November 2011, Vol. 238 No. 11


Energy Exec Offers Bright Outlook For U.S. Energy

Jeff Share, Editor

Breitling Oil and Gas Corp. was founded in Irving, TX in October 2004 as an independent exploration company willing to invest in state-of-the-art petroleum development throughout the United States, in particular Texas and Oklahoma.

Chris Faulkner, president and CEO, studied at the University of North Texas and Baylor University and received his doctorate from Concordia College. He has wide experience in all aspects of oil and gas operations including project management, production, facilities, drilling and business development. As such, he is in an excellent position to discuss the vast changes under way in America’s energy picture.

P&GJ: What is your perspective on the natural gas/unconventional play boom we’re witnessing today? Is it of historic proportions?

Faulkner: Coal and oil will remain key energy commodities well into the 21st century, but expect natural gas to increase its share of the global energy mix substantially. The long-term drivers of demand for natural gas are twofold: relative abundance and environmental friendliness.

The rapid development of massive U.S unconventional natural gas plays has changed the supply outlook for the world’s largest gas consumer. Just a few years ago, most forecast the U.S. would need to import ever-larger quantities of LNG to meet growing demand; domestic supplies were dwindling, and Canada would no longer be able to supply enough gas via pipeline to meet demand.

America’s problem is now too much natural gas; as recently as three months ago, many investors fretted over the potential for U.S. gas storage to reach capacity. A severe economic downturn crippled domestic demand for natural gas combined with a surge in supply from unconventional gas plays to test the limits of U.S. storage facilities.

A drilling boom amid high gas prices in early 2008 meant there was a large number of new wells feeding gas into storage through much of 2009. U.S. gas production didn’t top out until February, according to data from the Energy Information Administration (EIA). That production decline didn’t stem from a lack of reserves, but low prices that prompted producers to sharply reduce drilling activity through late 2008 and early 2009 which has continued through 2011.

Thanks to abundant domestic supply, U.S. imports of LNG have remained subdued. Natural gas prices in the U.S. remain around $4.20 per MMBtus, less than a third of their 2008 highs. This reflects the ongoing realization that some of North America’s unconventional natural gas fields offer attractive economics when gas prices are relatively low.

The magic price needed to incentivize production sufficient to meet demand in a “normal” year varies widely. But the consensus among producers is that the marginal price of natural gas is around $6 per MMBtus – a reasonable estimate for the average price of gas in coming years. There are also longer-term demand-side drivers for gas. Natural gas emits 50-60% less carbon dioxide (CO-2) than coal to produce the same amount of electricity. Gas emits far less of other pollutants, including sulfur dioxide, nitrous oxides and mercury. This makes it the fuel of choice for electricity generators looking to build new capacity amid uncertainty over future carbon and environmental regulation.

Several sectors will benefit from increased use of natural gas. Perhaps the most obvious beneficiaries are producers with significant acreage in the primary unconventional plays such as the Haynesville shale of Louisiana and the Marcellus shale in Appalachia.

Any gas producer with heavy exposure to unconventional gas can also be considered a takeover target; Exxon’s acquisition of unconventional-focused XTO Energy is likely to act as a blueprint for other major integrated oil companies to enter the space. Already this year, Chesapeake Energy announced a major joint venture in the Barnett shale with Paris-based giant Total.

P&GJ: What and where are the most significant plays today and for the next few years?

Faulkner: Breitling is still very bullish on the Marcellus due to its economic model as well as the Horn River and the Motney as some of the hottest emerging plays now in North America. We are switching our capital expenditure budgets to focus on liquids plays (shale oil) away from natural gas until the commodity price can increase since it is below the break-even point for most of these plays at sub $4/Mcf.

P&GJ: Has the industry resolved the challenges resulting from fracking?

Faulkner: It’s a huge challenge not because of the technology itself, but the public’s perception of the process and the fears they have from not fully understanding what takes place. Hydraulic fracking is absolutely essential if we’re going to exploit shale gas and oil.

The industry needs to focus on educating the public about the process and the intricacies that go along with fracking. We need to continue to expand the procedure to make it more environmentally friendly by focusing on water recycling, food-grade fracturing fluids, eliminating biocides and reducing BTX (benzene, toluene xylene). Breitling has been working on an initiative called EnviroFrac for the last 18 months. We will release our results later this year.

P&GJ: What do investors need to be wary of?

Faulkner: Investing within the oil and gas industry is safe and should definitely be a part of any investor’s portfolio. Commodity prices have been fairly stable and natural gas has nowhere to go but up. I’m very bullish we’ll see $6/Mcf pricing by year-end 2012 which would be a roughly 50% uplift in today’s price.

I am comfortable saying oil will correct its pricing and stabilize in the mid $80 range and hold steady through 2012, increasing slightly but remaining sub $90/barrel.

P&GJ: Do you think we have seen the last of price volatility as concerns natural gas, and how can this ultimately benefit our economy?

Faulkner: You will continue to see price volatility due to market speculation. Most of the fluctuation is due to uneasiness with Middle East unrest, lack of confidence in our economy and speculation from traders. My bullishness in my price predictions have a lot to do with my belief in NGVs (natural gas vehicles) and LNG becoming a reality over the next 12-24 months.

As we convert LNG import terminals to export terminals (five under way in North America), I am confident we can ship some of this glut to Europe and Asia. By reducing our supply we can drive the commodity price back up to above basin break-even points and get back to drilling shale gas. We are sitting on a century-plus worth of supply and for the first time the U.S. can be in the energy supply business.

P&GJ: Do you expect to see a significant rise in gas-powered generating plants as more coal-fired and nuclear plants are retired?

Faulkner: I believe the mix will come down to less than 40% of our energy coming from coal within the next 10 years. States will start laying out mandates to convert the plants just as Colorado is doing and in the Appalachian Basin. We are starting to see a real attraction to natural gas as the energy source for 2011 and beyond.

P&GJ: What is the outlook for NGVs?

Faulkner: This is a proverbial “chicken before the egg” scenario – to really ramp up NGVs you need refueling stations. There are more than 250,000 gasoline fueling stations in the U.S. and less than 1,000 natural gas refueling stations. Station owners are not going to invest capital to expand and add in natural gas pumps if there are no vehicles.

It’s hard to convince Big Auto to manufacture new NGVs and conversion kits for gasoline-powered vehicles if there is no place to refuel them. What we need is a national energy policy that dictates conversion to a cleaner burning fuel (natural gas) and incentives to Big Auto and refueling stations to convert and add in natural gas to the pump mix.

P&GJ: What are the prospects for new pipeline development?

Faulkner: We need to focus on increasing the pipeline coming out of Cushing where all WTI crude is delivered for refinement. A bigger domestic pipeline could move oil to much needed areas quicker than trucking it, which includes the Gulf Coast. This would assist in commodity stabilization and ensure a steady supply for manufacturing and demand users.

The current Cushing MarketLink project from TransCanada is facing serious regulatory slowdown and is on hold. The project has been a target for environmental groups who simply oppose oil.

P&GJ: In Pennsylvania the U.S. Army Corps of Engineers wants to tighten the permitting process for new pipeline construction which is upsetting big producers such as Chesapeake Energy. Is this a reasonable approach?

Faulkner: This is going to slow down the construction of pipelines which will in turn slow down the marketability of natural gas and resources that have been explored and produced within mostly the Utica shale and the Marcellus shale and other plays within this geographic region. The bottom line is that wells that are drilled and completed sit idle because gathering pipelines aren’t being built to them, and consequently landowners are not receiving royalty checks.

The new rules from the Corps of Engineers have turned what was an average 45-day process to file paperwork into a 300-day process. This is not the way to go about regulation. Everyone from the oil companies to the landowners are being affected and in a very negative way.

P&GJ: What is your view of the recent call by federal lawmakers asking for investigation following a series of critical articles in the New York Times into whether the gas industry is providing accurate information about the long-term profitability of their wells and the amount of gas these well produce? Is there validity to this or is it political?

Faulkner: I think it’s easy to fudge the numbers because it’s not an exact science. It’s all estimation and no two shale plays perform the same. A big attraction for investors is the increasing size of the oil and gas reserves that some companies are reporting. Reserves — in effect, the amount of gas that a company says it can feasibly access from its wells — are important because they are a central measure of an oil
and gas company’s value.

Forecasting these reserves is a tricky science. Early predictions are sometimes lowered because of declines in gas prices, as happened drastically in 2008. Intentionally overbooking reserves is illegal because it misleads investors. However, there is never a clear understanding in emerging unconventional plays as to what the decline curves will look like as the well comes down off year 1, year 2 and so forth.

The declines can be steep – sometimes as high as 80-85% in some basins after the first two years. These are unconventional plays because of the geology and the means it takes to extract them. This can lead to overbooking of reserves if not dealt with correctly. I am not a proponent of regulation; I am a proponent of using our industry experts to make accurate predictions based on relevant data and experience and adjust those predictions when necessary.

P&GJ: Will we continue to see larger companies push their way into these shale plays?

Faulkner: Most people in the oil and gas industry believe conventional oil and gas plays are dying. Unconventional plays – shale, tight, and coal-bed methane – are where the industry is focusing with the majority of exploration capital going toward shale oil and liquids plays. Eighty percent of that driving factor is the commodity price of natural gas which, if we can offload some of the glut in this country, we can get some uplift on the price and return to drilling shale gas as well.

It’s also easy to book reserves in shale plays so public companies can drill a few test wells and book large scale reserves which help
justify their stock price uplift for Wall Street.

P&GJ: What is your outlook for the natural gas industry through 2020 and beyond? Can the industry actually meet growth projections?

Faulkner: My expected outlook is as follows: Natural gas prices remain in the $5-7.25 per MMBtu range for most of the eight-year period with a 2020 forecast price of $8. Supply will become more diverse in contrast to the traditional 85% Lower-48 and 15% Canadian. We will see much greater supply diversity, including major contributions in the form of Alaskan natural gas, but very limited LNG imports. The U.S and Canada will become suppliers to the world energy markets (namely Asia and Europe) through LNG exports from 2013 and beyond.

Delays or denials of these sources will shift supply to more expensive
marginal sources of domestic natural gas. Despite higher prices, annual consumption is projected to exceed 30 Tcf by 2020. This growth will be attributable primarily to continued rising demand for gas for electricity generation and demand from big user countries like the U.S. and China.

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