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Logistics Engineering Supply Chain

Shale Gas Implications for US Manufacturing RenaissancePrepared for

Taylor Robinson, President

December 5, 2013 Houston, TX

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» Boutique consulting firm specializing in logistics, engineering, and supply chain

Established in 2001Over 80 clients and 200 engagements

» Headquarters in Chicago USA, with team members throughout the US and with “on the ground” experience in:

North America / Europe / South America / Asia / Middle East

» Key servicesStrategy and optimizationAssessments and benchmarkingSupply Chain design and implementationTransportation assets and infrastructureLogistics operationsInvestment strategy and due diligence

» Key industry verticalsEnergy Bulk commodities incl. chemicals & plasticsManufactured goodsPrivate equity and Corporate Development

About PLG Consulting

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Shale Gas Is More Important to US Industry Competitiveness Than Oil

» Natural gas is 4X cheaper than oil on a BTU-basisInnovation will convert more transportation fuels and other energy requirements to natural gas

» US electricity prices are the lowest in the industrial worldUS industries are now the power cost leadersGas drives an increasing share of the US electricity generation capacity

» US gas downstream products will have world class competitiveness - are the “building blocks of manufacturing”

ChemicalsResinsCompounds

» Natural gas is a cleaner burning fuel compared to other hydrocarbons

$0$5

$10$15$20$25$30

2005 2006 2007 2008 2009 2010 2011 2012 2013

Oil vs. Gas Price on BTU Basis

WTI Crude ($/MMBTU)

Natural Gas ($/MMBTU)

Source: EIA

31¢ 30¢

18¢13¢

9¢7¢ 4¢ 3¢

05101520253035

¢/kW

h

AAverage Cost of Electricity (2012)

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US Shale Gas History

Source: Bentek, September 2013

Rig Count by Class vs. Gas ProductionGas rig count has decreased significantly, but gas production has increased – Why?

» Shale gas prolific supply growth in 2007 & 2008 caused a dramatic price drop in 2009, rigs shifted to oil & liquids

» Drilling productivity continues to lower costs and increase production with less rigs

» And the Liquids (Crude, NGL) wells produce dry natural gas as a by-product

Source: Southwestern Energy investor presentation, September 2013

Representative Productivity Gains – Fayetteville Shale Play

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» Abundant US gas supply for the foreseeable futureLow cost reserves in accessible locations near populationUS will become a net gas exporter by 2020

» US gas demand will grow gradually due to:• Coal-fired generation plant converting to gas• More industrial use – steel, fertilizer, methanol• Mexican export via pipeline and LNG export overseas• Increasing use as transportation fuel

» US gas cost competitiveness is sustainableSupply will overwhelm demand as prices approach $5US government will likely limit LNG export to protect US from world gas market price

Source: BENTEK, September 2013

US Shale Gas Future

US Natural Gas Supply/Demand

Annual Average Henry Hub Spot Natural Gas Prices

Source: EIA, Annual Energy Outlook, 2013

2011

$pe

r M B

tu

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» Marcellus is gas play of choiceMassive scale near highest US population densityRapid increase in production – now 5th largest production “country” in the worldLow cost wells with high productivity enables dry gas profitability for efficient drillers at current priceExport potential for LNG & NGL from Marcus Hook and other export terminalsHowever, no ethane crackers in the region, so gas NGL’s need to be piped to Gulf region for further processing

Marcellus: Future Gas Play of Choice

Source: Bentek, September 2013

Shale Gas Development Rates

Source: Bentek, September 2013

Currently, onlyprofitable dry 

gas play

Shale Play IRR

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Shale Gas Downstream Products

» Shale crude oil makes the headlines, but shale gas & NGLs will drive US industry and manufacturing cost competitiveness and growth

Other Refined Products

Feedstock (Ethane)

Feedstock (Propane, Butane, etc)

Home Heating (Propane)Home Heating (Propane)

Other FuelsOther Fuels

GasolineGasoline

Diesel, Jet FuelDiesel, Jet Fuel

Inputs >> Wellhead >> Direct Output >> Thermal >> Fuels >> Raw Materials >> Downstream Products

Gas

NGLs

Crude

Proppants

OCTG

Chemicals

Water

Cement

GenerationProcess Feedstocks

SteelSteel

Fertilizer (Ammonia)Fertilizer (Ammonia)

MethanolMethanol

Chemicals and ResinsChemicals and Resins

Petroleum ProductsPetroleum Products

PetrochemicalsPetrochemicals

Chemicals and Resins

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» NGL = Natural Gas Liquids or “Wet Gas”Prevalent in large Crude plays as a by product – Bakken, Eagle Ford, PermianProlific areas in eastern Marcellus and UticaAdds profitability potential for oil & gas production companies

» NGL’s require processing and fractionationCapacity coming on line quickly in multiple plays3-9 gallons/MCF (thousand cubic feet)

– Ethane ~42-65%– Propane ~28%– Normal Butane ~8%– Iso-Butane ~9%– Condensate ~13%

» NGL supply growth will outpace downstream product demand in North America

Ethane currently “rejected” in large volumes due to low pricesAs processing capacity increases, export of downstream products will grow significantly due to cost advantage

NGL Boom In Progress

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Ethane is the “Building Blocks” for Manufacturing

Feedstock/Intermediary

Finished Products

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Shale Gas Phased Impact To US Industrial & Manufacturing Cost Competitiveness

2008 2010 2012 2014 2016 2018 2020

Phase I ‐ Gas & Power‐intensive Industries: Steel, Fertilizer, Methane 

Phase II ‐ Downstream Products:  Resins, Chemicals

Phase III – “Manufacturing”: Raw material cost driven

» Phase I & II expansion, brownfield and greenfield plants announced – 2014-2017 investment peak

Over $100B of chemical industry investments have been announced with more announcements expectedForeign investment is over 50% of announcedNot all of the announced factories will be built or be delayed due to regulatory issues

» Ethane crackers are vital to downstream growth10 expansions and 7 greenfield crackers announced3-5 world scale crackers likely to be built

Shale 

Boom

Shale GasBoom

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Phase I – Gas- and Power-Intensive Industries Are Advantaged Now

» Steel example -- Direct Reduction Iron (DRI) Gas strips oxygen from iron core to make high purity/quality pellets DRI pellets cost ~$270/ton vs. scrap steel cost ~$390/tonNucor/Encana $750 M plant in St. James Parish, LA is starting early 2014 with capacity of 2.5 M tons/year (will be largest DRI plant in the world)Voestalpine 2 M tons/year HBI and DRI plant is due online in early 2016

» Fertilizer example – Numerous new plant announcementsGas is feedstock for ammonia/nitrogen5 plants will likely be built out of the 20 factory announcements First world scale plant in nearly 25 years in Wever, IA – Iowa Fertilizer (OCI) – projected to start in late 2015CF Industries’ two fertilizer expansions that have been announced in IA and LA are likely to be built – 2016 start

» Methanol example – Imports will be displacedBeaumont OCI plant restoration in 2012 – producing methanol & ammoniaLyondellBassell’s restart of mothballed Texas plant operational late 2013Methanex is relocating two plants from Chile to LA – first plant expected operational by end of 2014 and second early 2016OCI new plant announced in Beaumont – Q4 2016 startValero evaluating bolt-on approach for methanol plant at refinery in LA, project could startup in 2017

Average Cost of Electricity (2012)

Three iron‐ore storage domes stand near Nucor's direct‐reduced iron plant in Convent, La.www.wsj.com ‐ Feb 1, 2013

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Phase II - Low Cost Gas Feedstock Provides Significant Cost Advantages for Chemicals & Resins

» US has a large structural cost advantage due to gas-based ethane for downstream products

Europe and Asia are tied to crude-based naptha as a feedstock for their downstream processingUS has shifted to ~90% ethane feedstock for ethylene

» However, US ethane cracker and processing capacity is tight and ethylene prices are inflated

Current ethane cracker margins 50-60 cents/lbAdditional cracker capacity expected in 2016/2017Margins/prices will moderate as more capacity comes onlineNew US resin facilities also on the drawing boardExcess resin capacity will promote globally competitive prices and large export increases

Source: Townsend Solutions

Sources: Townsend Solutions

30,00035,00040,00045,00050,000

2012 2013 2014 2015 2016 2017 2018 2019 2020

North America Ethylene Expansions

Actual Capacity Additional Capacity

k tons

k tons

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Phase III - Raw Material Cost Advantage Is Key Cost Driver to Reshoring Growth

» Raw materials normally accounts for 60-70% of manufacturing cost of goods sold (COGS)

Most product cost competition is won or lost hereShale gas giving the US an advantage for steel, plastics, chemicals

» Total labor cost is usually ~20% of COGS for US manufacturers

China labor cost in $ will continue to rise due to inflation and currency appreciationUS labor rate expected to remain stable

» Transportation & Logistics costs are in “Other”Asia/China has 5~10% cost disadvantage due to extra ~ 1 month shipping lead time (major cash flow disadvantage)Transportation costs continue to rise

» Energy cost is usually less than 5% for final manufacturer

However, energy costs are buried in raw material costs and transportation and can be more substantial in energy-intensive productsUS has a tremendous advantage vs. industrialized world

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Implications and Wrap Up

» Reshoring manufacturing volume will be limited until raw material costs are advantaged with some exceptions:

Durable goodsQuality differentiationInnovation / proximity to market advantagesMexico near-sourcing

» Shale gas-driven raw material advantages will take 5 years+ to flow through supply chain

Ethane crackers are current bottleneck to downstream cost competitivenessBottleneck will be relieved in 2016/2017 timeframeImports will be displaced – exports will grow dramatically in some industries

» Shale gas competitiveness is sustainable with huge, accessible supply reserves with continuous production cost improvement

» Shale oil is “icing on the cake” for the US Shale oil and gas supply chain will drive job growthEnergy independence coming!Improvement in trade deficit

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Thank You!For follow up questions and information, please contact:

Taylor Robinson, President+1 (508) 982-1319

trobinson@plgconsulting.com