North American Natural Gas Fundamentals and Market Based

North American Natural Gas Fundamentals and Market Based Long-term Pricing Tommy Inglesby and Ankush Kumar Mc. Kinsey & Company, Inc. November 16, 2007 – Houston Baker Institute/CEE Energy Forum © 2007 Mc. Kinsey & Company, Inc. No part of this report may be circulated, quoted, or reproduced for distribution without prior written approval from Mc. Kinsey & Company. This material was used by Mc. Kinsey & Company during an oral presentation, it is not a complete record of the discussion. The views expressed herein are based upon assumptions as to marketplace evolution and dynamics, and other factors which are inherently uncertain and are subject to change. There can be no assurance that all such assumptions will in fact be borne out, and, in fact, it can be anticipated that the assumptions will be subject to change over time.

PERSPECTIVES ON NATURAL GAS PRICES Market based perspective on gas price: Estimating long-term gas price and probability distributions based on commodity and capital markets Gas price fundamentals: What you would need to believe to see a sustained gas price linkage to petroleum conversion capacity Questions 1

CONSENSUS ESTIMATES INDICATE A SHIFT IN LONG TERM GAS PRICE PROJECTIONS Current forward HH spot Historical forwards NYMEX Henry Hub (natural gas) price $/MMBtu Historical Futures Industry estimates for 2015 -2030 Average market price $, MMBtu 2015 -2030 EEA EIA GII 2007 2013 SEER 6. 68 GII 6. 72 EEA SEER Previous futures range 1995 7. 70 EIA 6. 08 Wide range of future gas price range *EEA = Energy and Environmental Analysis, GII = Global Insight, Inc. , SEER = Strategic Energy and Economic Research, EIA = Energy Information Administration Source: NYMEX, EIA, Team analysis 2

LONG LIVED E&P ASSET VALUATIONS PROVIDE THE CAPITAL MARKETS PERSPECTIVE OF LONG TERM GAS PRICE – EXAMPLE DEAL Production profile Gas price assumptions Reserves • 0. 6 tcf of proven reserves • 1. 4 tcf of unproven reserves Long-term price Asset value $ Billion 8. 00 Development and operation costs estimates • Reserve risk factor • Drilling profile • Well production costs 6. 75 Forward curve for first 5 years Production profile Mmcf/d 0 0 6. 75 5. 50 Long-term price for 5+ years 40 Transaction value ($2. 2 Billion) Implies an embedded long tern gas price of $6. 75/MMBTU 0 Source: Mc. Kinsey Analysis 2036 3

SIMILAR VALUATION OF OTHER LONG LIVED GAS EXPOSURES INDICATE LONG TERM GAS PRICE RANGE OF $6. 50 -7. 50/MMBTU $ Millions Long life E&P Transactions Deal 1 790 Deal 2 2, 200 Deal 3 945 Company Enterprise value $ Millions E&P Company A 4, 000 E&P Company B 7, 500 E&P Company C 8, 000 E&P Company D 4, 500 Utility Source: Asset value $ Millions Mc. Kinsey Analysis 45, 000 Implied long-term price $/MMBTU 7. 00 6. 75 7. 25 Implied long term price $/MMBTU 7. 00 • Narrow range of long term implied gas prices • Implies a long term gas price 6. 50 to 7. 50 $/MMbtu 7. 25 6. 75 6. 50 7. 50 4

MARKET OBSERVATIONS CAN BE COMBINED TO ESTIMATE GAS PRICE PROBABILITY DISTRIBUTION Stochastic simulations with market based inputs Simulated natural gas price* distribution $ / MMBtu • Expected Price – Near term : • Source: Forward prices – Mid- long term: Fundamentals combined with long term price embedded in E&P company valuation Price volatility – Option implied volatilities combined with mean reversion from price history Mc. Kinsey Analysis <5% probability of gas price being above 13 $ /MMBTU in 2018 <5% probability of gas price being below 3. 50 $/MMbtu in 2018 5

PERSPECTIVES ON NATURAL GAS PRICES Market based perspective on gas price: Estimating long-term gas price and probability distributions based on commodity and capital markets Gas price fundamentals: What you would need to believe to see a sustained gas price linkage to petroleum conversion capacity Questions 6

SINCE 2000, NATURAL GAS PRICES HAVE TRADED WITHIN THE BAND #2 Distillate OF A RESID FLOOR AND A DISTILLATE CEILING Natural gas US Gulf Coast gas and energy NYMEX prompt month prices* $/MMBtu • Natural gas priced between • resid and coal Refining margins were tight #6 Resid Coal • Natural gas priced • between resid and distillate Refining margins were wide $10+ Crude linked • Do gas prices stay linked to resid in a high crude price environment? $6 -8 Gas on gas • Do gas prices fall to gas or gas competition / or crude prices decline significant? *Converted at EIA heat content of 6. 287 for No. 6 low sulfur and 5. 825 for No. 2. Coal prices shown as delivered spot prices to Northeast. Does not include estimate NOX and SOX costs Source: Bloomberg; Mc. Kinsey Analysis 7

SIGNIFICANT GENERATION INVESTMENT WILL SOON BE REQUIRED; IF NUCLEAR AND COAL PLANTS CANNOT BE PERMITTED, CCGT BECOMES THE DEFAULT CHOICE Economic fuel choice* Capacity to meet minimum U. S. power reserve margin of 15% GW By 2015 CO 2 price $/ton Nuclear favored 125 Natural gas (CCGT) favored** By 2020 Coal (SCPC) favored*** 225 Natural gas price $/MMBtu *All plants use 9% WACC and 30 -year life **CCGT at 7, 000 Btu/k. Wh heat rate; $800/k. W nominal greenfield Capex; 90% capacity factor; 3 -year time to build ***Coal at 9, 100 Btu/k. Wh heat rate; $2, 100/k. W nominal greenfield Capex; 92% capacity factor, 4 -year time to build; $75/MMBtu coal Source: EIA; Mc. Kinsey 8

A SIGNIFICANT GROWTH IN GAS DEMAND CREATES A SIGNIFICANT SUPPLY GAP THAT MUST BE MET Bcfd New demand drivers acting on top of traditional growth engines… Power • High demand growth (1. 8% per year) • Difficult to permit new builds for nuclear …increase demand growth, implying a potential supply gap of ~37. 5 Bcfd by 2015 Demand 20061 and coal plants • Growth in power demand met almost entirely by gas through higher utilization of existing CCGT gas plants and new gas fired plants Oil Sands • Rapid increase in oil sands production • Ethanol (projections of 3 -5 million bpd by 2020) Production requirement of 0. 75 mcf per barrel of oil • North American ethanol demand assumed • to reach 15 billion gallons by 2015 and grow to 30 billion gallons by 2020 Production requirement of ~1 cm of gas per gallon of ethanol Traditional growth 2 7 Power 3 12 Oil sands 4 2. 5 -4. 0 Ethanol 5 2 -3 2020 demand Supply 2006 production 2015 supply gap 28 1 November 2005 to October 2006 EIA reported demand for US 2 EIA estimate of 1. 6% growth in US, 2. 4% growth in Canada 3 Assumes historical capacity creep for nuclear and coal capacity and utilization, with 30 GW new coal build. Assumes renewable growth to 50 GW of capacity (7% of US power consumption). Remaining demand met by new CCGT at 7000 Btu/k. Wh Heat rate. Assumes 75% increase in gas-to-power demand growth met by capacity creep and new CCGT. 4 Assumes accelerated growth as Oil Sands development to 6. 6 MMBd of production by 2020, utilizing 13 cm per barrel of oil 5 Assumes US achieves 20 BGY ethanol standard by 2015, growing to 30 BGY by 2020 – results in incremental 2 bcfd of natural gas demand by 2015 and 3 bcfd by 2020. Source: EIA Annual Energy Outlook (2006); National Energy Board of Canada; MMS Deepwater forecast; Renewable Fuels Association; BP Statistical report 2006; press clippings Mc. Kinsey analysis 9

THE INCREASING SUPPLY GAP WILL DRIVE SIGNIFICANT E&P ACTIVITY AND REQUIRE ATTRACTING ADDITIONAL LNG VOLUMES FROM EUROPE Within ten years, over 60% of the production will come from new wells in existing and YTF* fields as well as LNG … E&P activity will increase dramatically Number of new wells drilled per year +10% NA Natural gas supply requirements Bcfd 70, 000 30, 000 Net NA Natural gas demand, ~3% CAGR 2006 Gap to be filled by new resources and LNG New prod from existing onshore fields Existing onshore** prod Canada production Offshore*** Rigs Average rig count 1400 2015 2550 High US prices required to attract LNG: • Limited LNG liquefaction capacity worldwide; NA plus Europe demand LNG regas capacity to exceed liquefaction capacity • US gas prices will likely be above oil parity (Europe prices) to attract LNG cargos *Yet To Find **Assumes hyperbolic decline from IHS 2006 survey ***Estimate from EIA/MMS Source: EIA Annual Energy Outlook (2006); Wood Mackenzie; MMS Deepwater forecast; Mc. Kinsey analysis 10

LNG PRICES IN A SHORT ENVIRONMENT RISE TO THE VALUE IN ALTERNATE MARKET – IN THIS CASE EUROPE ILLUSTRATIVE Oil-linked pricing band 2012 North American Natural gas supply and demand curve $/MMBtu Nonswitching demand If Demand stays robust and US supply not sufficient to push LNG back into the Atlantic, the marginal price setter for the US becomes LNG competing with Europe Distillate switching Power dispatch switching LNG Imports (competitive) Indigenous production Indigenous supply marginal lifting costs LNG Imports (fixed) Resid switching North American gas volumes Bcfd Source: Mc. Kinsey 11

PERSPECTIVES ON NATURAL GAS PRICES Market based perspective on gas price: Estimating long-term gas price and probability distributions based on commodity and capital markets Gas price fundamentals: What you would need to believe to see a sustained gas price linkage to petroleum conversion capacity Questions 12

UNUSED SLIDES 13

IN EUROPE, NATURAL GAS CONTRACTS INDEX PRICES TO LOW SULFUR FUEL OIL PRICES Brent $ / MMBtu, 1991 -2006 Q 3 Oil-linked gas price (WGI)* Low Sulfur Fuel Oil (LSFO) Oil-linked gas border price* compared to Brent and LSFO prices Oil-linked gas prices reflect longrun marginal cost of Europe’s next alternative supply (Russia) Growing price gap to gas cost as oil prices increase and stay high 50 $/bbl ($6. 65/MMBtu)** 40 $/bbl ($5. 25/MMBtu)** 30 $/bbl ($3. 90/MMBtu)** 20 $/bbl ($2. 50/MMBtu)** Cost of Russian imports (full cost) 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 * Monthly prices. Gas prices average for Spain, Belgium, Netherlands, Germany, Italy, France & UK. 6 -month lag compared to oil (Brent) and LSFO **Assumes 6. 287 MMBtu / Bbl for LSFO, FCC is marginal refining unit in Europe, and an average of narrow and wide light / heavy differentials (modeled) Source: Platts; World Gas Intelligence; EIA; Mc. Kinsey GGM; Mc. Kinsey refining equilibrium pricing model 14

LIQUEFACTION ACROSS THE ATLANTIC IS CONSTRAINED AND WILL NOT BE SUFFICIENT TO FILL US REGAS CAPACITY Atlantic Basin Liquefaction and regas capacity* Bcfd • Natural gas delivered into Europe currently prices at a residual fuel oil linked contract price North America • If the US prices below resid, then more majority of excess LNG should divert to Europe Atlantic basin liquefaction Europe • If US is pricing at a premium to resid – it becomes the advantaged market * Assuming end-of-year in-service dates. Regas projects shown only in operation and under construction. 47. 6 Bcfd facilities approved by FERC. Liquefaction assumes projects operating, under construction and in development. Includes Middle Eastern projects with expected delievries to Atlantic Basin based on investing partners or signed contracts 15 Source: LNG Asian demand – Dr. Fesharaki, FACTS Inc. , September 2005; Mc. Kinsey Energy Practice; Mc. Kinsey analysis