KKR REPORT NOVEMBER 2012

Historic Opportunities from the Shale Gas Revolution

BY MARC S. LIPSCHULTZ GLOBAL HEAD OF ENERGY & INFRASTRUCTURE

Table of Contents
3 4 6 9 11 17 20
Definitions

Executive Summary

Americas New Gas Supply Profile: A Doubling of Recoverable Resources

Will the New Supply Picture Reduce Price Volatility?

Economic Impact: Gass Expanded Role in the U.S. Economy

Managing the Environmental Impacts/Risks of Shale Gas

Conclusions

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Denitions
Hydraulic Fracturing the process of injecting fluid and proppants under high pressure through a [horizontal] well into a shale gas, tight oil or other formation to stimulate production. Horizontal Drilling the practice of drilling a horizontal section in a well (used primarily in a shale or tight oil well), typically thousands of feet long. Natural Gas Liquids (NGLs) components of natural gas in gaseous form in the reservoir, but can be separated from the natural gas at the wellhead or in a gas processing plant in liquid form. NGLs include ethane, propane, butane, and pentane. Original Gas-in-Place the amount of natural gas in a reservoir (including both recoverable and unrecoverable volumes) before any production takes place. Original Oil-in-Place the amount of oil in a reservoir (including both recoverable and unrecoverable volumes) before any production takes place. Oil and Gas Value Chain Upstream Oil and Gas Activities all activities and expenditures relating to oil and gas extraction, including exploration, leasing, permitting, site preparation, drilling, completion, and long term well operation. Midstream Oil and Gas Activities activities and expenditures immediately downstream of the wellhead, including gathering, gas and liquids processing, and pipeline transportation. Downstream Oil and Gas Activities activities and expenditures in the areas of refining, distribution and retailing of oil and gas products. Oil and Gas Resource Terminology Conventional gas resources resources associated with higher permeability fields and reservoirs. Usually, such a reservoir is characterized by a water zone below the oil and gas. These resources are discrete accumulations, typified by a well-defined field outline. Economically recoverable resources that part of technically recoverable resources expected to be economic, given a set of assumptions about current or future prices and market conditions. Proven reserves the quantities of oil and gas expected to be recoverable from the developed portions of known reservoirs under existing economic and operating conditions, and with existing technology. Technically recoverable resources the fraction of gas in 1 2 3 4 5 6 7 8 9 10 11 Estimated U.S. Lower-48 Recoverable Gas Resource Base by Source North American Shale Plays Game-changing Production Forecasts Net Surplus of Natural Gas Monthly Average Gas Prices at Henry Hub (Nom$/ MMBtu) Recent and Planned Natural Gas Infrastructure Additions Supply Rationalization Process is Reflected in Forward Curve U.S. Map of Employment Gains in 2017 Projected Growth in Natural Gas Consumption by Sector Natural Gas Upstream Capital Requirements Natural Gas Infrastructure Capital Requirements Gas-fired Power Generation Employment to Double through 2035 9 11 12 13 14 15 17 18 18 19 20 place expected to be recoverable from oil and gas wells without consideration of economics. Unconventional gas resources low permeability deposits more continuous across a broad area. The main categories are shale gas, coalbed methane, and tight gas, although other categories exist, including methane hydrates and coal gasification. Shale gas and tight oil gas, condensate, and crude oil produced from shale plays. Tight oil plays are those shale plays dominated by oil and associated gas, such as the Bakken in North Dakota. Coalbed methane (CBM) gas produced from coal seams (also known as coal seam gas, or CSG). Tight gas gas and condensate produced from very low permeability sandstones.

LIST OF EXHIBITS

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HISTORIC OPPORTUNITIES FROM THE SHALE GAS REVOLUTION

Executive Summary
Recent advances in production techniques unlocked long known but previously untapped natural gas resources of immense scale. We believe these newly recoverable gas resources can provide the U.S. with at least an additional 100 years of supply at current usage levels. This presents a truly transformative change in Americas energy supply picture, and one with potential to grow the economy, reduce energy import dependence and enhance national security, lower household energy bills, reduce emissions, and spur a manufacturing renaissance. However, the ability to reap these benefits is far from assured, and significant challenges must be overcome to fully seize this historic opportunity. The following white paper presents an analysis and assessment of what brought about this revolutionary advance in recovery techniques, the necessary conditions for full development of the opportunity, and a view of the transformative impact it can have on Americas energy infrastructure and economy if we successfully harness this vital resource. It also presents a view of key challenges that must be overcome, which include smoothing out the boombust cycle in gas prices that undermines consumer and producer confidence, and mitigating the environmental impacts and risks that limit social acceptance of the resource opportunity. More broadly, a national dialogue is needed to achieve consensus on the standards that must be met to secure and maintain the social license to develop this critical resource. We believe the following key points must be addressed in order to achieve success: First and foremost, industry must continue to proactively engage with regulators, the local community, environmental and other stakeholders to develop appropriate regulation and best practices that reduce impacts and protect human health and the environment, including the reduction of fugitive methane emissions. For example, Anadarko, Encana, Shell, and ExxonMobil subsidiary XTO Energys work with the Environmental Defense Fund (EDF) on methane leakage testing to better quantify and eliminate methane emissions from the industry. Consensus is a necessary and desirable pre-condition for success and industry leaders must continue to actively seek to achieve this through open dialogue and demonstrated commitment to responsible stewardship. Second, expansion of natural gas-based transportation infrastructure including mid-sized municipal and corporate natural gas powered fleets, natural gas powered heavy duty trucks, and consumer vehicles should be encouraged through a variety of incentives, including where appropriate federal, state and local policy initiatives. This infrastructure is particularly capital intensive, but will also yield important benefits, such as reduction in oil consumption. Third, procedures for securing permits on federal land need to be clearer, expeditious, and more consistently applied to provide greater certainty and transparency regarding the rules, criteria and procedures. This clarity should expand access to federal lands where significant oil, gas, liquids and unconventional gas is present and can be responsibly produced. Finally, there must be support for, and action to encourage development of a natural gas export infrastructure. In our view, Liquefied Natural Gas (LNG) exports are expected to play an important and constructive role in maximizing the domestic economic benefits of the shale gas revolution. The U.S. now enjoys significant comparative advantage relative to many of our energy import dependent trading partners, and LNG export sales to these partners will directly reduce our trade deficit. We believe the U.S. can capture these benefits of trade without ceding its energy price advantage to purchasers of LNG exports, as these exports will be priced significantly higher than prices paid in the U.S. market. Additionally, because the resource base is so large, these exports are expected to have only a modest impact on domestic prices while providing a steady source of demand to support expanded production and delivery infrastructure.

This presents a truly transformative change in Americas energy supply picture, and one with potential to grow the economy, reduce energy import dependence and enhance national security, lower household energy bills, reduce emissions, and spur a manufacturing renaissance.
Referred to as shale gas, these newly accessible resources are trapped deep below the surface in shale formations. As a lowporosity rock, the shale formation must be broken, or fractured, to release the gas trapped within. Advances in integrating two mature exploration and production technologies, horizontal drilling and hydraulic fracturing, have progressed to the point where these resources may now be economically recovered. While this paper focuses on dry gas recovery from shale formations, it is important to note these techniques are also being used on a significant scale to exploit natural gas liquids and oil opportunities. The challenge at hand is to successfully mobilize the financial, technical, environmental risk mitigation techniques and policies necessary to bring these gas resources online and into the economy in a manner that stimulates sustainable economic growth, while preserving and protecting the environment.

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HISTORIC OPPORTUNITIES FROM THE SHALE GAS REVOLUTION

The U.S. and Canada are not the only countries with significant shale gas resources; Poland, China and India possess significant resources, as do other nations. Yet, these countries currently lack the resources, technology and infrastructure necessary to safely, effectively, and efficiently extract the resource and bring it to market. We believe successful recovery of this resource will have a tremendous economic impact. It would dramatically increase gas market share in the electricity generation sector, make inroads as a transportation fuel, reduce petrochemical production costs, and improve U.S. manufacturing and overall economic competitiveness. The U.S. would also potentially shift from being a net importer of natural gas to a net exporter, creating a balance of trade benefits. Tapping the full potential of this resource is not yet a given and requires significant changes to, and investment in, our basic energy infrastructure, including significant expansion of the U.S. natural gas pipeline and storage system, the gas-fired generating fleet and, potentially, development of compressed natural gas fueling and other forms of transportation infrastructure. Transformation at this scale will require significant capital mobilization to finance the recovery of the resource, the expansion of gas delivery, storage infrastructure and investment in the plant, and equipment that will consume the growing gas supply. As discussed below in Chapter 2, we estimate if we do what is needed to successfully exploit the resource, gas production should increase by 44% from 2011 to 2035. Developing the resource and the delivery infrastructure to bring this new supply to market will require: $2 trillion in upstream investments for natural gas production (including associated volumes of condensate and NGLs) between 2011 and 2035, with $1.7 trillion needed for dry gas production alone. $205 billion in capital expenditures between 2011 and 2035 for gas infrastructure development. Expansion of the mainline gas transmission system by approximately 35,600 miles and an additional 589 billion cubic feet (bcf) of working gas storage by 2035. Similar to other recent growth opportunities in technology and biotech, exploiting the opportunities presented by natural gas carries with it tremendous basic industry and skilled-labor employment growth potential. Extraction and delivery of natural gas requires significant material inputs including steel and concrete, and skilled construction workers, welders and operating engineers to build and operate the new wells and infrastructure. In addition to expanding the gas production and delivery system, skilled workers, machinery and inputs will also be needed in gasfired power generation, construction of new ammonia, liquefaction, methanol plants, and new transportation infrastructure. In short, exploitation of the newly accessible gas resource holds the potential to shift us to a cleaner-energy economy and spur an industrial and manufacturing renaissance that would provide significant new employment opportunities for Americas skilled labor forces.

A recent study found that recent improvements in hydraulic fracturing and horizontal drilling techniques used to produce shale gas could lead to the creation of 835,000 to 1.6 million annual jobs throughout the U.S. economy by 2017, due to the significant multiplier effect associated with investment and employment in the gas sector. To put this in perspective, the low range of this estimate exceeds total employment in the entire U.S. auto manufacturing industry (including parts suppliers). If the nation joins together to make successful development of this resource a shared national priority, even greater employment gains may be expected over the longer term. Some projected economic and employment gains from these new production techniques include: Increasing annual GDP between 1.2% and 1.7% by 2017; Improving the U.S. trade balance by increasing net exports by approximately $120 billion annually by 2017. This is equivalent to nearly one-quarter of the U.S. 2010 trade deficit; Saving consumers $41 billion in 2017 as a result of lower gas prices, enough to cover the electricity bill of 30 million homes. This figure includes direct savings to natural gas consumers, indirect savings from lower electricity prices, and lower prices for industrial products; Creating hundreds of thousands of well-paying jobs, including: 330,000 direct jobs in natural gas, oil, and natural gas liquids production; 120,000-210,000 manufacturing jobs; and, 33,000-40,000 construction jobs. While the potential economic benefits of increased natural gas are hard to dispute, efficient and effective realization of these tremendous opportunities is not yet a given. Significant technical, market, policy and environmental risks and challenges must be addressed to successfully capture the opportunities presented by the shale gas revolution.

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HISTORIC OPPORTUNITIES FROM THE SHALE GAS REVOLUTION

Americas New Gas Supply Prole: A Doubling of Recoverable Resources

The ability to cost-effectively recover shale gas has dramatically increased the amount of economically recoverable natural gas resources in the U.S. With the advent of economic shale gas recovery, the total recoverable resource base now represents over 3,500 trillion cubic feet (Tcf), representing more than 100 years of U.S. gas supply at current demand levels (see Exhibit 1). Shale gas recovery is at the heart of this increase in supply and now accounts for over half of the recoverable U.S. resource base, whereas just a decade ago it made up less than 5%.
exhibit 1

Shale Gas Recovery Process

Pioneered in the Barnett shale in Texas over the last decade, hydraulic fracturing of horizontal gas wells has gone from being an effective but high cost method of producing gas to the primary source of new, low-cost natural gas production. Shale gas production today typically involves drilling vertically to 6,000-12,000 feet below ground, followed by another 5,000-10,000 feet of lateral (horizontal) drilling. Hydraulic fracturing fluid, or frack fluid, is then pumped into the well at high pressure to fracture the rock and release the gas. The frack fluid is made up of 98.0-99.5% water. Typically sand is added to the fluids to prop open the fractures and allow the gas and other chemicals to flow. After the fracture is complete, 20%-30% of the frack fluid flows back to the surface and must be disposed of. Some gas may also be released during the flow back and can be either vented, flared (burned) or captured for sale. Capturing the gas is the best option from an economic and environmental perspective. Flaring the gas is preferred to releasing the gas into the air, sinice it reduces the amount of conventional and greenhouse gas (GHG) pollution. The illustrations below provide an overview of where these recoverable resources are found and how the hydraulic fracturing process works.

Estimated U.S. Lower-48 Recoverable Gas Resource Base by Source

4,000 3,500 3,000 2,500 TCF 2,000 1,500 1,147 1,000 500 0 Shale Gas Other Unconventional Resources* Conventional Resources 3,572

2003 NPC

2012 ICF

Source: ICF estimates October 2012. *Includes tight gas, associated tight oil, and coalbed methane

This increased base has led to significant increases in domestic gas production, and in our view shale gas produced through horizontal drilling and hydraulic fracturing is the primary driver of this increase. An overview of the horizontal drilling and hydraulic fracturing process is presented in the text box on the next page.

With the advent of economic shale gas recovery, the total recoverable resource base now represents over 3,500 trillion cubic feet (Tcf), representing more than 150 years of U.S. gas supply at current demand levels.

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HISTORIC OPPORTUNITIES FROM THE SHALE GAS REVOLUTION

NATURAL GAS RESOURCES

Conventional Non-Associated Gas Land Surface

Coalbed Methane Conventional associated gas

Oil

Seal

Sandstone

Tight Sand Gas

Gas-rich Shale

HYDRAULIC FRACTURING PROCESS

Sand Truck Blender Truck Groundwater Aquifers Fuid Storage Tank Private Well Municipal Water Well: < 1,000 ft. Protective steel casing Shale Fractures Additional steel casingand cement to protect ground water Pumper

Fracturescreated by high pressure uid Approximate distance from surface: 8,000 feet

Source: Bipartisan Policy Center and American Clean Skies Foundation, March 2011

exhibit 2

North American Shale Plays

Lower besa river Montney Doig Phosphate

Muskwa-Otter Park, Evie-Klua

MuskwaOtter Park

NORTH AMERICAN SHALE PLAYS (as of May 2011)

CURRENT SHALE PLAYS

Colorado Group Niobrara* Cody Hillard-BaxterMancos-Niobrara Monterey Temblor Mancos Hermosa Lewis Monterey ExcelloMulky Woodford PierreNiobrara Bend Avalon Barnett BarnettWoodford
Eagle Ford, La Casita Eagle Ford, Tithonian Pimienta Pimienta, Tamaulipas

Stacked plays
Frederick Brook Utica Horton Bluff

SHALLOWEST / YOUNGEST INTERMEDIATE DEPTH / AGE DEEPEST / OLDEST * MIXED SHALE & CHALK PLAY ** MIXED SHALE & LIMESTONE PLAY *** MIXED SHALE & TIGHT DOLOSTONESITSTONE-SANDSTONE PLAY PEOSPECTIVE SHALE PLAYS BASINS

Bakken ***
Gammon Mowry Niobrara* New Albany Fayetteville Floyd Neal Antrim

Heath**

Denovian (Ohio) Marcellus Utica

Chattanooga Conasauga Tuscaloosa

Eagle Ford

HaynesvilleBossier

Maltrata

Source: U.S. Energy Information Administration (EIA). North American shale plays. EIA, 2011: Washington, D.C. Available at: http://www.eia.gov/oil_gas/rpd/northamer_gas.jpg

Already, the growth in shale gas production has resulted in a 27% increase in U.S. natural gas production between 2005 and 2011, and production is expected to increase another 44% by 2035. These production gains mean that after over two decades as a net importer of natural gas, the U.S. is projected to become a net gas exporter by 2017 (see Exhibit 3). It also means natural gas is poised to expand its share of the primary energy market, becoming a more plentiful and cost-effective feedstock for a variety of industries (previously relocating to lower cost countries), including methanol, Gas to Liquids processing (GTL), ammonia, and nitrogen fertilizer plants. Exhibit 2 shows the major shale plays throughout the U.S. and Canada. The success with shale production in the Barnett shale, where these techniques were advanced and costs lowered dramatically, is now being replicated in shale plays across the country. As shown in exhibit 3 below, nearly 60% of the forecasted production in 2035 will be from shale gas. This increase in shale gas production would enable the U.S. to shift from a net importer to a net exporter of natural gas despite significant declines in domestic conventional gas production (see Exhibit 3). The increased production would serve a growing domestic demand and displace imports of natural gas (primarily from Canada) which have been an important part of the U.S. gas supply for the last 20 years.

After over two decades of natural gas imports, the U.S. is expected to become a net exporter in 2017, which will provide the U.S. significant balance of trade benefits.
exhibit 3

Game-changing Production Forecasts Net Surplus of Natural Gas

35 30 TCF 25 20 15 10 5 0 1950 Conventional Other Unconventionals* Net Imports Offshore Shale-Net Exports Net Exports

1960

1970

1980

1990

2000

2010

2020

2030

Source: EIA and ICF estimates, October 2012. *Includes tight gas, associated tight oil, and coalbed methane

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HISTORIC OPPORTUNITIES FROM THE SHALE GAS REVOLUTION

Will the New Supply Picture Reduce Price Volatility?

Natural gas has long been recognized as a preferred fuel for residential or commercial heating, industrial processes, and power generation, as well as a valuable chemical feedstock. However, despite its myriad advantages and uses, it has had difficulty reaching a market share reflective of its technical potential. As discussed throughout this section, natural gas historic underperformance relative to potential has been driven by a variety of factors that should be overcome by the newly abundant resource base. During some periods, energy policy created explicit limitations on gas use. One such example, The Power Plant and Industrial Fuel Use Act, of 1978, prohibited the use of natural gas for new large industrial boilers and power plants for nearly 10 years. At other times, changing market rules or other factors resulted in price volatility, which made natural gas uneconomic and led to economic distress for large gas consumers. As can be seen in Exhibit 4, natural gas prices have been volatile during the last decade. During the winter of 2000-2001, wholesale gas prices spiked to a level nearly four times the average gas price since 1993, and remained at nearly double this average for almost a year. This run-up appears to have been caused by a combination of factors, including declining production from conventional supply basins, unusually low storage levels, skyrocketing demand due to extremely cold weather, and high underlying demand due to strong economic growth. In 2005, outages from hurricanes Katrina and Rita resulted in another brief doubling of gas prices as a result of damage to, and lost production from, facilities in the Gulf of Mexico. In 2008, gas prices again doubled as part of a global run-up in energy and other commodity prices.
exhibit 4

Monthly Average Gas Prices at Henry Hub (Nom$/MMBtu)

$16 $14 $12 $10 $8 $6 $4 $2 $0 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12

Source: ICF and Platts, September 2012

The new supply picture has brought not only lower prices but, in our view, also increased confidence that the supply/demand balance permanently shifted in a way that will reduce volatility. The geographic dispersion of shale plays also reduces vulnerability to weather-induced supply disruptions, which may have contributed to historic volatility, as production from the Gulf of Mexico becomes a less significant source of overall supply. The key question is if the resource base unlocked by the shale gas revolution will result in reduced prices and volatility. We believe this is indeed the case. Infrastructure growth is at the heart of this question. Expansion is already well underway and we expect this trend to continue. Capital expenditures for gas infrastructure development are forecast at $205 billion from 2011 to 20351, which would expand the mainline gas transmission system by approximately 35,600 miles and create an additional 589 billion cubic feet (bcf) of working gas storage by 2035.2 Exhibit 5 provides an overview of recent and planned natural gas infrastructure additions.3

The key question is if the resource base unlocked by the shale gas revolution will result in reduced prices and volatility. We believe this is indeed the case.
Even though average gas prices were not unfavorable relative to other fuels during this period, these price swings may have dampened enthusiasm for major gas-based investments. The one common thread throughout this decade of volatility is the market was characterized by a tight supply and demand balance, resulting in high volatility in response to even periodic market events and disturbances. We believe this is the critical factor that is changing as a result of the shale gas revolution.

Inter-state Natural Gas Association of America (INGAA) Foundation. North American Natural Gas Midstream Infrastructure Through 2035. 28 June 2011: Washington, D.C.

2 Ibid. P. 13. 3 Note that this graphic includes only certificated natural gas pipelines; it does not represent the existing natural gas transmission system or existing and/or planned oil, natural gas liquids or gasoline pipelines.
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exhibit 5

Recent and Planned Natural Gas Infrastructure Additions

COLORADO CORRIDOR 23 Projects 29 Certificates 12,930 MMcf/d
10 17 11

NEW ENGLAND CORRIDOR 22 Projects 31 Certificates 9,773 MMcf/d

22
Ruby P ipeli ne (1 ,456 )

14 16 8

20 13 1 5 18

28 35 26 33 36 25 27

34

29 31 9 Rockies Express East (1,800)

12

32 23 30 24

21 3 2 6 15 19
4

FAYETTEVILLE CORRIDOR 12 Projects 23 Certificates 20,240 MMcf/d EAST TEXAS CORRIDOR 18 Projects 22 Certificates 22,125 MMcf/d

MARKET RESPONSIVE INFRASTRUCTURE ADDITIONS

60 61 63 64 65 66 67 62 57 59 58

Major Gas Pipeline Projects Certificated (MMcf/d) January 2000 To February 2011 115.00 BCF/D Total 16,178 Miles 152 Projects 212 Certificates

56 51 52 54 50 53 55 49 39 47 40 46 48 38 37 45 41 42

Source: Federal Energy Regulatory Commission, February 2012

While we are confident that the fundamentals are in place for sustained expansion of natural gas production and deliverability, current historically low gas prices raise concern about the development of the resource; persistently low prices may dampen enthusiasm for additional production. We believe that current low gas prices result from a perfect storm that included an historically mild winter (resulting in gas storage oversupply), slowed economic growth and continued supply expansion. We also believe, as evidenced by the forward curve, that these conditions are poised to turn around. We expect prices to firm over the near term as supply comes back into balance and the current supply overhang is worked off. Part of this rebalancing, we believe, comes from a shift in upstream producers exploration and production strategies, leading them to focus on oil and wet gas plays instead of maximizing dry gas production gains. These wet gas plays contain natural gas liquids (NGLs) made up of ethane, propane, butanes and pentanes-plus, and tend to provide more attractive margins given historically low natural gas prices. This shift in development strategy, coupled with heating season demand, should continue to work off some of the supply overhang weighing on short-term pricing. Exhibit 6 (right) provides a graphical representation of the supply overhang and rationalization process as reflected in forward pricing for NYMEX Henry Hub Futures contracts.

exhibit 6

Supply Rationalization Process is Reected in Forward Curve

GAS PRICES AT HENRY HUB (2010$/MMBTU) 12 10 8 6 4 2 0 2005 Historical 2010 2015 NYMEX Futures (Oct. 19, 2012)
Perfect storm leads to unsustainably low gas prices

Supply rationalization

Source: Historical: ICF estimates. NYMEX Futures: CME Group. Henry Hub Natural Gas Futures. Chicago Mercantile Exchange (CME) Group, 4 October 2012: Chicago, IL. Available at: http://www.cmegroup.com/ trading/energy/natural-gas/natural-gas_quotes_settlements_futures. html

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Economic Impact: Gass Expanded Role in the U.S. Economy

U.S. natural gas consumption is projected to increase by nearly a third from 2011 to 2035 and the integration of this newly plentiful and relatively inexpensive natural gas into the U.S. economy would have profound impacts4. This chapter examines the investment, industrial and employment changes that would result from bringing the shale-gas resource base on-line and integrating it into the economy. The shale gas revolution could lead to the creation of 835,000 to 1.6 million annual jobs throughout the U.S. economy by 2017,5 relative to projections made in 2007 based on that years technology. To put this into perspective, the low range of this estimate would exceed
4 American Clean Skies Foundation (ACSF). Tech Effect: How Innovation in Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012: Washington, D.C. Available at: http://www.cleanskies.org/techeffect/ 5 American Clean Skies Foundation (ACSF). Tech Effect: How Innovation in Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012: Washington, D.C. Available at: http://www.cleanskies.org/techeffect/ The study assessed the incremental annual change in GDP, employment, and tax receipts for the U.S. that is directly attributable to upstream technology gains. The methodology involved comparing forecasting assumptions and results on the U.S. natural gas and oil production and consumption forecasts from 2007 (before the recent technology gains were realized) to those of 2012. The study then compared the difference in production between these two results, and estimated the impact on the aggregate economy for each time period through 2017. exhibit 7

total employment in the entire U.S. auto manufacturing industry (including parts suppliers). These employment gains would come from expanded natural gas production, processing, transportation and use, as well as throughout the broader economy as new wages and earnings create additional spending throughout the economy. Exhibit 7, below, provides a snapshot of projected state-by-state employment impacts from the upstream technology gains ushered in by the shale gas revolution.

U.S. Map of Employment Gains in 2017

U.S. MAP OF EMPLOYMENT GAINS IN 2017 (Attributable to upstream technological advances since 2007)
2.0 - 16% 1.0 - 2.0% 0.8 - 0.9% 0.7-0.8% <0.7%

Source: American Clean Skies Foundation (ACSF). Tech Effect: How Innovation in Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012: Washington, D.C. Available at: http://www.cleanskies.org/techeffect/

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11

Provided the necessary steps are taken to fully exploit the resource, we project consumption will grow from 23.8 Tcf in 2010 to approximately 31.5 Tcf in 2035, or an increase of nearly one-third, driven largely by gains in the power sector, as well as sustained industrial consumption, LNG exports, and potentially increased use of natural gas for transportation (see Exhibit 8). An overview of projected growth in domestic gas consumption in key parts of the domestic economy is presented in Exhibit 8.6 In the sections that follow we look at the industries and investments that would create this new natural gas demand, and the benefits these would bring to the U.S economy if the resource is successfully developed.
exhibit 8

tion of roughly 35 Tcf annually by 2035.8 Over one-quarter of these upstream investments are for the incremental growth in natural gas production, which would require over $560 billion in investments between 2011 and 2035, and support over 500,000 new upstream production and supplier jobs by 2035.9 We believe these high-paying jobs have a significant multiplier effect in the broader economy, as well.
exhibit 9

Natural Gas Upstream Capital Requirements

U.S. UPSTREAM NATURAL GAS CAPITAL REQUIREMENTS U.S. TOTAL* DRY GAS ONLY INCREMENTAL PRODUCTION FROM 2010* BASE INCREMENTAL DRY GAS PRODUCTION FROM 2010 BASE 2010$ BILLION AVG. ANNUAL EXPENDITURES $79.7 $66.9

Projected Growth in Natural Gas Consumption by Sector

2.0 1.5 ANNUAL GROWTH (TCF) 1.0 0.5 0.0 -0.5 -1.0 -1.5 2011 Other Commercial 2016 2021 2026 2031 Industrial (petrochems) LNG Exports

2011-2020 $649.0 $544.2

2011-2035 $1,993.6 $1,671.5

$107.8

$561.2

$22.4

$90.4

$470.6

$18.8

Source: ICF estimates, October 2012. * Includes natural gas and associated lease condensate and NGLs. Does not include oil wells.

Industrial (others) Industrial (GTL)

Residential Power

Source: ICF estimates, October 2012

Bringing Gas to Market: Investment and Employment from expansion of Natural Gas Production and Delivery Infrastructure
Bringing this new natural gas to market would require $205 billion in infrastructure investment, or an average of $8.2 billion annually, between 2011 and 2035 (see Exhibit 10). A recent INGAA report found that these infrastructure investments would support roughly 105,000 jobs between 2012 and 2035.10 Because infrastructure and deliverability are key components of gas pricing, these infrastructure expansions (including transportation, storage, and processing) are essential to maintaining the long-term price stability needed for gas to reach its potential.11

Recovering the Resource: Investment and Employment from Expanded Exploration and Production
While recovering shale gas is now economically attractive, it remains a capital intensive activity, with typical horizontal wells costing $5 - $10 million depending on location, geology, and commercial factors. Some estimates put total cumulative capital expenditure for upstream natural gas production at over $2 trillion between 2011 and 2035.7 These upstream investments average $80 billion annually over the period, and are associated with total dry gas produc-

8 ICF estimates, Includes production of associated volumes of lease condensate and NGLs. 6 Note that power sector gas consumption is projected to decline in 2013 before resuming a steady growth pattern. This is the result of projections of power sector gas consumption in 2012 reaching 9.5 Tcf in 2012 as compared to 2011 consumption of 8.1 Tcf. This large increase in consumption is the result of industry taking advantage of historically low gas prices. As prices firm up in 2013, power sector consumption is projected to decline as it reverts to trend in 2013 and then resumes steady growth in the coming decade. 7 ICF estimates, October 2012, Includes production of associated volumes of lease condensate and NGLs. 9 The INGAA Foundation. Jobs and Economic Benefits of Midstream Infrastructure Development. INGAA Foundation, 15 February 2012: Washington, D.C. 10 The INGAA Foundation. Jobs and Economic Benefits of Midstream Infrastructure Development. INGAA Foundation, 15 February 2012: Washington, D.C. Available at: http://www.ingaa.org/File.aspx?id=17744 11 Inter-state Natural Gas Association of America (INGAA) Foundation. North American Natural Gas Midstream Infrastructure Through 2035. http://www. ingaa.org/Foundation/Foundation-Reports/Studies/14904/14889.aspx

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exhibit 10

exhibit 11

Natural Gas Infrastructure Capital Requirements

NATURAL GAS INFRASTRUCTURE CAPITAL REQUIREMENTS GAS TRANSMISSION MAINLINE LATERALS TO/FROM POWER PLANTS, GAS STORAGE, PROCESSING PLANTS GATHERING LINE GAS PIPELINE COMPRESSION GAS STORAGE FIELDS GAS PROCESSING CAPACITY TOTAL GAS CAPITAL REQUIREMENTS 2010$ BILLION AVG. ANNUAL EXPENDITURES $3.9

Gas-red Power Generation Employment to Double through 2035

140,000 EMPLOYMENT (NO.) 120,000 100,000 80,000 60,000 40,000 Combustion Turbine Combined Cycle

2011-2020 $46.2

2011-2035 $97.7

$14.0

$29.8

$1.2

$16.3 $5.6 $3.6 $12.4

$41.7 $9.1 $4.8 $22.1

$1.7 20,000 $0.3 $0.2 $0.9 0

2011

2035

Source: ICF estimates, October 2012. Note: Employment includes operations performed at the plant, as well as services, equipment, and materials provided to maintain plant operations.

$98.1

$205.2

$8.2

Source: The INGAA Foundation, 2011

Industrial Gas Use

The industrial sector has historically been the largest natural gas consumer in the U.S. economy. However, during the past 15 years gas consumption in the industrial sector has declined by 20%, as manufacturers became more efficient, shifted production overseas, or moved toward less energy intensive products.13 Higher gas prices and price volatility from 2000 to 2010 had a significant role in this decline, and a particularly negative effect on such gas-intensive feedstock industries as ammonia and methanol, causing plant shutdowns and increased imports. In our view, the abundant supply of relatively inexpensive natural gas from the shale gas revolution has already begun to reverse this decline. Recent lower gas prices and increased supply have resulted in a surge in industrial gas use, allowing shuttered ammonia plants to reopen and other plants to be built or relocated from abroad14. States are now competing with each other to provide economic incentives to induce construction of capital-intensive new plants within their borders. These developments can create a large number of direct and indirect jobs and significant base load demand for natural gasone ammonia plant (producing 1,500 metric tons of product per day) could consume 44 MMcf/d, or as much gas as 165,000 CNG cars.15,16
13 U.S. Energy Information Administration (EIA). Natural Gas Consumption by End Use. EIA, 2012: Washington, D.C. Available at: http://www.eia.gov/dnav/ ng/ng_cons_sum_dcu_nus_a.htm 14 American Clean Skies Foundation (ACSF). Tech Effect: How Innovation in Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012: Washington, D.C. Available at: http://www.cleanskies.org/techeffect/ 15 American Clean Skies Foundation (ACSF). Tech Effect: How Innovation in Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012: Washington, D.C. Available at: http://www.cleanskies.org/techeffect/ 16 ICF
KKR HISTORIC OPPORTUNITIES FROM THE SHALE GAS REVOLUTION

Electricity Generation
The electric generation sector would be the prime consumer of the expanded gas supply, with gas-fired generating capacity capturing the lions share of new builds in the power sector. Gas consumption in the power sector is forecast to nearly double between 2011 and 2035 increasing from 7.5 Tcf (21 bcf/d) to 13.3 Tcf (36 bcf/d) in order to serve an additional 280 GW of gas-fired generating capacity that will be brought online during this period (see Exhibit 11). This enormous expansion in the gas-fired generating fleet would require $245 billion in capital investment. It would also more than double the labor force in the sector, which is forecast to rise from 50,000 to 120,000 employees between 2011 and 2035.12 These employment gains include operations performed at the plants, as well as services, equipment, and materials provided to maintain plant operations.

Bringing this new natural gas to market would require $205 billion in infrastructure investment, or an average of $8.2 billion annually, between 2011 and 2035.
12 ICF estimates, October 2012, These jobs do not include the job attrition related to coal plant retirements.

13

Within the industrial sector, natural gas is used as both a fuel and feedstock. The largest gas users are quite energy-intensive and include the food, paper, chemicals, petroleum refining, non-metallic minerals, and primary metals industries. These industries account for 79% of total industrial gas consumption, while chemicals and petroleum refining alone account for 46%. Industries that use gas as a feedstock tend to be the most gas-intensive17; these include ammonia, hydrogen and methanol production. The following section discusses two important future sources of gas demandGas-toLiquids (GTLs) and Liquefied Natural Gas (LNG) exportsand their potential implications for the U.S. economy.

ence further GTL development.22,23,24 Because the GTL product is a petroleum substitute, a GTL plants economic viability is a function of the gas and oil prices. GTL plants require natural gas prices around $5 to $6/MMBtu to be economic if crude prices are $80 to $90/bbl. With gas and oil prices projected to stay in these ranges, based on the forward curve, GTL plants may prove to be a profitable long-term investment. That said, the capital cost is significant, nearly $10 billion for a 100,000 bbl/day plant25 and one plant in the Middle East has gone significantly over budget. GTL plants constitute a significant capital risk in the event that the fuel price spread shifts over time.

Gas-to-Liquids (GTLs)
One high-use industrial application for natural gas is as a feedstock for GTL facilities. These plants convert natural gas to liquid fuels, primarily a low-sulfur diesel fuel. This is another path to apply natural gas for transportation applications, but the investment would be in the fuel production rather than the delivery infrastructure and vehicles, since the fuels are compatible with conventional diesel and gasoline engines. GTL plants are in operation in or near large gas-producing countries, such as South Africa (using gas from Mozambique) Qatar, and Malaysia, allowing these countries to capitalize on gas resources and limit dependence upon traditional diesel and gasoline fuels.18 U.S. based GTL plants could provide similar domestic energy security benefits. It is likely that two such plants would be built in Louisiana; a Sasol plant is expected to come partially online in 2017 and fully in 2018, and a proposed project from Shell is expected to come online in 2019. These plants would require capital investment of $27 billion over the 20-year life of the plant, and create nearly 215,000 direct and indirect construction and operations jobs over the 20-year period.19,20,21 These plants would also be major sources of natural gas demand, consuming a total of 2.6 bcf/d (949 bcf annual), or an incremental increase in GTL gas use of 17 Tcf over an 18-year period (20182035). If the two GTL plants are successful, the U.S. may experi-

Liqueed Natural Gas (LNG) for Export

We believe another important potential source of gas demandand significant balance of trade benefitsis development of LNG export facilities. As U.S. production ramps up and we shift from being a net importer of natural gas to a net exporter, LNG export facilities are likely to form a crucial link to external markets. However, there is some political opposition to allowing significant exports of LNG, due to concerns that these exports may drive up domestic prices and harm U.S. competiveness. We believe this concern is overstated and fails to take account of well-understand benefits of trade based upon U.S. comparative advantage in natural gas production costs. The U.S. has a significant trade deficit and the earnings from LNG exports would directly benefit the U.S. balance of trade. It is also important to recognize that importing countries would likely not be securing gas at prices comparable to U.S. wellhead prices, and therefore not gain energy price competiveness. Rather, they would likely be purchasing gas at landed LNG rates typically linked to oil prices, and are much higher than U.S. domestic prices. And, while exports could exert modest upward price pressure on domestic pricingwhich should spur production growththese impacts are believed to be relatively modest and more than outweighed by the economic benefits. One study estimated that export of 6 bcf/d (2.2 Tcf annually) between 2015 and 2035 would increase the Henry Hub gas price by just 10% (or $0.64 per MMBtu).26 The U.S. Department of Energy (DOE) must approve all applications for projects designed to export natural gas to countries with whom the U.S. does not have a free trade agreement, and in so doing it must find these exports do not harm the public interest. While there are several applications pending at the DOE, only one recent application has been approved, for Cheniere Energys 2.2 bcf/d Sabine Pass project in Louisiana. DOE retained an independent third-party contractor to review the economic impacts of proposed LNG exports,
22 Claus, Kristian. Sasol announces gas-to-liquids complex. KPLCTV, 13 September 2011. Available at: http://www.kplctv.com/story/15452188/sasolannounces-selects-calcasieu-parish-as-location-for-potential-8-10-billiongas-to-liquids-complex 23 Gold, Russell. Shell Weighs Natural Gas-to-Diesel Processing Facility for Louisiana. Financial Times, 4 April 2012: London. 24 ICF estimates 25 http://www.iea-etsap.org/web/E-TechDS/PDF/S02-CTL&GTL-GS-gct.pdf 26 ICF International. Resource and Economic Issues Related to LNG Exports. Unpublished report, August 2011: Washington, D.C.

17 American Clean Skies Foundation (ACSF). Tech Effect: How Innovation in Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012: Washington, D.C. Available at: http://www.cleanskies.org/techeffect/ 18 Energy Technology Systems Analysis Programme (ETSAP). Liquid Fuels Production from Coal and Gas. International Energy Agency (IEA), May 2010: Paris. Available at: http://www.iea-etsap.org/web/E-TechDS/PDF/S02CTL&GTL-GS-gct.pdf 19 Claus, Kristian. Sasol announces gas-to-liquids complex. KPLCTV, 13 September 2011. Available at: http://www.kplctv.com/story/15452188/sasolannounces-selects-calcasieu-parish-as-location-for-potential-8-10-billiongas-to-liquids-complex 20 Gold, Russell. Shell Weighs Natural Gas-to-Diesel Processing Facility for Louisiana. Financial Times, 4 April 2012: London. Available at: http://online. wsj.com/article/SB10001424052702304072004577323770856080102.html 21 ICF estimates

14

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HISTORIC OPPORTUNITIES FROM THE SHALE GAS REVOLUTION

which is scheduled for completion by the end of 2012, and is not expected to act on any further applications until this report is released. 27 Canada is also seriously considering LNG export facilities. Despite the significant economy-wide benefits, opposition to natural gas exports remains a potent political issue. and regulatory or legislative actions to restrict exports could undermine this important opportunity. The U.S. has long been a champion of free markets, arguing that free trade agreements are imperative for economic growth. A restriction on exports, aside from eroding the longtime stance of the U.S. on free trade, would exacerbate the U.S. net export deficit, adversely impact domestic producers, and limit U.S. growth opportunities in an already tenuous economic climate. Recognition of the general benefits of trade explains why the U.S. does not place export restrictions on other essential commodities such as wheat or soybeans, and the same logic should hold for LNG.

These facilities also have the potential to generate attractive returns. Because oil is the alternative fuel for most LNG importers, the price of LNG in the international market is typically linked to oil prices. An oil price of $100/bbl equates to a landed LNG rate of $12.00 - $15.50-/MMBtu, a significant premium relative to current U.S. gas prices.30,31 This premium has resulted in great interest in developing LNG export facilities in the U.S. 32 LNG facilities are, however, quite capital intensive, the average cost for a greenfield 1 billion cubic feet per day (bcf/d) LNG plant is estimated at $4.8 billion, while retrofit of an existing import terminal would cost 65% of this, or $3.1 billion. The investment risk for an export terminal would be borne by the developer.33

Employment in the broader economy

In addition to the direct investment and employment impacts associated with increased gas production and utilization the shale gas revolution would also have significant positive spillover effects in the broader economy. A recent study found that the new production techniques driving the shale gas revolution could produce between 835,000 to 1.6 million jobs by 2017.34 The study calculated the jobs along the natural gas and oil value chain as a result of the domestic natural gas, oil, and NGL supply surge and found that the upstream and midstream sectors (i.e., natural gas production, transportation, and processing) together require 13,000 annualized direct and indirect jobs per additional 1 bcf/d of production. The study estimated that in oil and gas production, every $1.00 of direct and indirect economic activity generates between $1.30 and $1.90 in induced economic activity (thereby creating between $0.30 and $0.90 in economic activity outside the oil and gas sector and its suppliers). Taken as a whole, the shale gas revolution has the potential to increase GDP by 1.2% to 1.7% per year by 2017. 35,36

The U.S. has a signicant trade decit and the earnings from LNG exports would directly benet the U.S. balance of trade.
A recent report from the Brooking Institution, based on a yearlong assessment of the implications of US LNG exports, reached the conclusion that A proscription on LNG exports would constitute a de facto subsidy to domestic consumers at the expense of domestic producers. History suggests that government intervention in the allocation of rents can lead to inefficient outcomes and unintended consequences. To avoid these outcomes, the U.S. Government should neither act to prohibit nor promote LNG exports. 28 Notwithstanding the current regulatory impasse, we expect that three U.S. export facilities would be constructed and brought into operation between 2016 and 2019. These three U.S. LNG facilities, all located on the U.S. Gulf Coast, would require over $18 billion in capital investments and create nearly 150,000 construction and operation jobs over the 20-year lifetime of the plants. With a combined capacity totaling 1.5 Tcf annually (4 bcf/d), these facilities would also be major sources of demand, consuming an estimated 26 Tcf between 2016 and 2035.29

30 A barrel of oil contains 5.8 MMBtu, thus $100/bbl is the equivalent of $17.24/ MMBtu. Landed LNG is typically priced at 70%-90% of oil, or $12.00-$15.50/ MMBtu. 31 ICF estimates 32 ICF estimates 33 American Clean Skies Foundation (ACSF). Tech Effect: How Innovation in Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012: Washington, D.C. 34 American Clean Skies Foundation (ACSF). Tech Effect: How Innovation in Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012: Washington, D.C. Available at: http://www.cleanskies.org/techeffect/, The study assessed the incremental annual change in GDP, employment, and tax receipts for the U.S. that is directly attributable to upstream technology gains (i.e., horizontal drilling, hydraulic fracturing). The methodology involved comparing forecasting assumptions and results on the U.S. natural gas and oil production and consumption forecasts from 2007 (before the recent technology gains were realized) to those of 2012. The study then compared the difference in production between these two results, and estimated the impact on the aggregate economy for each time period through 2017. 35 Ibid. 36 U.S. Bureau of Economic Analysis. Gross DomesticProduct (GDP): CurrentDollar and Real GDP. U.S. Department of Commerce Bureau of Economic Analysis, 2012: Washington, D.C. Available at: http://www.bea.gov/national/ index.htm#gdp
KKR HISTORIC OPPORTUNITIES FROM THE SHALE GAS REVOLUTION

27 US DOE. http://www.fossil.energy.gov/programs/gasregulation. 28 Brookings Institution Energy Security Initiative (ESI). Liquid Markets: Assessing the Case for U.S. Exports of Liquefied Natural Gas, ESI, May 2012. P. 47. 29 American Clean Skies Foundation (ACSF). Tech Effect: How Innovation in Oil and Gas Exploration is Spurring the U.S. Economy. ACSF, 2012: Washington, D.C.

15

Transportation Sector Potential

Natural gas is currently substantially less expensive than petroleum on an energy basis, yet transportation is the one sector of the economy where gas does not currently play a substantial role. The shale gas revolution has prompted renewed and expanded interest in transportation applications for natural gas, which would have significant balance of trade and energy security benefits. The major obstacle to increased gas utilization in transport is fueling infrastructure, which is highly capital intensive and presents something of a chicken and egg challenge. Natural gas engines themselves are already commercially available. They would not be produced in significant volume however, until there is sufficient fueling infrastructure to support more widespread production and use of gas-fueled vehicles. Two gas fueling options have significant potential for development and growth: 1. Compressed natural gas (CNG) is stored in high-pressure tanks and can be delivered via compressors from existing natural gas distribution lines. However, CNG vehicles typically have a shorter operating range than conventional vehicles. 2. LNG is gas cooled to a liquid at -260oF. LNG allows greater on-board fuel storage and greater range, but also requires additional infrastructure for liquefaction, transportation and storage. Urban Fleet Vehicles: The most immediate opportunity for natural gas in transportation is for urban fleet vehicles using CNG. This market includes either public fleets (e.g., city buses, garbage trucks, other vehicle fleets) or private fleets (urban delivery trucks, garbage trucks, company fleet cars and trucks). The key factors that support this market are that the vehicles can operate within the range of on-board CNG storage and can return to a central facility every night for refueling. Short-haul heavy-duty trucks that can be fueled with LNG from dedicated fueling facilities may also be in this category. The investment is very specific to each project and uses commercially available technology. Individual refueling stations cost from $0.3 million to $3 million. Natural gas engines are available and several additional manufacturers are considering the production of natural gas vehicles. Heavy-Duty Trucks: Long-haul, heavy-duty trucks should use LNG in order to achieve the range required for this market. The high incremental cost of natural gas engines for these trucks requires significant fuel savings to provide a positive return on the investment. The payback also depends on individual company turnover policy. Some companies sell their trucks after only a few years, leaving not enough time for the fuel cost savings to pay back the higher cost of the natural gas vehicle. In addition, the secondary market for LNG trucks may be weak if the buyers of used trucks do not have the resources to maintain and fuel LNG trucks. Additional investments may be necessary for owners to meet specific safety requirements for LNG use (for example truck maintenance facilities may need to be modified to allow work on gas vehicles). In addition, public fueling infrastructure that includes liquefaction and LNG transportation and distribution would be required to ensure adequate coverage for a viable long distance trucking network. Development of a national fuel infrastructure may require public investment to establish adequate support for long-haul trucking through LNG fueling stations that can cost $2.5 to $5.5 million dollars each. Additional investments would be required for liquefaction and LNG transportation equipment. Although efforts are being made to provide LNG infrastructure along certain main truck routes, it is not clear how much fuel coverage would be needed to make this a fully viable option. Dedicated fleets with known routes and short haul trucks with central fueling facilities would be the best early option. Consumer Light-Duty Vehicles: Development of a large consumer market for CNG vehicles should address the chicken and egg fueling/ vehicle problem. All required technologies have been available for many years but consumer perceptions, resale issues and hedonic characteristics (trunk space, vehicle range, search time for fueling stations, long refueling time) as well as fuel availability have been a hindrance to the market for many years. There is only one automobile manufacturer currently producing CNG vehicles, though others are considering adding such vehicles. Home refueling stations connected to residential natural gas supply are available for as little as $4,000. Refueling facilities at service stations can cost from $0.5 million to $3 million. Local gas distribution companies (LDCs) or gas producers might invest in home or public fueling stations, but LDCs might also require approval from Public Utility Commissions to make such investments. Additional investment may be required to create a truly national infrastructure for CNG cars, and the hedonic issues may still be a barrier.37,38

37 GTI. Removing Technical Barriers to Refueling NGVs at Home. GTI, 25 September 2012. Available at: http://www.gastechnology.org/webroot/ app/xn/Removing_Technical_Barriers_NR_09_25_2012.html 38 ICF estimates

16

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HISTORIC OPPORTUNITIES FROM THE SHALE GAS REVOLUTION

Managing the Environmental Impacts/ Risks of Shale Gas

The preceding chapters have addressed how the shale revolution came about and its potential economic impact. This chapter addresses the principal non-financial obstacle to realization of this potential: public resistance to the resource based on environmental and safety concerns. Natural gas has long been viewed as the environmentally preferred fossil fuel and as the best bridge fuel for the long-term transition to a low-carbon economy. In fact, the environmental community has frequently advocated for increased natural gas use as an alternative to coal. Despite this relatively benign view of natural gas generally, development of shale gas has become a polarizing energy and environmental issue. The social license to develop the newly accessible natural gas resource is already facing significant challenges stemming from environmental concerns related to the exploration and production process. As evidenced in the fracking moratoria in New York, western Maryland, and parts of Pennsylvania, these concerns must be addressed. Securing and maintaining social acceptance of shale gas development is a key ingredient to long-term success. There are water, air quality, land use, and seismicity impacts associated with exploration and production that must be acknowledged and mitigated. Improved communications and transparency, commitment to best practices and openness to appropriate regulatory oversight and enforcement would be keys to securing sustained public acceptance. This section discusses the main areas of public concern, the sources of the risks and impacts, how they are regulated, and actions underway to reduce impacts and mitigate environmental risk. to hydraulic fracturing, frack fluid handling, and some aspects of wastewater disposal is currently being implemented at both the federal and state level.

Water Issues
Human health and environment issues associated with shale gas operations include ground water and surface water contamination, and water resource impairment or depletion. Ground water contamination: The headline concern regarding the water impacts of fracking is that frack fluids, produced water, and/ or methane would migrate from the fracturing zone into aquifers, contaminating drinking water supplies with methane, fracking fluids, salts, other minerals and, in certain cases, radiological material. There are no documented cases of migration of fracking fluid or methane (gas) from the fracking production zone of a shale gas play (where the fracking of shale takes place) to a drinking water table. EPAs investigation into potential ground water contamination near tight gas production wells in Pavillion, Wyoming, which began in 2009, has heightened concerns over potential ground water contamination and chemical use.39 More recently, the U.S. Geological Survey (USGS) released data indicating ground water contamination at the site.40 However, the Pavillion site is not a shale gas play, but a shallow tight gas play in which drilling is much closer to ground water than in the shale gas plays currently being developed. Furthermore, at Pavillion there is evidence of well construction issues and some evidence of surface spills, indicating that poor production practices may have played a role in contamination, and not the fracking itself. While highly unlikely, the risk of pollutants migrating from a fracking zone directly to groundwater can be greatly minimized through careful pre-screening of the surrounding geology, and monitoring of the geology as fracking is performed. Testing of groundwater prior to fracking, to create a baseline against which any future changes can be evaluated, is also a practice recommended by organizations such as the Environmental Defense Fund. The public perception about the nature of water contamination risk and the fracturing zone as a pathway for potential contamination may result in part from a different definition of the term fracking as it has entered the public lexicon. As used in the public discourse, fracking refers to the entire exploration and production process, including horizontal drilling, fracturing, and extraction of the gas via the well, rather than an engineering process for fracturing low permeability rock.
39 U.S. Environmental Protection Agency (EPA).Investigation of Ground Water Contamination near Pavillion, Wyoming. EPA, 2011: Washington, D.C. Available at: http://www.epa.gov/region8/superfund/wy/pavillion/EPA_ ReportOnPavillion_Dec-8-2011.pdf 40 U.S. Geological Survey (USGS). Groundwater-Quality and Quality-Control Data for Two Monitoring Wells near Pavillion, Wyoming. USGS, 2012: Washington, D.C. Available at: http://pubs.usgs.gov/ds/718/DS718_508.pdf
KKR HISTORIC OPPORTUNITIES FROM THE SHALE GAS REVOLUTION

Shale Gas Regulation Rigor

There is public concern that shale gas production lacks effective environmental regulation and enforcement. The industry is regulated under a web of federal state and local regulations, and there is increasing attention being paid by federal, state and local officials to the adequacy of these regulations to protect public health and the environment. Many aspects of oil and gas operations are covered by federal environmental regulations such as the Clean Air Act, Clean Water Act and the Safe Drinking Water Act. While there are a number of partial exemptions for various oil and gas-related operations, in our view there is no evidence that these exemptions resulted in any significant environmental impacts. Nevertheless, there is some public pressure for the Administration and Congress to reconsider some or all of these exemptions. The absence of federal regulation does not indicate a lack of regulation. State and local authorities in gas-producing regions have taken the lead in implementing regulations and, in particular, regulations specific to shale gas production. Regulation specific

17

The principal pathways for potential contact between fracking fluids and drinking water/the water table are via the well bore/casing, surface handling of the frack fluids before and during the fracking operation, and during the flow back of fluids up the well as the cleanout process is completed. This is where the bulk of regulatory and industry best practice activity is and should be focused. There have been cases where methane from gas drilling has affected groundwater. These incidents are believed to result from well casing failure near the surface, where methane from non-pay formations in the drilling path has infiltrated the bore.41 Proper well casing (steel piping used in 1-3 layers down the well) and cementing (applied between each layer of steel well casing) ensures that gas and fracking fluids do not migrate out of the pay-zone.

quirements for reporting of fracturing fluid constituents are under development. Surface Water Contamination: Another area of potential risk to groundwater and drinking water relates to safe handling, storage, and treatment of the returning frack fluids. Roughly 20%-30% of the liquid injected to fracture a well is returned and that water contains both the fracking fluid and hydrocarbons, salts and metals from the shale formation. Spillage can be addressed through improved handling practices, including use of storage tanks and properly sealed settling ponds to capture and store the wastewater, rather than unlined open ponds. In our view, treatment and disposal must be handled in geologically appropriate manners. Injection of drilling wastewater in deep injection wells in the southwestern U.S. has been an effective disposal technique, but we believe this is due to the geology of that region. The geology in parts of the East (Marcellus shale in Pennsylvania) is not conducive for this option, thus specialized wastewater treatment plants are being developed and some wastewater is being transported to injection wells in other states (e.g., Ohio). Wastewater is increasingly being reused for future fracking jobs, which minimizes both water use and wastewater disposal. Some aspects of wastewater disposal are already regulated under the Federal Clean Water Act and Safe Drinking Water Act, and states including Michigan, New York, Pennsylvania, and West Virginia instituted new regulations on water use and disposal. Water use: A final water-related concern is the water intensity of the fracking process itself. This is a highly location-specific issue. Development of a well requires 3-5 million gallons of water (for context, 5 million gallons of water is the equivalent to the amount of water required for 7.5 acres of corn over a season, or the amount of water New York City consumes every 7 minutes).42 This can be a significant drawdown in arid or semi arid environments and/or locally sensitive areas. As one of our most precious natural resources, we believe fresh water usage should be managed aggressively and reuse of water, as well as use of brackish water instead of freshwater, should be encouraged and pursued by industry.

Natural gas has long been viewed as the environmentally preferred fossil fuel and as the best bridge fuel for the long-term transition to a low-carbon economy.
Well casing and cementing requirements vary from state to state, based in part on geological conditions and operating experience, with some requiring bottom-to-top cement circulation of production casing and other states requiring cementing of production casing to a certain height above the production zone. In an effort to address public concerns and ensure safe operations, states such as Ohio and New York are implementing more rigorous state-level well construction measures (e.g., dictating the number of casing layers). In Pennsylvania, a group of natural gas producers, environmental groups and other stakeholders have formed the Institute for Gas Drilling Excellence (IGDE) to jointly develop an independent certification program for superior environmental performance in shale gas production. Overall, best practices and potential regulation are focusing on better benchmarking of pre-drilling groundwater conditions and better well casing practice to reduce the incidence of well casing failures. A related concern is the composition of the fracking fluids used in the process and their potential impact on human health and water supplies. Although such additives typically make up less than one percent of the fracking fluid and are often absorbed onto the mineral surface, disclosure continues to be an area of contention. One response is the FracFocus database, in which companies provide chemical disclosure through a public database. States such as California, Colorado, Michigan, Montana, New York, and Texas require disclosure of fracking chemicals to state authorities, although the specifics of what must be reported are variable. Additional re41 U.S. Geological Survey (USGS). Groundwater-Quality and Quality-Control Data for Two Monitoring Wells near Pavillion, Wyoming. USGS, 2012: Washington, D.C. Available at: http://pubs.usgs.gov/ds/718/DS718_508.pdf

Chemicals Issues
Use of chemicals in the fracking fluid is a serious public concern. While ground water contamination from fracking itself is unlikely, as mentioned above the preliminary results of EPAs investigation into potential ground water contamination in Pavillion, Wyoming, has heightened concerns.43 While the analysis of the USGS data is underway, a small but more likely pathway for contamination, relative to that of well leakage, is spillage due to accidents or improper handling. Chemicals used in fracturing, particularly proprietary blends, are sometimes not disclosed to health officials, though organizations such as FracFocus, which has a public database online, allows companies to report chemicals used. Disclosure requirements are a
42 Chesapeake Energy. Water Use in Deep Shale Gas Exploration. Chesapeake Energy, May 2012. Available at: http://www.chk.com/media/educationallibrary/fact-sheets/corporate/water_use_fact_sheet.pdf 43 U.S. Environmental Protection Agency (EPA).Investigation of Ground Water Contamination near Pavillion, Wyoming. EPA, 2011: Washington, D.C. Available at: http://www.epa.gov/region8/superfund/wy/pavillion/EPA_ ReportOnPavillion_Dec-8-2011.pdf

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HISTORIC OPPORTUNITIES FROM THE SHALE GAS REVOLUTION

key concern that should be addressed through both regulation and best practices to ensure safe practices and understanding of risks in the event of contamination.

conventional Clean Air Act regulations, but some producers are voluntarily updating equipment to the most recent standards, and some states are requiring more stringent limits.

Air Emissions
Shale gas production generates air emissions under normal conditions and has the potential to create additional pollution through spills or accidents. Emissions are generated through releases of gas during production (called gas venting and fugitive emissions), and from the trucks or other equipment needed during production, as explained below. Greenhouse gas (GHG) emissions: When combusted, natural gas has the lowest GHG emissions of any fossil fuel. However, natural gas itself is composed of methane, which when vented to the atmosphere is a potent greenhouse gas. This is an important consideration because fugitive methane vented to the atmosphere during the exploration and production process reduces the overall GHG benefit of natural gas relative to other fuels. The largest potential source of these fugitive methane emissions from shale production is during the period when fracking water flows out of the well after the fracturing process. Methane entrained by this water can be controlled by flaring or reduced emission completions (REC) where the gas is captured and sent to the pipeline. A numbers of states, including Colorado, Ohio, Texas (Fort Worth), and Wyoming, have established regulations to control well completion methane emissions. The EPAs recently enacted New Source Performance Standards (NSPS), under the federal Clean Air Act, requires RECs for completion or recompletion of hydraulically fractured gas wells.44 Producers must comply by January 1, 2015, if not sooner. These new regulations do not cover associated gas production or liquids unloading, leaving a fraction of fugitive methane emissions from natural gas production unregulated. Environmental NGOs are likely to push the EPA to address these gaps in future rulemaking. While fugitive methane emissions are significant, recent studies show that the lifecycle GHG emissions from gas-fired power generation are roughly 30 to 40% lower than coal, when fugitives are taken into account.45 The data surrounding these estimates is uncertain, leading the Environmental Defense Fund to partner with the University of Texas and nine major gas producers to undertake field measurements of production emissions, in an effort to get better data to inform emission reduction efforts and future policy. Air emissions: The conventional air pollutant emissions from shale gas production are diesel engine NOx and PM emissions from drill rigs, pump engines, trucks, gas compressors and flares and volatile organic compounds (VOCs) associated with venting of gas from various production processes. The engines are regulated under
44 U.S. Environmental Protection Agency (EPA). EPAs Air Rules for the Oil & Natural Gas Industry. EPA, 2012: Washington, D.C. Available at: http://www.epa.gov/airquality/oilandgas/pdfs/20120417changes.pdf 45 Christopher L. Weber and Christopher Clavin, Life Cycle Carbon Footprint of Shale Gas: Review of Evidence and Implications, Environmental Science & Technology 2012 46 (11), 5688-5695

Seismic Activity and Other Issues

Earthquakes: Noticeable seismic activity, mostly very small earthquakes, has occurred in shale gas production areas. To date, investigations have linked almost all of these events to deep well injection of wastewater, rather than fracturing itself.46 Deep well injection of hazardous wastes is a well-established practice and has been shown in the past to cause seismicity. Seismic activity related to fracking or disposal of fracking wastewater has been reported in Youngstown, Ohio, the Eola Field in Gavin County Oklahoma, and also in central Arkansas, Texas, British Columbia and in Lancashire, UK. Nevertheless, new regulations are being developed to regulate the injection of wastewater in areas of known seismicity.47 Regulatory measures include site characterization and testing before, during, and after disposal well drilling to assess the full seismic impact of the underground disposal process. Land Use and other concerns: Other issues, including the land use footprint, traffic and road damage, and noise and light pollution are also concerns related to shale gas production. The land use footprint of shale gas operations is actually less than that of conventional wells due to the high production per well (through horizontal drilling) and the practice of drilling multiple wells per pad. Traffic and road damage can result from truck traffic to transport materials, water and wastewater since each well can require over 1,000 truck trips. Noise and light pollution can also be disruptive to neighboring residents. Supplying water via pipeline and reusing wastewater can help reduce truck traffic and disruption. There is a need to work closely with local communities in establishing operating procedures that minimize community impacts and that set reasonable setbacks from homes, schools, hospitals and the like.

Conclusions on Environmental Risks

As with any significant extractive process, there are environmental impacts and risks. Efforts are currently underway to better characterize and manage key health and safety risks, reduce the footprint and impact of the gas recovery process and develop additional requirements and procedures that improve safety and performance. Well casing and cementing standards, wastewater handling and treatment and reducing fugitive emissions are among the key areas for improvement. States will likely continue to focus on tightening flowback water disposal requirements at wastewater treatment plants, increase requirements for water well testing, increase storm water control measures, and site restoration procedures. Industry should continue do its part by actively engaging in the development and uptake of best practices and recognizing that environmental performance will be a key determinant of sustained support for development of the resource.
46 United States Government Accountability Office, Information on Shale Resources, Development, and Environmental and Public Health Risks, GAO12-732, September 2012. 47 Ibid.
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Closing: Leveraging Natural Gas

The more than doubling of our natural gas supply is a truly disruptive change in what had been a relatively stable energy supply outlook. Prior to this, US oil and gas production was on the decline for decades and many associated industries and business had moved offshore. Today, this trend is reversing thanks to the shale gas revolution. If exploited to its potential we believe the shale gas revolution would provide lasting economic benefits and drive growth in long-dormant or declining parts of the economy including manufacturing and basic industry, improve our trade balance, increase energy independence, advance U.S. national security, and spur new technology and innovation. This paper has sought to illuminate some of the key issues, challenges and requirements to safely capture this tremendous opportunity. We are confident that with appropriate care, oversight and industry leadership, the underlying resource can be safely developed and integrated into the U.S. economy in a manner providing investment opportunity, economic and employment growth and broad based social support. We also recognize there is diversity of opinion regarding appropriate development of the resource, as well as genuine environmental concern and risks to address. We need to have a national discussion and work together to capture this extraordinary opportunity. It is our hope that this paper can make a useful contribution to this critical dialogue, highlighting the following three principles for inclusion in this conversation: 1. The shale gas revolution represents a critical change in our energy resource base that should be harnessed in a responsible and sustainable manner. Shale gas is our pathway to a clean energy future, and we must take it. 2. The revolution in supply should be accompanied by sustained demand-side responses including use of incentives to develop and sustain demand, particularly in the transportation sector where gas utilization can provide important energy security and balance of payment benefits. Prudent levels of natural gas exports should also be encouraged to maintain demand and reduce our trade deficit. 3. The human health and environment risks and impacts of the shale gas revolution should be addressed thoughtfully and comprehensively, using a scientific and risk-based approach to mitigation of risks and impacts.

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Important Information The views expressed in this publication are the personal views of Marc Lipschultz of Kohlberg Kravis Roberts & Co. L.P. (together with its affiliates, KKR) and do not necessarily reflect the views of KKR itself. This document is not research and should not be treated as research. This document does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of KKR. It is being provided merely to provide a framework to assist in the implementation of an investors own analysis and an investors own views on the topic discussed herein. The views expressed reflect the current views of Mr. Lipschultz as of the date hereof and neither Mr. Lipschultz, nor KKR undertake to advise you of any changes in the views expressed herein. In addition, the views expressed do not necessarily reflect the opinions of any investment professional at KKR, and may not be reflected in the strategies and products that KKR offers. KKR and its affiliates may have positions (long or short) or engage in securities transactions that are not consistent with the information and views expressed in this document. This publication has been prepared solely for informational purposes. The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this document has been developed internally and/or obtained from sources believed to be reliable; however, neither KKR nor Mr. Lipschultz guarantee the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Target allocations contained herein are subject to change. There is no assurance that the target allocations will be achieved, and actual allocations may be significantly different than that shown here. This publication should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy. The information in this publication may contain projections or other forward-looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Performance of all cited indices is calculated on a total return basis with dividends reinvested. The indices do not include any expenses, fees or charges and are unmanaged and should not be considered investments. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Please note that changes in the rate of exchange of a currency may affect the value, price or income of an investment adversely. Neither KKR nor Mr. Lipschultz assume any duty to, nor undertakes to update forward looking statements. No representation or warranty, express or implied, is made or given by or on behalf of KKR, Mr. Lipschultz, or any other person as to the accuracy and completeness or fairness of the information contained in this publication and no responsibility or liability is accepted for any such information. By accepting this document, the recipient acknowledges its understanding and acceptance of the foregoing statement.

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