US Ethane Outlook: The Sequel Implications for Midstream Players

1. US Ethane Outlook: TheSequelImplications for Midstream Players Presented to the 86th Annual GPA Convention March 13, 2007 Peter Fasullo En*Vantage, Inc pfasullo@envantageinc.com

2. Characteristics of a Sequel: A Warning • A sequel is most likely a work of fictionin that is produced after a completed work, and is set in the same "universe", but at a later time. It usually continues elements of the original story. • The popularity of a sequel comes about in large part because it is less risky to build on a known success than to gamble with new and untested characters and settings. • Sequels are often criticized as artistically inferior, and accused of simply repeating the story of the original work.

3. A Flashback -- Market Climate Two Years Ago In early 2005, the market climate for ethane had vastly improved for US gas processors: • Lingering effects of an 2002/2003 economic downturn were over. • Gas prices were dropping relative to crude oil after being over 100% of crude in 2003 and near 100% in the 1st half of 2004. • US ethylene production had rebounded in 2004 and ethane feedstock consumption was strong. • Processing margins favored full ethane extraction instead of rejection just 2 years before. Major question back then was: Will the good times last?

4. What Was Our Conclusions Two Years Ago? Conditions should remain favorable for ethane cracking and extraction, even with moderate ethylene production growth: • Ethane frac spreads should remain strong to encourage extraction in all processing regions. • A tighter crude market keeps gas to crude price ratios below 90%. • This is not the time for processors to retreat from cryogenic plants. • As ethylene production grows, ethane cracking increases and the flexibility to switch off ethane diminishes. • By 2010, ethane production should reach and sustain the 800 MBPD level, with the Rockies and La Gulf Coast contributing a larger share. • Ethylene producers need to track the regional shift in ethane supplies.

5. Why Focus on Ethane Again? • In 2006, midstream players announced $2 billion in projects betting on the long-term viability of ethane. • Over 3 bcfd of cryogenic processing capacity, capable of extracting 150 MBPD of NGLs • 450 bpd of new NGL pipeline capacity • 215 bpd of additional fractionation capacity • Major NGL component – constitutes 39% of the US NGL barrel. • In some processing regions, ethane is 50% of the NGL barrel . • Ethane extraction mostly discretionary - sensitive to economic conditions. • Ethane has only one end use as an ethylene feedstock. • US Ethylene industry needs ethane - constitutes 40% of their feedstock mix, but the ethylene industry has a wide range of feedstock flexibility. • Ethane supply/demand has demonstrated swings of 150 MBPD or more in a market averaging around 660 MBPD for ethane from processing.

6. What are the Major Questions Today? • Will new ethane volumes from gas processing flood the market? • What is the long-term viability of the US Ethylene Industry and the outlook for ethane feedstock consumption? • What will be the regional distribution of ethane supplies and which processing regions will have the economic advantage of extracting ethane? • Which segments of the midstream value chain are taking the most risk in betting on ethane and how can this risk be mitigated?

7. Topics to be covered today • Overview of ethane supply/demand and simple benchmarks to follow. • Examine fundamentals driving ethane cracking. • Look at ethane extraction trends and outlook for the future. • Implications for midstream players

8. Ethane supply & demand fundamentals appear simple, but they are complex and volatile. • Key market drivers for ethane extraction and cracking: • Ethane Extraction • Frac spreads • Processing contracts • Plant type • Plant location • Gas quantity & quality • Ethane Cracking • Ethylene business cycles • Cracker capacities & feedstock capabilities • Competing feedstocks • Ethylene co-products • Derivative Imports/Exports Source: DOE, En*Vantage, Hodson

9. Our analysis of ethane supply & demand focuses on three primary drivers. Both being inversely related to the gas to crude price ratio

10. Relative value of gas to crude can affect U.S. NGL supply/demand, particularly for ethane. Source: Platts, DOE and En*Vantage

11. Ethane (NGL) frac spreads are inversely correlated to the gas to crude price ratio..... Source: Platts & En*Vantage

12. Ethane extraction closely tracks ethane cracking, influenced by the gas to crude price ratio.

13. A couple of concerning long-term trends • For the past several years, ethane cracking does not seem to be increasing. • Ethane extraction seems to be trending down even at times when extraction economics are extremely good. This raises the questions of how much influence one trend is having on the other and are there specific demand and supply factors influencing the long-term trends for ethane cracking and extraction, respectively.

14. Let’s take a closer look at what drives ethane cracking

15. Ethane cracking, as compared to alternative ethylene feedstocks, is definitely trending downward.

16. As ethylene production increases, ethane cracking increases and the flexibility to swing ethane usage diminishes.

17. The shift in US ethylene capacity is estimated to shift the ethane cracking range downwards by about 40 to 55 MBPD.

18. Growth in US ethylene production and capacity has stagnated over the past 5 years and the forecast is not that optimistic.

19. In the future, the stability of ethane demand continues to be uncertain with a wide range possible.

20. So what does the future hold for ethane extraction?

21. US NGL extraction is declining 2.5%/yr since peaking in 2001. Declining gas production is the primary factor for lower volumes.

22. But we are also seeing signs that the liquid content in US proven gas reserves is also declining. That is, gas is getting leaner.

23. The processors along the TX and LA Gulf Coast have shown the greatest declines in NGL extraction volumes.

24. Ethane extraction is declining. If trend continues, ethane extraction volumes will be down 12% by 2011.

25. However, there is a number of new cryogenic plants under construction in the 3 of the hottest gas producing basins. • What is the ethane extraction capability of these new plants assuming 95% utilization? • What is the growth potential for these growing gas producing basins? • What are the prospects for additional ethane extraction in these growing basins? • How much does this potential incremental ethane extraction add to total ethane supplies from gas processing?

26. Major new cryogenic processing capacity will be installed in the Rockies and Barnett Shale in 2007 and 2008 Source: DOE, En*Vantage

27. These new processing plants increase the industry’s maximum ethane extraction capability by an additional 65 to 70 MBPD Source: DOE, En*Vantage

28. In addition to ethane from announced processing plants, at least one US LNG terminal will be recovering NGLs by 2009. • Trunkline is building a 1.050 BCFD NGL extraction plant at its Lake Charles LNG Terminal. • Depending on the quality of LNG being imported, we estimate that anywhere between 18 MBPD to 48 MBPD could be extracted. • Most likely, the Trunkline LNG terminal will process Nigerian LNG which has as an average BTU content of 1150 +/- 25. • That would imply an ethane recovery rate of ~32 MBPD. • To be conservative we are assuming Trunkline will extract at least 30 MBPD. This ethane will not be economically sensitive because it needs to be recovered to make the LNG pipeline quality.

29. If no additional cryo plants are built, ethane balances should be reasonable, unless “low ethane demand case” occurs. But….. Source: DOE, En*Vantage

30. Incremental gas production should come from Barnett Shale, Rockies, Anadarko, and Arklatex regions based on reserve growth.

31. By 2011, there could be an additional 2.8 BCFD of gas production that could be processed. Should cryo plants be built?

32. Processors have to consider the consequences of adding more cryo capacity as there could be a large ethane supply overhang. Source: DOE, En*Vantage

33. In the future, more ethane will be extracted from the inland growth basins. Source: DOE, En*Vantage

34. There are several implications for midstream players if a large ethane overhang causes ethane on ethane competition: • Independent gas processors with “keep whole” contracts have the highest exposure to economic risks. • Processors in the Rockies should experience narrower gas basis in the future as new gas pipeline takeaway capacity comes on-line. • Processors with POP contracts or fee based contracts could prolong oversupplied ethane conditions. • Integrated midstream players should have less economic risks as they can distribute those risks across their NGL value chain. • Logistic assets (pipelines, fractionation, storage) to be built or expanded to service NGLs from new processing capacity will also have exposure to ethane rich NGL streams.

35. Let’s Review the Trends and the Analysis Demand Side: • US ethylene capacity not expected to increase. Contraction possible. • US ethylene producers will have greater feedstock flexibility. • Low ethane demand case: 600 to 620 MBPD. High ethane demand case: 700 to 725 MBPD. Supply Side • US NGL (ethane) extraction is in decline, but announced plants plus ethane recovered from LNG will offset this decline. • Any “New” cryogenic capacity could create a large ethane extraction overhang. Processing contracts can prolong oversupplied conditions. • Regional shifts to the Rockies and N. Texas will spur new “logistics” that will be heavily dependent on ethane. More ethane demand variability

36. In Conclusion • The US Midstream Sector can no longer take for granted that the US Petrochemical Industry will always be there for ethane. • Any processor considering to add more cryo capacity must: • Carefully follow and evaluate the state of the US petrochemical industry. • Examine economic position versus competition that may be more integrated across the NGL value chain. • Have the ability to reject ethane, because ethane market conditions will be more volatile. • Structure processing deals to minimize economic damage when a downturn occurs. • Logistic players will need to recognize and manage the risks of having projects that handle high ethane content NGL streams .