PLG REFC presentation "Shale Development: The Evolving Transportation Impacts"

1. Logistics Engineering Supply Chain Shale Development: The Evolving Transportation Impacts Prepared for: Rail Equipment Finance Conference 2013 March 3, 2014 2. About PLG Consulting Boutique consulting firm with team members throughout North America Partial Client List Established in 2001 Over 90 clients and 250 engagements Significant shale development practice since 2010 Practice Areas Logistics Engineering Supply Chain Consulting services Strategy & optimization Assessments & best practice benchmarking Logistics assets & infrastructure development Supply Chain design & operations Hazmat training, auditing & risk assessment M&A/investments/private equity Industry verticals Energy Bulk commodities Manufactured goods Private Equity Shale Development: The Evolving Transportation Impacts 2 3. Shale Supply Chain and Downstream Impacts Inputs Wellhead Direct Output Thermal Fuels Raw Materials Downstream Products All Manufacturing Generation Steel Gas Proppants Process Feedstocks Fertilizer (Ammonia) Home Heating (Propane) OCTG NGLs Methanol Other Fuels Feedstock (Ethane) Chemicals Chemicals Byproduct (Condensate) Water Petroleum Products Cement Crude Petro-chemicals Other Fuels Gasoline 2010 onward DEMAND ON RAIL CARS Shale Development: The Evolving Transportation Impacts 2016 onward 3 4. Burning Questions Frac sand: Resurgent growth? - Denouement of coal? - Is reshoring real? - Crude by rail: Is it safe? Here to stay? Shale Development: The Evolving Transportation Impacts 4 5. Correlation of Operating Rig Count with Sand and Crude Shipments 250,000 2,500 Operating On Shore Rigs All Sand Carloads Petroleum Carloads * 150,000 1,500 * 100,000 1,000 50,000 Operating Onshore Rigs 2,000 Carloads 200,000 500 0 0 2007 Avg. 2008 Avg. 2009 * Q4 2014 UP carloads estimated STCC 14413 (sand) and 13111 (petroleum) 2010 2011 2012 2013 Source: US Rail Desktop, Baker Hughes, Surface Transportation Board, PLG Analysis, February 2014 Shale Development: The Evolving Transportation Impacts 5 6. U.S. Frac Sand Industry Trends Rapid growth and maturation of both industries (hydraulic fracturing and sand production) over the past 5 years Total Delivered Cost per Ton ~ $122 Destination Transload & Trucking 25% Ownership shifting supply chain responsibilities reduced tasks by end customer Sand supply base growing and consolidating at the same time Rail - Freight, FSC and Eqp Lease 42% Mines continue to open; supply base is consolidating Sand 33% Large fluctuations in price of sand based on supply/demand balance Unit train shipping is the game-changing logistics development spurring investment in larger loadout sand transload facilities Logistics costs drive ~ 67% of total delivered sand cost Benchmark high-efficiency unit train example Illinois to South Texas Single-line haul (one rail carrier), private railcars achieving two round trips per month, origin sand facility has direct rail load-out and destination trucking is less than 100 miles Source: PLG analysis using BNSF public pricing does not include fixed assets at origin or destination, December 2013 Shale Development: The Evolving Transportation Impacts 6 7. Sand Railcar Market Conditions Small Covered Hoppers Current market described as high demand, red hot by leasing companies Proppant Consumed by Volume Freedonia Group Analysis 8/13 Increased frac sand per well demand, surging liquids production Additional sand sources opening in Wisconsin New orders from cement shippers Best availability is May/June 2014 (limited) Most likely availability is August-October 2014 Typical full service lease rates $535 - $575 5-7 year leases Less than 75,000 mileage caps Frac sand shippers/receivers will continue to move towards more efficient methods of rail transportation Manifest shipments require 2X the number of railcars vs. unit trains due to increased cycle times Use of manifest service usually encourages use of railcar as storage at destination, further increasing fleet requirements Cement consumption is expected to grow by 6.4% in 2014 and 6.2% in 2015, encouraging railcar orders Shale Development: The Evolving Transportation Impacts 7 8. Natural Gas Displacement of Coal for Thermal Generation Natural gas now supplying 27% of U.S. Electricity Generation US coal electricity generation share capture has dropped 10% from 2006 Adversely affecting coal industry, railroad coal loadings 2013 coal production hit 20 year low (less than 1B s/t) Export opportunities diminishing due to weak demand in Europe, declining demand and competition in Asia Source: EIA, February 2014 Despite recent increases in prices, natural gas share capture expected to maintain or grow Environmental regulations of coal burning Scheduled coal unit retirements; 55GW through 2020 Shale Development: The Evolving Transportation Impacts 8 9. Shale Related Rail Traffic Still Small Relative to Coal Volumes Railcars Handled: Sand, Crude, & Coal 2,500,000 1,500,000 Sand 1,000,000 Crude 500,000 Coal 2013 2012 2011 2010 2009 0 2008 Carloads 2,000,000 * Sand * * Crude Coal Quarterly Data * Q4 2014 UP carloads estimated STCC 14413 (sand), 13111 (petroleum), 11212 (coal) Source: US Rail Desktop, Surface Transportation Board, PLG Analysis, February 2014 Shale Development: The Evolving Transportation Impacts 9 10. Coal, Crude & Sand Trends: Carloads and Revenue Sand Revenue $18 9 $16 8 7 $14 Crude Revenue 1,400 Thousands 10 Billions Millions Carloads Combined Sand and Crude Carloads and Revenue 1,200 $4.5 $4.0 Billions Total Coal Carloads and Revenue $3.5 1,000 $3.0 $12 6 $10 800 $2.5 600 $2.0 5 $8 4 3 2 $6 $1.5 400 $1.0 $4 200 1 $2 - $0 STCC 14413 (sand), 13111 (petroleum), 11212 (coal) Shale Development: The Evolving Transportation Impacts $0.5 $0.0 Source: US Rail Desktop 10 11. Shale Gas Is More Important to US Industry Competitiveness Than Oil Natural gas has recently been ~5X cheaper than oil on a BTU-basis WTI & Henry Hub Natural Gas Energy Equivalent Pricing Innovation will convert more transportation fuels and other energy requirements to natural gas US electricity prices are the lowest in the industrial world US industries now have substantial power cost advantage ~5X Electricity costs 2x higher in China, 8x higher in Europe Source: EIA, February 2014 US gas downstream products will have world class competitiveness - are the building blocks of manufacturing Chemicals Resins Natural gas is a cleaner burning fuel compared to other hydrocarbons (coal, oil) Source: International Energy Agency, October 2013 Shale Development: The Evolving Transportation Impacts *estimate 11 12. Low Cost NGLs Will Give US Long Term Material Cost Advantages US Ethane has significant structural cost advantage vs. Europe and Asia Europe and Asia petrochemical plants utilize oil-based Naphtha as their feedstock Domestic ethane supplies to quadruple by 2025 Prices at historic lows NGLs (especially ethane) are basic building blocks in chemical supply chain Source: IHS Chemical, September 2013 Source: Townsend Solutions, December 2013 Source: American Chemicals Council, February 2014 Shale Development: The Evolving Transportation Impacts 12 13. Shale Gas Driving Steel, Methanol, & Fertilizer Manufacturing in US Shale gas boom makes direct-reduced iron steel economical DRI process uses natural gas in place of coal to produce iron $2+B in new US projects announced DRI-derived steel of higher quality than that created from recycled scrap, further driving demand Opportunity in U.S. methanol production Capture price spread between low-cost natural gas and methanol Source: GE Capital presentation, November 2013 Methanol is a very cost-efficient way to move natural gas to higher-value foreign markets US represents 10% of the global market U.S. imports 89% of its supply on average Natural gas is a feedstock for ammonia production Represents ~70% of cash costs (CF Industries) 12MM mt new domestic manufacturing capacity announced Source: IHS Energy, September 2013 Shale Development: The Evolving Transportation Impacts 13 14. US Shale Gas Background and Future US gas demand will grow 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 sustainable 30+ year supply at ~$4 mm/btu; cost of production decreasing Supply will overwhelm demand as prices approach $5 mm/btu US government will likely limit LNG export to protect US from world gas market price Industrial use will represent only ~1/3 of 2020 production (75B cf/d) Source: RBN Energy Shale Development: The Evolving Transportation Impacts 14 15. Shale Gas Phased Impact To US Industrial Renaissance 2008 2010 2012 2014 2016 2018 2020 Phase III Manufacturing: Raw material cost driven Phase II - Downstream Products: Resins, Chemicals SHALE GAS BOOM Phase I - Gas & Power-intensive Industries: Steel, Fertilizer, Methanol Phase I Industries using gas as primary feedstock have global cost competitiveness and new US factories being built >$100B of Chemical Expansion Announced Phase II Downstream products require significant processing facilities investment and lead time Phase III About 65% of the cost of manufactured product is material cost; US material cost advantage will enable more traditional manufacturing to return to the US from low cost labor countries Source: American Chemistry Council, February 2014 Shale Development: The Evolving Transportation Impacts 15 16. The Importance of Price Differentials to Crude by Rail Differentials made rail attractive Bakken and WTI differential as high as ~$20/bbl vs. Brent in 2012 CBR enables producers to sell at trading hubs with higher benchmarks Market response: E&P, midstream players willing to rapidly deploy significant capital to enable access and capitalize on spreads Multi-modal logistics hubs in shale plays and at destination markets (i.e. Cushing, OK, St. James, LA, Pt. Arthur, TX, Albany, NY, Bakersfield, CA) Lease and purchase of railcar fleets Source: North Dakota Pipeline Authority, January 2014, PLG Analysis Refineries install unit train receiving capability Particularly coastal refineries previously captive to waterborne imports (i.e. Philadelphia, PA, St. John, NB, Washington state) Pipeline capacity underutilized Rail captures 73% Bakken takeaway by April 2013 Differentials are both an incentive and a risk for crude by rail 3Q 2013 a cautionary note Source: North Dakota Pipeline Authority, PLG Analysis, Feb. 2014 Shale Development: The Evolving Transportation Impacts 16 17. Crude by Rail Statistics Carloads/Quarter 300,000 Bbls/Day 800,000 700,000 250,000 600,000 200,000 500,000 WTI-Brent WTI-Brent equilibrium equilibrium 3Q3012 3Q3013 150,000 400,000 * 300,000 100,000 200,000 50,000 100,000 - Feb-12 May-12 Aug-12 Nov-12 Petroleum & Petroleum Products (carloads/quarter) Feb-13 May-13 Aug-13 Crude Originated (carloads/quarter) Nov-13 Feb-14 Williston Crude by Rail (bbls/day) * Q4 2014 UP carloads estimated Source: AAR, North Dakota Pipeline Association, Surface Transportation Board, PLG Analysis, February 2014 Shale Development: The Evolving Transportation Impacts 17 18. Shale Development and Crude By Rail: Current Market Dynamics Adverse 3Q 2013 market forces have reversed Brent vs. WTI Spread WTI-Brent spread now ~$9/bbl CBR rebound driven by Bakken to coasts Weak long-term outlook for Bakken CBR to USGC Key driver: LLS now aligned with WTI, not Brent Next wave of CBR development: Canadian Oil Sands Terminal investments in Alberta and PADD II and III Source: Y Charts, February 2014 ~800 bbl/day planned AB loading capacity through 2015 = 25% of production NOT like the Bakken more challenges Complexities of heavy/sour product handling (steaming, diluent, unit train challenges) Fewer destinations Existing and growing mode competition to logical markets (pipelines and barge) Tank car market reorienting to coiled/insulated car types (~2/3 of CBR fleet order backlog) Source: RBN Energy, February 2014 Shale Development: The Evolving Transportation Impacts 18 19. ANS Light/Sweet Crude Logistics and Price Differentials and CBR Impact (+ - = ) February 2014 Light/Sweet at PNW Bakken (rail): $103 Brent (ship): $112 2,525 kbpd Pipeline Marine (wellhead) Pacific Northwest Refiners PADD V Demand Rail $90 Bakken Clearbrook, MN Light/Sweet at EC Bakken (rail): $105 Brent (ship): $111 Light/Sweet Heavy/Sour Niobrara Chicago, IL East Coast Refiners California Refiners 1,075 kbpd Brent PADD I Demand Light/Sweet WTI:$100 Heavy/Sour Cushing, OK Sources: EIA, PAALP, CIBC, CME Group, PLG analysis (Google Earth) Spread Brent - WTI LLS - WTI WTI - Bakken (Clearbrook) Permian Feb. 2014 $8.58/bbl + $5.41/bbl = St. James, LA CBR Impact $4.09/bbl Light/Sweet at LA GC Bakken (rail): $105 LLS (local): $106 = Eagle Ford TX Gulf Coast Refiners Light/Sweet at TX GC Bakken (pipe): $101 Brent (ship): $111 WTI (pipe): $105 LA Gulf Coast Refiners 8,150 kbpd $6 Brent PADD III Demand Light/Sweet Heavy/Sour 19 20. Oil $76 Sands Heavy/Sour Crude Logistics and Price Differentials February 2014 Hardisty, AB Rail Pacific Northwest Refiners PADD V Demand 2,525 kbpd Pipeline Clearbrook, MN Marine Light/Sweet Heavy/Sour PADD II Demand California Refiners 3,375 kbpd Chicago, IL Light/Sweet Heavy/Sour Midwest Refiners Spread Jan. 2013 Feb. 2014 Change Mexican Maya - WCS $38.07/bbl $15.45/bbl TX Gulf Coast Refiners -$22.62/bbl Sources: EIA, CME Group, CIBC, PLG analysis (Google Earth) Heavy/Sour at TX GC Mexican Maya (ship): $91 WCS (pipe): $94 WCS (rail): $100 8,150 kbpd PADD III Demand Light/Sweet Mexican Maya Heavy/Sour 20 21. Forecast of Light Crude Railcar Supply and Demand Light crude production increases vs. general purpose railcar capacity increases Significant increase in railcar capacity with the large railcar backlog If pipelines and local refining can consume production increases in Permian and Eagle Ford, light crude by rail (non Oil-Sands) will be primarily Williston Basin (Bakken) Under best-case scenario for rail market share capture, data suggests existing & planned general purpose tank car (light crude) fleet exceeds demand Possible retrofit of old design railcars could dramatically decrease capacity Approx. 2/3 of unlined, 30K/gallon fleet would need retrofit Assumptions: Williston: 80% rail market share of Willistons projected volumes 39,000 tank cars in crude service for light crude in February and build rate of 12,000 railcars/year of tank cars for light crude service through end of 2015 with attrition rate of 2,500 railcars/year 700 bbl. average railcar capacity and average 23 day turn Other production sources increase at rate of 16% per year Sources: CAPP, AAR, NDPA, Various Industry Sources and PLG analysis, February 2014 Shale Development: The Evolving Transportation Impacts 21 22. High Profile Accidents Changing Crude by Rail Rail industry has a strong safety record, but optics of CBR accidents are overwhelming any positive statistics Railroad operating rule changes on hazmat train handling Increased scrutiny, insurance requirements Short line and regional railroads in particular May have consequences in CBR freight rates Increased product testing, documentation and traceability (FRA directive) Oil chemistry varies by well/pad Concerns with extremely low flash and boiling points Bakken terminals at varying levels of compliance Shale Development: The Evolving Transportation Impacts 22 23. Bakken Crude Higher Volatility Click image to watch video Shale Development: The Evolving Transportation Impacts 23 24. Looking Ahead: Crude By Rail SWOT Primary strengths and opportunities Rapid implementation, scale up of operations, terminals, transit times Shorter contracts (2-3 year commitments vs. 10 years for pipeline) Access to coastal areas not connected via pipeline Origin/destination flexibility/facilitation of arbitrage opportunities Foundational business (i.e. refining and E&P majors who have made a structural commitment to CBR) Growth in Canadian CBR Capital Supply Sources KEY DRIVERS Destination Markets Oil Prices Primary threats and weaknesses Exposure to changing price differentials Structural changes in supply Narrow WTI-Brent spread (EIA projects $11-12/bbl for 2014) Adverse benchmark alignment (i.e. WTI-LLS; now ~$5 differential) Impacts to Brent beyond US control (geopolitical events, global demand) Permian and Eagle Ford supply to USGC Water-borne Eagle Ford crude deliveries to USEC Continued pipeline development Adverse commercial consequences from recent accidents, i.e. unreasonable timeline for tank car retrofits Oversupply resulting in crude prices at