upper limit on future increases, natural gas remains a volatile commodity, like any other. There can be substantial upward and downward movement in prices especially seasonally and sometimes year-over-year. Businesses can manage these ups and downs on their own but having a supplier to help analyze pricing trends and forecasts, provide helpful market intelligence and regulatory updates, and plan a strategy accordingly, could help you make more informed decisions for your business. The changes in the natural gas industry since 2004 have been nothing short of extraordinary. Natural gas went from a relatively high-priced fuel that was viewed as a source of expensive peaking electricity and commercial and residential heating, to a baseload generation resource that will help to carry the country from a coaldominated electric past to a cleaner, greener future. Commercial and industrial organizations will have the opportunity to participate in this future, provided they stay informed of developments in shale gas production and its impact on the energy markets. Those organizations that have a trusted supplier, like Direct Energy Business, to lean on for straightforward guidance and deep energy expertise, will ultimately have an opportunity to gain the most value from the changing energy market landscape. For more information, visit business.directenergy.com/market-insights. About Direct Energy Business Direct Energy Business is part of the largest retail energy supplier in North America and a champion in serving businesses diverse energy needs. Our leadership position, deep expertise and commitment to addressing our customers unique energy demands is how we earn the trust of our customers and help to make their businesses better. With more than 25 years of industry experience, we are dedicated to helping companies make smart energy choices for their business. Contact us today to discuss your energy needs and we ll help you navigate the opportunities available to your service location(s). Learn more about Direct Energy Business and other energy strategies for businesses and organizations of all types by visiting business.directenergy.com or call 888.925.9115. 1. Retrieved from EIA website at http://www.eia.gov/forecasts/aeo/archive.cfm 2. EIA, 2014 Annual Energy Outlook Early Release Overview (http://www.eia.gov/forecasts/aeo/er/early_production.cfm) 3. EIA, 2014 Annual Energy Outlook, chart page MT-22 4. EIA, Today in Energy, August 5, 2014 (http://www.eia.gov/todayinenergy/detail.cfm?id=17411) 5. EIA, 2014 Annual Energy Outlook, chart page MT-23 EIA, Today in Energy, August 5, 2014 6. EIA, Today in Energy, August 5, 2014 7. Marcellus Shale Fast Facts, September 2014 edition (retrieved from Pennsylvania state government website at www.portal. state.pa.us/portal/server.pt/gateway/ptargs_0_2_1281125_0_0_18/ Marcellus_Shale_Fast_Facts_Viewing.pdf) 8. Marcellus Shale Coalition fact sheet, retrieved from http://marcelluscoalition.org 9. http://stateimpact.npr.org/pennsylvania/tag/marcellus-locations-app 10. http://www.eia.gov/dnav/ng/hist_xls/n9140us2a.xls 11. EIA, Short-Term Energy Outlook, October 2014 12. EIA, Today in Energy, August 5, 2014 13. EIA, Today in Energy, October 15, 2014 14. http://www.eia.gov/dnav/ng/hist/n3045us3a.htm 15. EIA, Today in Energy, August 5, 2014 16. EIA, 2014 Annual Energy Outlook, ES-4 17. Calculated using the EIA s data browser at http://www.eia.gov/electricity/data/browser 18. EIA, 2014 Annual Energy Outlook 19. Derived from the reference case tables in the EIA s 2014 Annual Energy Outlook (accessed through http://www.eia.gov/ forecasts/aeo/mt_liquidfuels.cfm) 20. Chart derived from EIA s data browser at http://www.eia.gov/electricity/data/browser Copyright 2014 Direct Energy Business. Direct Energy and the Energy Bolt Design are either registered trademarks or trademarks of Direct Energy Marketing Limited in the United States and/or Canada used under license. District of Columbia License No. EA-04-4-4. Maryland License Nos. IR-437; IR-719; IR-791. Texas PUCT Cert. No. 10011. DC PSC License No. EA-04-4-4; EA-13-12; GA-13-03-1; MD PSC License Nos. IR-719; IR-791; IR-3123; IR-3108; PUCT Cert. No. 10011; CT PURA License Nos. 00-05-14; 12-03; 13-03 MA DPU License Nos. CS-021; GS-052; CS-108; GS-051 888.925.9115 business.directenergy.com DEB 01029 [14]