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Energy & Power Industry Update Energy & Power Industry Update February 2012 Member FINRA/SIPC www.harriswilliams.com Energy & Power Industry Update February 2012 What We’ve Been Reading • Despite a warm embrace of the natural gas industry from President Obama in his 2012 State of the Union Address, January has been a tough month for fuel. An unusually mild winter has dampened demand, sent prices to new lows, and accelerated rig count shifts towards liquids-rich plays. Most notably, Chesapeake Energy, self-proclaimed as “America’s Champion of Natural Gas,” announced that it would divert approximately $2 billion of capital slated for natural gas drilling to more profitable oil-directed drilling. The net effect on North American drilling activity from this shift is expected to be minimal. In fact, many of the oilfield services majors offered bullish commentary on North American activity despite some pricing headwinds in dry gas basins. We’ve included some of that commentary on the following pages for reference. • While natural gas may be encountering some near-term hurdles, the long-term view is certainly positive. This is made particularly clear in Black & Veatch’s (“B&V”) Energy Market Perspective 2011 Fall Forecast Overview: Adapting to the “New Normal,” which deserves mention for the length of its title alone. The report notes that approximately 300,000 MW of natural gas capacity could be added over the next 25 years. Part of this growth is due to the fact that more than 61,500 MW of coal capacity in the continental U.S. may be retired by 2020 (28,000 MW of coal plant retirements have already been announced). B&V believes that the “market share” of electricity generation will accrue to natural gas and, to a lesser extent, renewables. From 2012 to 2036, B&V projects that natural gas will increase from 24% of consumption to 44%, while coal is projected to decline from its current 41% to just 16%. • The Edison Foundation’s Institute for Electric Efficiency (“IEE”) released its Summary of Ratepayer-Funded Electric Efficiency Impacts, Budgets, and Expenditures this past month. 2011 ratepayer-funded electric efficiency budgets totaled over $6.8 billion in 2011, a 25% increase from 2010 (and in-line with the 25% average annual growth for the sector from 2007 to 2011). As a result, IEE believes that ratepayer-funded electric efficiency budgets are highly likely to exceed the Lawrence Berkeley National Laboratory’s (“LBNL”) high case scenario projection of $12 billion by 2020 (See 2009’s The Shifting Landscape of Ratepayer-Funded Energy Efficiency in the U.S.). Much of this growth has been driven by state regulatory frameworks developed to support energy efficiency programs, and the report details support-mechanisms and budgets on a state-by-state level. For an overview of the energy efficiency program management sector, please also feel free to view our 2010 whitepaper. • Finally, Harris Williams & Co.’s Tyler Dewing, writing for GigaOm, provides an overview of opportunities in energy information technology in “The Quiet but Massive Market for Energy IT.” Dewing writes, “Beyond the clamor and excitement surrounding traditional cleantech companies – solar, wind, energy efficiency, and alternative fuels – there are many attractive and growing, middle market energy technology companies quietly improving the operations and capabilities of electric utilities, oil and gas companies, government agencies, and energy market traders, among others, with software, data and analytics, and consulting and integration services. While the “green” aspects of these businesses aren’t always obvious or essential to their marketing, the benefits they provide to businesses in the energy sector are compelling, and strategic and financial acquirers are taking notice and paying attractive prices.” We encourage you to check out the full article at the link above. page 1 Energy & Power Industry Update February 2012 From the Transcripts1 Last week marked the kick-off of quarterly earnings season. On the energy side, Halliburton, Schlumberger, and Baker Hughes all reported. While we’ll refer you to the filings and press releases for the earnings data, we thought we’d highlight some relevant commentary on the outlook for North American oilfield services in their respective earnings calls. While all acknowledge some current headwinds in dry gas basins, the long-term consensus appears to be that North America is still in the early innings of the long-term service opportunity. Halliburton David Lesar, Executive Chairman, Chief Executive Officer and President “We have highlighted for some time the dramatic impact that oil-directed horizontal activities has had on the North America market. For instance, in addition to natural gas rigs targeting liquids-rich plays, the oil rig count now represents more than 60% of the total in North America, a level we have not seen in decades. Our customers' sources of revenue has [sic] also shifted dramatically toward oil, with the sale of U.S. oil and liquids representing approximately 70% of total upstream revenue today. This compares with an approximate 50-50 split just 5 years ago. And our customer mix continues to shift toward IOCs, NOCs and large independents, who tend to have a more stable spending pattern and more sophisticated supply chain management and away from those customers who might be more financially challenged in the current market. We are also seeing a trend toward higher average footage drilled per well, up to approximately 7,000 feet from 5,000 feet just 5 years ago. And finally, today, reserve development demands 4x as much horsepower per rig as compared to 2004. So clearly, there's been a dramatic shift over the past several years, and all of this bodes well for a continuation of high demand in the North America unconventional markets. So what will that market look like going forward? The last time the breakeven price for oil development was so far below prevailing oil prices was back in the early '80s, when the rig count was more than double what it is today. And despite the vast amount of work we've done in North America in recent years, there's only been a modest increase in net oil production, as new supplies are barely offsetting declines for mature North America basins. As a result, we expect continued liquids-driven activity growth in the coming years, as our customers invest in their resources and optimize their development technologies, and we plan to continue to expand our capability and drive efficiency through technology and logistical improvements to enable this growth.” “The concern about what will happen in the dry gas basins is a real one. However, there are customers who will continue to drill in these basins, as they have a low-cost gas basis, a hedge bought before the collapse of pricing, or contracts to send their natural gas to markets where the pricing is better…As we look at the market dynamics today and even apply a downside scenario to how it might play out, based on frac equipment adds as well as reduced gas drilling, which would accelerate the equilibrium in the market for pumping, it is clear to us that the strength of liquids demand will provide a cushion to equipment coming out of the dry gas basins. We also believe that there will be a net overall increase in rig count in 2012. Meaning that in our view, the increase in liquids-directed rigs will more than offset the decline in natural gas rigs. We believe a much more pessimistic scenario is currently priced into our stock, and we do not see that happening.” page 2 Energy & Power Industry Update February 2012 From the Transcripts1 Schlumberger Limited Paal Kibsgaard, Chief Executive Officer, Chief Operating Officer and Director “Looking at our industry, the general feedback from our customers and the findings from the recent spending surveys indicate that E&P investment in 2012 will be up, although the predicted levels vary. The surveys also suggest that exploration spending will continue to increase. Against this backdrop, we are planning for growth in 2012, although we are building significant flexibility into our plans given the uncertainties.” “Overall, we remain confident that any potential reductions in activity will be short-lived due to limited spare oil capacity and to growing international demand for natural gas. “ Baker Hughes Martin Craighead, Chief Executive Officer, President, Chief Operating Officer and Director “The underlying business in North America is very strong. Geology in the shale plays is obvious. And for that reason, we intend to continue growing Pressure Pumping capacity this year. Increasing demand for high-quality and predictable operations and leading-edge reservoir characterization and completions technologies aligns very well with the capabilities of Baker Hughes. As such, we have every reason to be bullish on the long-term prospects of this market.” “I -- the way we look at this is this market, I would say we're still in the very early stages of these unconventional plays. And I know that might be very hard for a lot of people to understand given how rapidly they've come on the scene. But in talking to our customers, tens of thousands of locations are coming up in these discussions to be drilled in these plays, like the Marcellus, the Eagle Ford, and even the Utica. And…when you see that kind of outlook, it's that you can't but conclude that adding additional capacity, and not only in pressure pumping, but also in roofline and rental tools, is absolutely the right way to go forward. So there may be a little bit of weakness in some of these basins until things settle down and you get the right balance of supply and demand balance.
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