Becca Followill

bfollowill@tudorpickering.com
(713) 333-2995
Dave Pursell
dpursell@tudorpickering.com
(713) 333-2962
Anson Williams
awilliams@tudorpickering.com
(713) 333-2951

Midstream Update & Primer

November 2008
Midstream Overview
„ Natural gas processing, natural gas liquids (NGL) transportation and fractionation are major segments of the oil and natural gas
industry, distinct from oil and gas production and separate from oil refining. They are critical and indispensable in the energy
value chain. They are some of the most complex, yet least known and least understood segments.
„ The industry has gone through a major structural change, from the assets being held by major oil and integrated E&P companies
as a “necessity” to being held by MLPs and integrated infrastructure companies as a profit center. As an investor, you can now
“play” the Midstream sector.
„ Midstream profitability and growth is tied primarily to four factors (which can vary depending on business mix):
□ Domestic natural gas production: growing production = higher Midstream throughput.
□ Supply of NGLs: tied to gas production and whether processors choose to extract ethane from the gas stream. If there are
too many NGLs compared with demand, prices decline.
□ Demand for NGLs: driven primarily by petrochemical companies and therefore, the economy. Higher demand for NGLs =
higher pricing.
□ Relationship between the price of natural gas and the price of NGLs: NGLs generally move with crude oil prices. If ethane
(~40% of NGL stream) is more valuable in liquid form than gaseous form (liquids priced higher than gas), then more gas
processed and more money made.
„ Increased U.S. gas production, coupled with the completion of NGL take-away pipelines, has resulted in increased NGL supply,
just as the U.S. economy is entering a recession and chemical/NGL demand is falling. So, the fundamentals behind all four of
these midstream drivers are deteriorating.
„ Worldwide, companies are idling propylene and ethylene plants (use NGLs as feedstock) and chemical companies are issuing
cautious outlooks for 2009.
„ NGL prices, which have historically traded at ~65-70% of crude oil (1999-2007), have more recently traded at ~45% of crude oil.
Frac spreads, the most frequently quoted measure of processing profitability, have dropped into negative territory from a high of
$11/mmbtu in July ‘08. Prices for naphtha, the alternate feedstock for some petrochemical companies, have fallen to less than
$300/ton in some areas, from as high as $1,200/ton this summer, a 75% decline. Ethane prices have also fallen 75% from summer
highs (39c/gal currently vs 154c/gal in July).
„ Fortunately, the industry is self-correcting. If frac spreads continue to decline, we are likely to see more ethane rejection (40%
of NGL stream stays in gaseous form). This decreases NGL supply, but has the potential to add as much as 2-2.5 bcf/d to
domestic gas supply. If that happens, gas prices fall, producers slow down drilling, and gas supply falls - reducing gas available
to process, which in turn reduces NGL supply, and ethylene inventories deplete. Then NGL prices rise, creating favorable NGL
economics once again. The cycles can be very quick.
„ So, as we go to print today, the Midstream industry, like much of the energy patch, is facing negative fundamentals. Six months
from now, we suspect the outlook will be very different. Throughout the cycles, we hope this primer provides a better
understanding of a very complex, yet integral segment of the energy industry.

2
 Part I – An Overview
„ Frequently overlooked, the midstream industry is
a critical link to turn raw natural gas into usable
Midstream Overview products.
„ Natural gas is comprised of two parts - a light gas
component and a heavier liquids component. The
light gas consists of methane, while the liquids
Dry or
Marketable consist of ethane, propane, n-butane, iso-butane
Gas and natural gasoline. These natural gas liquids
(NGLs) are used in the petrochemical industry, as
Processing refinery blend-stock, in home heating, and in
Interstate
Wet Gas Plant
Pipelines many other common applications.
Gathering
Onshore and „ Most wellhead gas does not meet the quality
Offshore Wells Raw NGL standards required by interstate pipelines, so it
Mix must be processed, removing contaminates and
Petrochemical
the heavier components (propane+).
Industry
Normal Butane „ After the NGLs and contaminants are removed,
what’s left is marketable gas (or dry gas),
Isobutane
consisting of methane with some ethane. That
Ethane Refineries gas is then ready to be delivered to interstate gas
Fractionator Propane pipelines.
Natural gasoline „ The raw NGLs are then sent to large fractionators
Finished NGLs to break the stream into usable components
(ethane, propane, etc.).
Industrial/
Heating

Source: Tudor, Pickering, Holt & Co.

3
NGL Removal is Non-Discretionary

The typical NGL “barrel” looks like this: „ We stress: propanes and heavier components
(propanes+), make up ~60% of the NGL stream, and
have to come out of the wet gas produced from the
wellhead. Pipeline specs mandate it.

40-45% Ethane „ Ethane is “discretionary,” meaning

producers/processors can opt to keep it in the
stream or remove it, depending on economics.

25-30% Propane „ Keeping ethane in the steam is called “ethane

rejection” (we know, it is the opposite of what is
intuitive, but think of it from the processors’
standpoint). The amount of Btus is always the
same - it’s just the state of matter that’s different.
5-10% Normal Butane
Ethane rejection = more gas, fewer NGLs
Normal processing = less gas, more NGLs
10% Isobutane

10-15% Natural Gasoline

4
 What Drives Midstream Economics?

Commodity
„ There are lots of ways to make money
Contract Structure Sensitive? through the midstream value chain.
While most are fee-based, processing is
Gathering Fee N usually commodity sensitive.
Processing Fee N „ Since processing involves converting
Keep Whole Y
MMBtus from a gaseous form to a combo
of liquids and gas, non fee-based
Percent of Proceeds Y processing economics are dictated by the
spread between the price of gas and the
Raw NGL Pipelines Fee N
price of NGLs (the “frac spread”).
Finished NGL Pipelines Fee N

Fractionation Fee N
Low gas prices/High NGL prices =
Favorable processing economics
Storage Fee N (Btus worth more taken out of gas stream)

Marketing Fee N High gas prices/Low NGL prices =

Unfavorable processing economics
(Btus worth more in gaseous form)

5
 Frac Spreads – The Midstream Economic Bellweather
Gulf Coast Frac Spread (45% Ethane)
„ Frac spreads, like refiners’ crack
$12

$10
spreads or power producers’ spark
$8
2008
spreads, are a measure of gross margin.
$6 It is the delta between the cost of gas
7-yr High
(processing input) and its value in NGL
$/mmbtu

$4

$2 form (processing output).

$0

($2) * 7-yr avg Gulf Coast Frac Spread ~$1.75/mmbtu

Frac spread = NGL Value – Cost of Gas
($4)

($6)
7-yr Low
These spreads are an industry
n b ar r ay n Ju
l g pt t v c bellweather when watching processing
Ja Fe Ap Ju Au Se Oc No De
economics.
M M

„ If frac spreads are positive, the MMBtus

Gulf Coast Frac Spread, 1999 to Present are more valuable in NGL form. If
$13.00 spreads are negative, the MMBtus are
$11.00 more valuable in gaseous form.
$9.00
$7.00 „ Shown here is a Gulf Coast frac spread,
$5.00
$3.00
but frac spreads can vary significantly
$1.00 by region.
($1.00)
($3.00)
($5.00)
99

00

01

02

03

04

05

06

07

08
19

20

20

20

20

20

20

20

20

20

Source: Bloomberg, Tudor, Pickering, Holt & Co.

6
 Frac Spread vs Ethane Production

„ If frac spreads go negative,

850 $12
800 $10
processors will reject ethane (~35-
750 $8
45% of stream) keeping it in the
700
$6 gas.

$/mmbtu
650
Mbpd

$4
600 „ Gas supply then increases, gas
$2
550
$0
prices go down, feedstock becomes
500
450 Cold winter and
Gas price spikes
following -$2
cheaper, and markets correct.
gas price spike Katrina/Rita
400 -$4
„ If frac spreads go negative, most
processors have “conditioning
9

8
9

0
n-

n-

n-

n-

n-

n-

n-

n-

n-

n-
Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja
Ethane Production Monthly Average Frac Spread language,” which allows them to at
least cover costs.
Source: EIA/DOE, Tudor, Pickering, Holt & Co.

7
Market for Processing is Self-Correcting
Fewer
NGL prices
NGLs are
increase
processed

Ethane economic
Gas supply decreases to process – more
ethane produced

Too much ethane

E&P
-prices
shut-ins
decrease

Gas prices Ethane

decrease Ethane rejection
production
decreases &
gas supply
increases
8
 U.S. Gas Processing/NGL Snapshot
U.S. Processing Statistics „ U.S. gas processing capacity and wellhead NGL
2005 2006 2007
production have been relatively flat since 2005,
Gas processing capacity, bcfd 70.3 70.2 71.0
increasing at a slower rate than gas production.
% Change -0.1% 1.2%
„ Seven gas plant projects were completed in
Gross (Wet) nat gas production, bcfd 64.3 64.4 67.2
2007, adding ~0.8 Bcfd of capacity. For 2008,
% Change 0.2% 4.4%
seven more projects either have been completed
Gas processing throughput, bcfd 46.8 45.5 45.3
% Change -2.6% -0.4%
or are expected in-service, which will add ~1.9
NGL production from processing, 1,000 bpd 1,717 1,739 1,783
Bcfd of additional capacity.
% Change 1.3% 2.5%
„ An additional 2.0 Bcfd of expansions are planned
for 2010+.
Source: Oil and Gas Journal 2008 & 2005, EIA/DOE, Tudor, Pickering, Holt
„ Two major NGL pipelines recently completed or
under construction, Arbuckle and Overland Pass,
NGL Sources NGL Uses should add 270k bpd of NGL pipeline capacity by
Crude Q1’09.
refining Exports
Heating & fuel 3%
17%
17%

Imports
10%
Petrochemicals
Gasoline 55%

Gas blending
processing 25%
73%

Source: EIA/DOE, Tudor, Pickering, Holt & Co.

9
 Major U.S. Gas Processors

Top U.S. Gas Processors „ The table to the left shows the major U.S. gas
Processing
processors. Gas processing represents only one
segment of the midstream value chain.
Stock Capacity % of
Company Symbol MMcf/d U.S. Total „ E&P companies used to be the primary owners
DCP Midstream LLC SE/COP/DPM 13,117 21% of gas processing plants, in order to support
Enterprise Products Partners LP EPD 4,666 8% their E&P operations. In the 1990s, companies
Williams Cos. WMB/WPZ 4,376 7%
began selling off midstream assets to focus on
Targa Resources Private/NGLS 4,341 7%
their core E&P business.
BP PLC BP 4,163 7% „ The industry consolidated further as pure
Crosstex Energy LP XTEX 2,936 5% “midstream” plays developed. In 2008, the
Aux Sable Liquid Products LP EEP/FCE.UN/WMB 2,200 4% top ten gas processors held two-thirds of U.S.
ONEOK OKS/OKE 1,751 3% processing capacity (excluding Alaska).
Enbridge Energy Partners LP EEP 1,470 2%
„ MLPs now dominate the space, as midstream
Kinder Morgan Energy Partners LP KMP 1,293 2% earnings are perceived to provide a certain
ExxonMobil Corp. XOM 1,195 2% degree of stable, reliable cash flows,
CDM Max LLC Private 1,100 2% especially when exposure to the frac spread is
Copano Energy LLC CPNO 1,058 2% minimized.
Chevron Corp. CVX 854 1%
Total 44,520 72%

Source: Oil and Gas Journal 2008, Tudor, Pickering, Holt (Excludes Alaska)

10
 U.S. NGL Production by Region (2007)
„ Gas processors describe natural gas
as “rich” (wet) or “lean” (dry),
depending on the amount of heavy
4.9% recoverable components contained.
(87 Mbpd)
„ A very rich gas may contain 5-6
1.1%
gallons of recoverable liquids per
(20 Mbpd)
12.1% mcf (gpm). A lean gas usually
(216 Mbpd) 12.3% contains 1 gpm or less.
3.6% (219 Mbpd) „ Deepwater Gulf of Mexico (GoM) gas
(64 Mbpd) can have 4+ gpm, compared with 1-
10.2% 1.5 gpm for the GoM shelf and 2-3
(182 Mbpd) 36.0% gpm on the Texas Gulf Coast. West
(641 Mbpd) 14.5% Texas gas is also very rich.
(258 Mbpd) „ Coal bed methane gas is essentially
5.4% free of NGLs and is comprised of only
(97 Mbpd) methane, water and sometimes CO2.

Source: EIA/DOE, Tudor, Pickering, Holt & Co.

11
 Processing Plants Follow Major Producing Areas

U.S. Gas Processing Plants „ There were 539 gas processing plants and
32 fractionators operating in the U.S. as of
January 1st, 2008.
„ About 33% of U.S. gas processing capacity is
located along the Gulf Coast. But the bulk
of new adds are planned for the Rockies
(currently 11% of capacity) and Ark/La/TX
(20% of current capacity).
„ About 80-85% of fractionation takes place
along the Gulf Coast; the NGLs are
produced close to the primary end-users –
petrochemical companies.
„ The average gas processing plant is getting
larger and more efficient.

Source: EIA/DOE

12
 Getting NGLs to Market
„ There are 2 major U.S NGL
trading hubs and 2 Canadian
hubs: Mont Belvieu, TX;
Conway, KS; Edmonton/Fort
Saskatchewan, Alberta; and
Sarnia, Ontario.
„ NGL pipelines transport NGLs
from producing fields to these
hubs, where they are stored,
fractionated, and/or distributed
for end use.
„ Mont Belvieu, the largest of
these hubs, is located on the
Texas Gulf Coast where there is
the highest concentration of
petrochemical, storage,
pipeline, fractionation, and
refinery infrastructure.
„ Given its strategic location,
Mont Belvieu is considered the
price setter for North American
NGL markets.

Source: Canadian NEB, edited for changing ownership & new pipelines proposed
13
 U.S. Petrochemical Plants
Puget Sound

Marathon
Lyondell BP Sunoco CVX
Sunoco
Sunoco Sunoco
Lyondell Ineos
Sunoco
Ineos
CVX Motiva

Frontier CVX Marathon

Premcor
Sunoco
CVX
Westlake
Ineos

El Dupont WMB
LA Refining
BASF
Motiva
Huntsman
Alon
Lyondell
TX Eastern
Valero
Citgo
Sasol BRPC
Flint Hills XOM XOM
EPD WMB
Lyondell Marathon
Valero Dow
Lyondell
Ineos Murphy
Westlake
Formosa Dow Shell
CVX
Lyondell Valero Louis Dreyfus
CVX Marathon
Javelina Dow Ineos

Citgo
Flint Hills
MarkWest

Source: ICIS Plants & Projects Database, Company Press Releases, Tudor, Pickering, Holt
14
Part II – Summary and Historic Trends
„ The first section of this primer discussed four drivers of Midstream profitability:
† U.S. gas production
† NGL supply
† NGL demand
† Relationship between price of gas, crude oil, and NGLs
„ This section reviews the historic trends of each of these drivers. With the recent collapse in commodity prices and
economic conditions, everything has been turned on its head. While historic trends aren’t always indicative of
where things are headed, the perspective should be helpful. Part III of this primer (p. 25) tackles where we think
things are headed.
„ In the meantime, a brief summary of historical trends:
† U.S. gas production: On the rise, +9% ytd after years of stagnant production. But, rig count is falling (and
with it, we hope, production).
† NGL supply: Also on the rise, albeit at a slower pace than gas production as NGL yields have fallen
(movement to leaner onshore gas production from richer offshore).
† NGL demand: Until quite recently, on the rise amid strong worldwide economies and a weak U.S. dollar.
Recently…in the tank.
† Relationship between gas, crude oil and NGLs: Midstream economics are most favorable when gas trades at
a discount to crude oil on a mmbtu basis and when NGLs trade at a high percent of crude oil price.
Historically NGLs have traded at 65-70% of crude oil, but the recent economic turmoil has pushed NGLs
down to ~45% of crude oil. Historically natural gas has traded at a 6:1 ratio (crude:gas). Over the past
couple of years, with the spike in crude, that ratio expanded to as high as 14:1. With the recent decline in
crude, the ratio is back to ~10:1.

15
 U.S. Gas Production – On the Rise
EIA-914 Gross U.S. Natural Gas Production Data
„ After stagnant/declining
production since 1997, U.S.
65 20% domestic production has been on
18%
the rise since mid-2006, driven by
60
a step change in gas prices, above
16%
Production (Bcf/d)

55 $6/mcf.
14%
50 „ Biggest increases in Texas (Barnett
12%
45
Shale) and the Rockies (Piceance,
10%
Powder River Basin and Green
40 8% River Basin), tempered by declines
35 6% in New Mexico and the GoM.
„ Excluding 2 months of
Se 5

Se 6

Se 7

8
Ma 5

No 5

Ma 6

No 6

Ma 7

No 7

Ma 8
05

05

06

06

07

07

08
05

06

07

08
l- 0

l- 0

l- 0

l- 0
0

0
p-

p-

p-
v-

v-

v-
y-

y-

y-

y-
n-

n-

n-

n-
r-

r-

r-

r-
Ju

Ju

Ju

Ju
Ma

Ma

Ma

Ma
Ja

Ja

Ja

Ja
Independence Hub downtime (at
Total Production Onshore Production Offshore as % of Total Production
almost 1 bcf/d), GOM production
year-to-date is +0.6% y/y.
Change in Gross U.S. Nat Gas Production
YTD Change
Region Thru Aug
Texas 16.0%
Wyoming 11.4%
New Mexico -3.0%
Oklahoma 4.2%
Louisiana 4.3%
Other 12.6%
Onshore Total 10.9%
GoM -3.2%
Total 9.0%

Source: EIA/DOE
16
 NGL supply growing at a slower rate…

U.S. Monthly NGL Production (Jan '01- Aug '08) „ Since early 2001, U.S. gas production is
+0.2%/yr on average.
2,100 „ During the same period, NGL
1,900 production is -0.9%/yr on average.
1,000 bpd

1,700 „ The slower pace of growth of NGLs is

1,500 due to periods of ethane rejection
(ethane kept in gas stream, resulting in
1,300
less NGLs processed out) as well as
lower NGL yields (leaner gas).
1

8
0

0
n-

n-

n-

n-

n-

n-

n-

n-
Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja
„ More recently, with the surge in U.S.
Source: EIA/DOE and Tudor, Pickering, Holt & Co. drilling, natural gas production is +9.0%
while NGL production is +5.2% (year-to-
date vs. ’07).

17
 … driven by lower NGL yields
Annual U.S. Historical NGL Yield (1970-2007) „ NGL yields (measured in
Declining GPM or gallons of liquids
1.30 NGL yields
per mcf) have been
1.25
1.20 declining since 1982.
gal/Mcf

1.15
1.10
„ The shift to drilling in
1.05 lower GPM/leaner gas
1.00 resource plays has
0.95
influenced the decline in
yield.
70

73

76

79

82

85

88

91

94

97

00

03

06
19

19

19

19

19

19

19

19

19

19

20

20

20
„ Declines have also
Monthly U.S. Historical NGL Yield (Jan '01 to Aug '08)
occurred despite adding
Leaner onshore more “deep cut”
1.60 production
1.50
cryogenic processing.
gal/Mcf

1.40
1.30
1.20
1.10
01

02

03

04

05

06

07

08
1

Ja 2

Ja 3

Ja 6

Ja 7

8
l -0

l -0

l -0

l -0

l -0

l -0

l -0

l -0
n-

n-

n-

n-

n-

n-

n-

n-
Ju

Ju

Ju

Ju

Ju

Ju

Ju

Ju
Ja

Ja

Ja

Ja

Source: EIA/DOE and Tudor, Pickering, Holt & Co.

18
 NGL Stream – Components and End Users

Historical Price
Optional to Relationship to
Component % Use Process? Crude
2000-2003: 51%
Ethane 40-45% Petrochemical feedstock Yes 2004-2007: 46%
2008 YTD: 37%
2000-2003: 75%
Petrochemical feedstock,
Propane 25-30% Partially 2004-2007: 69%
heating & fuel
2008 YTD: 60%
Petrochemical feedstock, 2000-2003: 87%
Normal Butane 5-10% fuel, gasoline blending, No 2004-2007: 82%
propellant 2008 YTD: 71%
Petrochemical feedstock, 2000-2003: 92%
Isobutane 10% gasoline blending, No 2004-2007: 85%
refrigerant, propellant 2008 YTD: 73%
2000-2003: 97%
Petrochemical feedstock,
Natural Gasoline 10-15% No 2004-2007: 96%
gasoline blending
2008 YTD: 89%

Source: Tudor, Pickering, Holt & Co.

19
 Demand Drivers for NGLs: Ethylene
Uses of Ethane & Ethylene

Surfactants: Ethylene glycol

Paints (antifreeze)
Fabric Softener
Adhesives Detergents
Inks
Insecticides Construction
Laxatives
Ethyline oxide 50%

VCM PVC
Ethylene dichloride Vinyl chloride monomer Polyvinyl chloride
Other Uses
30%

Ethane 97% Petrochemicals Ethylene 50%

Other Polyethylene Upholstery
High density (HDPE): Flooring
Containers Clothing
Welding gas Low density (LDPE): Automotive fittings Signs
Fruit ripener Packaging Plumbing Electronics
Anesthetic Films

„ Ethylene is the simplest alkene and the most widely produced organic compound in the world. 97% of
ethane is used for ethylene production.
„ About 50% of ethylene is polymerized into polyethylene. This polymer is used most commonly to form
lightweight packaging products (i.e. shopping bags) from low-density polyethylene (LDPE) and as a medium
for injection molding (to make products like plastic containers) from high-density polyethylene (HDPE).

Source: Tudor, Pickering, Holt & Co.

20
 Demand Drivers for NGLs: Propylene
Uses of Propane & Propylene

Medicines
Cosmetics
Cumene Nailpolish remover

Butanols Construction
Residential/Commercial (solvents) 27%
Heating % Transportation
24%
Cooking Propylene Oxide %
21%
40% 6% 6% % Furniture/Bedding
% % % 8%
%

Propane 49% Petrochemicals Propylene 62% Polypropylene Packaging

% 8% % Textiles
Other Uses
5% % Stationary
%
Acrylonitrile Plastics
Farming Paints Auto components
Crop drying Adhesives Banknotes
Weed control Detergents Acrylic fibers Synthetic rubber
Fuel PVC
Rubbing alcohol
Conveyor belts

„ Propylene is the second simplest alkene and is most commonly produced as a byproduct in ethylene production.
About 62% of propylene is polymerized into polypropylene. This polymer is most commonly used as a medium for
injection molding (for plastic products like containers) and in the fibers market (i.e. carpeting, textiles).
„ Propane demand has two seasonal offsets. Residential/commercial demand (40% of total) peaks during the winter
heating season and troughs in the summer. Petrochemical demand (49%) peaks during the summer when propane
prices are lower, as the petrochemical industry switches between feedstocks depending upon price.

Source: EIA/DOE and Tudor, Pickering, Holt & Co.

21
 Petrochemical Demand
Annual Chemical Carloads (1993-2007) „ Ideally, we would have outlined
ethylene and propylene
Million Car Loadings

1.7 consumption, but we just couldn’t

1.6 find any good source (if you have
1.5 one, please tell us!) However, we
feel that chemical rail car loadings
1.4
are a good proxy for petrochem
1.3 demand/NGL demand.
93

94

95

96

97

98

99

00

01

02

03

04

05

06

07
„ 2007 and 2008 saw a big pick-up in
19

19

19

19

19

19

19

20

20

20

20

20

20

20

20
loadings, driven by strong world-
AAR Weekly Chemical Car Loadings wide economies and a weak U.S.
dollar.
38,000
10-Yr High
„ The sharp fall-off in 2H’08 reflects
36,000 the immediate impact of Hurricane
2008
34,000
Ike, which slammed into the heart of
part of the Gulf Coast petrochemical
32,000
sector. But more than a month
Car Loadings

30,000 later, railcar loadings are still at 10-

28,000
year lows as a weak economy takes
its toll.
26,000
10-Yr Average
24,000
10-Yr Low Economic weakness
22,000

20,000
n

c
t

v
r
b

ay
ar

p
n

Oc
Ap

De
No
Ja

Au
Fe

Ju

Se
M

Source: Association of American Railroads (AAR), Tudor, Pickering, Holt

22
 NGLs, Crude and Nat Gas have historically
been highly correlated
Relationship Between Nat Gas & Crude
„ From a price standpoint, midstream economics are
20 $160 dictated by 2 key factors: 1) the relationship
18 between crude oil and natural gas; and 2) the
$140
price of NGLs relative to crude oil.
16
$120
14 „ The crude oil/gas relationship is important
Crude/Gas Ratio

$100 because gas needs to trade at a discount to

WTI ($/bbl)
12
10 $80
crude/NGLs in order to have an economic
incentive to convert the btus from a gaseous form
8 $60 to a liquid form. Generally, crude forms the
6
$40
ceiling while natural gas forms the floor.
4
$20 „ Processing economics have directionally improved
2
over the past 10 years, as crude traded at higher
- $0 and higher premiums to nat gas.
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
„ NGL prices are mainly influenced by the price of
Crude/Gas Ratio WTI ($/Bbl) crude oil, as NGL feedstocks compete most
directly with crude oil-based feedstocks such as
naphtha and heating oil.
NGL Basket as Percent of Crude Price
„ NGLs trade near parity with oil on a heat content,
140% $160 or Btu basis. However, on a volume basis, they
have historically traded at about 65-70% of crude
120% $140 oil.
$120
100% „ More recently, with the decline in crude oil prices
NGLs as % of Crude

$100 and softening chemical demand, NGLs have traded

WTI ($/bbl)

80% at closer to 45% of crude oil on a volumetric basis.

$80
60% „ Part of the reason for the declining relationship
$60
between NGLs and crude oil is that NGLs are
40% almost purely a physical commodity influenced by
$40
20%
end-user supply/demand. Crude is influenced
$20 much more significantly by financial markets.
0% $0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

NGL Composite (% Crude) WTI ($/Bbl)

Source: Bloomberg, Tudor, Pickering, Holt

23
 Ethane/Crude –The Critical NGL Component
Ethane (% of Crude) Ethane ($/Bbl)
„ Since ethane is the largest component of
120% $70 the NGL stream and is the only
discretionary NGL, its price and
100% $60 relationship to crude is the most volatile
and closely watched.
$50
80%
„ The ethane market is domestic, with very
$40 little storage (30mmbbls or ~40 days of
60% supply). Most ethane is used real-time in
$30
the petrochemical industry, so prices
40% reflect real demand.
$20

20% „ The historic relationship between NGL

$10
components and crude oil is shown
0% $0
below.
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
NGL Products (% of Crude)
Ethane Propane N-Butane I-Butane N-Gasoline Composite
Source: Bloomberg, Tudor, Pickering, Holt 1999 61% 74% 88% 91% 93% 73%
2000 56% 81% 93% 95% 101% 74%
2001 52% 76% 86% 92% 95% 69%
2002 41% 66% 79% 87% 93% 60%
2003 53% 78% 90% 93% 98% 71%
2004 51% 75% 89% 89% 101% 69%
2005 45% 68% 81% 85% 93% 63%
2006 41% 64% 77% 79% 91% 59%
2007 45% 70% 82% 87% 98% 64%
2008TD 37% 60% 71% 73% 89% 54%

24
 Part III – What is Changing?
„ What a difference a few months make! This summer, the midstream industry was experiencing record frac spreads,
rig count was at record highs, and massive investment was planned to increase ethylene and propylene capacity.
„ There was mounting concern that the U.S. would not be able to absorb the incremental ethane coming on as a
result of the surge in drilling and de-bottlenecking of NGLs via new pipelines. But there were also a number of
petrochemicals looking to expand, driven by a weak U.S. dollar and strong worldwide economies.
„ Slam on the brakes and put it in reverse. Fracs spreads have fallen from $10+ to negative; ethane is trading at 25%
of crude and NGLs 45%; petrochemical plants are idling across the globe; ethylene prices have fallen below
US$350/MT in Asia from highs of US$1,650 this summer; and while we haven’t seen it in scale yet, we expect to see
major projects cancelled/postponed. It’s about as ugly as it gets.
„ Fortunately, as we discussed earlier, this business is cyclical, which means rig count/gas production will fall.
Processors will reject ethane. Ethane, ethlyene and propylene inventories will fall. And we’ll start the up cycle
again.
„ This downcycle may last a little longer than others because of the potential depth of this recession and the amount
of new NGLs coming online – the result of both higher production and NGL debottlenecking due to the completion of
NGL take-away pipelines.
„ As a result, for our Midstream companies, for the next couple of years we are modeling that NGLs trade at ~50% of
crude oil (vs. historic 65-70% and 45% currently).
„ When we first looked at the amount of new ethylene and propylene capacity coming online, it was worrisome (39%
increase if everything done, but almost all outside the U.S.). We’re now assuming that only plants currently under
construction are completed, resulting in 3.5%/yr average growth in ethylene/propylene capacity worldwide through
2012.

25
 Worldwide NGL Production Still on the Rise,
While U.S. Contribution Continues to Decline
Global Annual NGL Production 1970-2007

10,000 80%
8,000 60%
1,000 bpd

6,000
40%
4,000
2,000 20%

0 0%
70

73

76

79

82

85

88

91

94

97

00

03

06
19

19

19

19

19

19

19

19

19

19

20

20

20
Global Production % U.S.

Global Monthly NGL Production (Jan-2001 to Aug '08)

8,500 35%
8,000 30%
1,000 bpd

7,500
25%
7,000
6,500 20%

6,000 15%
1

04

07

8
1

02

03

04

05

06

07

08
l-0

l-0

l-0

l-0

l-0

l-0
0

l-

l-
n-

n-

n-

n-

n-

n-

n-

n-
Ju

Ju

Ju

Ju

Ju

Ju

Ju

Ju
Ja

Ja
Ja

Ja

Ja

Ja

Ja

Ja

Global Production % U.S.

Source: EIA/DOE and Tudor, Pickering, Holt & Co.

26
 Gas Processing Capacity
Gas Processing Capacity (mmcf/d)
„ We see only modest gas processing
Existing Capacity Planned/Completed Adds % Added
capacity additions 2008-2010,
YE'07 2008 2009 2010 ('08-'10)
Rockies 8,059 1,560 780 350 33%
increasing L-48 capacity by 7%.
Ark-La-Tex 14,396 680 565 0 9%
Mid-Con 6,198 610 120 0 12%
„ However, this is in a market where
Gulf Coast 23,294 120 0 200 1% ethane and other NGL demand is
Other 9,342 40 20 0 1% weak, so incremental capacity
Alaska 9,525 0 0 0 0%
matters.
Total 70,813 3,010 1,485 550 7%

U.S. Gas Processing Capacity

80,000
70,000
60,000
50,000
MMcf/d

40,000
30,000
20,000
10,000
0
2007 2008 2009 2010

Alaska Other Gulf Coast Ark-La-Tex Mid-Con Rockies

Source: Oil and Gas Journal 2008, Company Press Releases, Tudor, Pickering, Holt
27
 New NGL Pipelines
„ The U.S. NGL system has been, and will
be, further de-bottlenecked via the
completion of several key NGL
pipelines.
„ EPD’s MAPL line was completed earlier
this year and OKS’ Overland Pass line
began ramping up in early October.
Arbuckle (also OKS) should be
completed by Q1’09.
Overland Pass
(OKS) 110,000 bpd „ All the pipes won’t be full from the
beginning. Overland Pass will somewhat
cannibalize MAPL, but that simply
relieves MAPL’s fully utilized facility.
„ All told, these pipelines have the
Arbuckle (OKS) capacity to allow an increase in NGL
160,000 bpd
supply by 18%.
MAPL Expansion
(EPD) 50,000 bpd „ Further expansion is possible. OKS has
been planning to expand Overland Pass
by 145,000 bpd by 2010, but we would
not be surprised to see that pushed out
a little. Arbuckle is expandable by
50,000 bpd with additional pump
stations

Source: Canadian NEB, edited for changing ownership & new pipelines proposed
28
 Changing Dynamics: Ethylene & Propylene

Worldwide Planned Ethylene Capacity Adds, by Status

„ Currently, the U.S. has the most ethylene
Capacity (tonnes/yr) % of Existing and propylene processing capacity in the
Construction under way 19,110,000 15%
world, at 22% and 27%, respectively. China
is second, with 8% of both ethylene and
Engineering under way 4,170,000 3% propylene capacity.
Planned 1,160,000 1%
„ Prior to the financial meltdown, there was
Approved 4,180,000 3% mounting concern that a massive amount of
Study 22,010,000 17% planned new international ethylene and
Potential Added by 2012 50,630,000 39% propylene capacity would flood the market,
eventually resulting in the U.S. becoming a
net importer, thus backing off demand for
domestic NGLs.
Worldwide Planned Propylene Capacity Adds, by Status „ The vast majority of the adds are in the
Capacity (tonnes/yr) % of Existing
Middle East, where they’ll use cheap gas to
make NGLs to feed the new petrochemical
Construction under way 11,365,000 15% plants.
Engineering under way 3,823,000 5%
„ Given the economic slowdown, we are now
Planned 1,010,000 1%
assuming that only the plants currently
Approved 1,250,000 2% under construction will be built. In total,
Study 10,195,000 13% these add 15% to existing capacity, or
Potential Added by 2012 27,643,000 35%
3.5%/yr growth – not helpful in a weak
economy, but not the onerous 39% addition
if everything was built.

Source: ICIS Plants & Projects Database, Company Press Releases, Tudor, Pickering, Holt
29
 Changing Ethylene Dynamics by Region
Planned Ethylene Capacity Under Construction (tonnes/yr)

Existing Planned Adds Total Capacity

Region Capacity to Capacity After Adds % Increase
NAM 35,170,000 0 35,170,000 0%
Asia/Pac 39,480,000 7,545,000 47,025,000 19%
W Europe 25,560,000 100,000 25,660,000 0%
Middle East 17,568,000 11,080,000 28,648,000 63%
E Europe 5,925,000 185,000 6,110,000 3%
SAM 5,055,000 200,000 5,255,000 4%
Africa 1,075,000 0 1,075,000 0%
Australia 565,000 0 565,000 0%
TOTAL 130,398,000 19,110,000 149,508,000 15%

Existing Global Ethylene Capacity (2008) Global Ethylene Capacity After Adds (2012)

Africa Africa
SAM Australia
SAM 0.8% Australia 0.7%
E Europe 3.5% 0.4%
3.9% 0.4% E Europe
4.5% NAM
NAM 4.1%
23.5%
Middle East 27.0%
Middle East
13.5%
19.2%

W Europe
19.6% W Europe
Asia/Pac Asia/Pac
17.2%
30.3% 31.5%

Source: ICIS Plants & Projects Database, Company Press Releases, Tudor, Pickering, Holt
30
 Changing Propylene Dynamics by Region
Planned Propylene Capacity Under Construction (tonnes/yr)

Existing Planned Adds Total Capacity

Region Capacity to Capacity After Adds % Increase
NAM 22,984,000 0 22,984,000 0%
Asia/Pac 27,523,000 6,965,000 34,488,000 25%
W Europe 16,747,000 0 16,747,000 0%
Middle East 4,624,000 4,045,000 8,669,000 87%
E Europe 2,969,000 0 2,969,000 0%
SAM 2,640,000 355,000 2,995,000 13%
Africa 455,000 0 455,000 0%
Australia 60,000 0 60,000 0%
TOTAL 78,002,000 11,365,000 89,367,000 15%

Existing Propylene Capacity (2008) Global Propylene Capacity After Adds (2012)

Africa
Africa
E Europe SAM SAM 0.5% Australia
3.4% 0.6% E Europe 3.4% 0.1%
3.8% Australia
0.1% 3.3%
NAM
Middle East NAM Middle East 25.7%
5.9% 29.5% 9.7%

W Europe
W Europe
21.5%
18.7%

Asia/Pac Asia/Pac
35.3% 38.6%

Source: ICIS Plants & Projects Database, Company Press Releases, Tudor, Pickering, Holt
31
 NGL Supply Outlook
Global & North American NGL Production (Jan '01 - Aug '08)
10,000
„ There are two ways to look at NGL supply –
domestically and on a global basis
NGL Production (mbpd)

8,000

„ In the U.S., while gas production is +9% year-to-

6,000 date, NGL production is up a more modest 5%.
Going back to 2001, the trend has been declining
4,000 NGL production as the overall gas stream becomes
drier. We think the recent surge in NGL
2,000 production is driven, in part, by incredible NGL
processing economics, which incent companies to
0 maximize NGL extraction. More recent processing
economics (negative-to-breakeven frac spreads)
00

01

02

03

04

05

06

07

08

09
c-

c-

c-

c-

c-

c-

c-

c-

c-

c-
should stem the rate of NGL production growth.
De

De

De

De

De

De

De

De

De

De
Global (ex/NAM) North American (NAM) Global „ On a global basis, NGL production is clearly on the
rise, growing at a CAGR of 5% since 2000
(excluding North America) and 3% including North
U.S. Monthly Gas & NGL Production (Jan '01- Aug '08) America. Going forward, most of the incremental
production is destined for in-country use, primarily
2,800 65 petrochemical, to feed new plants.
2,600 63
NGL Production (mbpd)

61 Gas Production (Bcf/d) „ The risk to the U.S. NGL industry is over-building
2,400
2,200 59 of worldwide ethylene and propylene plants,
2,000
57 resulting in cheap exports, and a decline in the
55 U.S. petrochemical industry. With the recent
1,800
53
1,600 economic meltdown, the risk of overbuilding has
51
1,400 49
been greatly reduced.
1,200 47
1,000 45
Ja 1

Ja 2

Ja 3

Ja 4

Ja 5

Ja 6

Ja 7

8
01

02

Ju 3

Ju 4

Ju 5

06

07

08
l-0

l-0

l-0

l-0

l-0

l-0

l-0

l-0
0

0
n-

n-

n-

n-

n-

n-

n-

n-
Ju

Ju

Ju

Ju

Ju
Ja

NGL Production Marketed Gas Production

Source: EIA/DOE and Tudor, Pickering, Holt & Co.

32
 Appendix – Midstream Primer

Midstream Overview „ There are four primary

segments within the Midstream
business:
Dry or
Marketable 1. Gathering – transports and
Gas often compresses natural
Processing
Interstate
gas and removes water and
Wet Gas Plant
Pipelines other contaminants;
Gathering
Onshore and
Offshore Wells Raw NGL
2. Processing – extracts NGLs,
Mix resulting in dry/marketable
Petrochemical natural gas and a raw NGL
Normal Butane
Industry stream
Isobutane 3. Fractionation – splits raw
Ethane Refineries NGLs into finished product
Fractionator Propane
Natural gasoline 4. Marketing – stores,
Finished NGLs
transports and markets
finished NGLs
Industrial/
Heating

Source: Tudor, Pickering, Holt & Co.

33
 Step 1: Gas Gathering
„ Gas gathering systems simply transports gas
from the well-head to the processing
facilities.
„ Gathering lines typically operate at relatively
low pressures (just below wellhead pressure)
and utilize pipe diameters of less of than
12”. Lower pressure systems reduce the
need to install field compression and
generally allow for greater production.
„ At this stage, the gas is usually treated to
Processing remove natural gas condensates, water and
Plant
other contaminants to prevent the
components from obstructing flow in or
destroying the integrity of the gathering
Gathering System system. Small-scale gas-oil separators,
condensate separators, and dehydration units
are typical treating equipment.

Source: Williams Companies and Tudor, Pickering, Holt

34
 Step 2: Plant Processing
„ Plant processing takes “wet” gas from the field
(Typical NGL Mix) and removes the heavier, more liquid
components (NGLs) and other contaminants
Ethane (40-45%)
(water, hydrogen sulfide, etc) to create
marketable gas – also known as “dry” or
Propane (25-30%)
“pipeline quality” gas.
Isobutane (10%)
Normal Butane (5-10%) „ For safety and integrity reasons, pipelines
Natural Gasoline (10-15%) impose restrictions on the composition of gas
allowed to enter the line. Gas composition is
measured in terms of dew point (the
Wet Gas temperature at which vaporized liquid will
(Wellhead condense at pipeline pressure) and the heat, or
gas) Raw NGL Pipeline BTU content of the gas. A higher BTU content
Processing Plant
means more liquids in the stream.
„ Processing economics depend, in part, on the
price of the liquids removed vs. their equivalent
BTU content if left in the original gas. The
difference between the price of the liquids
Marketable Gas to removed vs. their value in gaseous form is
Interstate Pipelines
called a “frac spread.”

Source: Williams Companies and Tudor, Pickering, Holt

35
 Step 3: Fractionation
„ Fractionation is the process of
Ethane
40-45% turning the raw NGL stream into
Propane
25-30% marketable products.
Fractionation Isobutane
10% „ One-by-one, the hydrocarbons are
Normal
5-10% Butane boiled off, moving lightest (ethane)
Raw NGL
“Barrel” Natural to heaviest (natural gasolines).
10-15% Gasoline
„ Fractionators are much larger scale
than gas processing plants, handling
the output from multiple processing
NGL Products
plants. They are usually located
Pipeline Pipelines close to the petrochemical end-
Fractionator
users.
„ Raw NGL pipelines transport NGLs
from processing plants to
Storage
fractionators. Finished NGLs
pipelines transport the product to
market.

Source: Tudor, Pickering, Holt

36
 Step 4: Marketing
„ NGL marketers match up sellers (E&P and
Midstream companies) with buyers –
petrochemicals, industrials, farmers, propane
companies, etc.
Refinery
„ Services include NGL transportation, storage
and risk management services.
„ NGL marketing is primarily a physical business,
with limited liquidity on financial hedging of
individual NGL components much beyond 6-12
months. Beware companies with “dirty
hedges” – NYMEX crude as proxy for regional
Chemical Plant
Fractionator NGLs.

Storage
Industrial & Other
End-Users

Source: Williams Companies and Tudor, Pickering, Holt

37
 Gas Processing: Three Major Contract Structures
Keepwhole (KH)
Structure: Processor
compensates (“keeps whole”)
the producer for the amount of
gas removed from the
processing stream. Processor
gets paid in NGLs, but
compensates producer based
on gas prices.
Commodity Exposure: Long
NGLs, short gas. So two
sources of exposure – relative
gas/NGL prices and absolute
NGL prices.
Volatility: High. Frac spreads
can and do move wildly and
seasonally. Because
midstream assets are held
more by MLPs who do not like
that exposure, the trend has
been to negotiate away from
keep whole contracts and to
insert, conditioning language,
which provides minimum fees
if fracs go negative.
Keepwhole Margin =
NGLs Removed (MMBtu) x Frac
Spread ($/MMBtu)
Percent of Proceeds (POP) Fee-Based
Structure: Processor is paid by Structure: Fixed fee, either
retaining a percent of the volumetric or a demand
outlet stream, either NGLs, payment.
gas or a combination.
Commodity Exposure: None.
Commodity Exposure: Long
liquids and/or natural gas, Volatility: If volumetric
depending on contract payment, only volatility is
structure. throughput based.
Volatility: Moderate. Higher
commodity prices = higher POP
proceeds.
Percent of Proceeds Margin =
[NGLs Removed (MMBtu) x Fee Margin =
NGL Price ($/MMBtu) x % of
NGLs Retained] + Inlet Gas (MMBtu) x Processing
[Gas Remaining (MMBtu) x Fee ($/MMBtu)
Gas Price ($/MMBtu) x % of Gas
Retained]
38
 Frac Spread – Sum of the Parts is Worth More Than the Whole
„ Step 1: Calculate the NGL value ($/MMBtu). Multiply component prices by
the heat content and composition of the gas. „ Frac spread is the difference
between the value of the
processed NGLs and the value of
A B C D =[D*A] the equivalent btus of gas input
into the processing plant.
=[A*B]
„ Frac spreads are negatively
correlated with gas prices (gas
Assumed Conversion Weighted NGL Price Composite goes up, fracs go down) and
Mix Factor Average ($/gal) positively correlated with NGL
($/gal) prices (NGLs go up, fracs go up).
(MMBtu/Gal)
„ Frac spreads are volatile and
Ethane 45% 0.0664 0.0299 $0.490 $0.221 usually seasonal – narrowing with
higher gas prices during the
Propane 30% 0.0916 0.0275 $1.248 $0.374 winter.
Iso butane 5% 0.0997 0.0100 $1.480 $0.074

Normal 10% 0.1037 0.0052 $1.475 $0.148

butane

Natural 10% 0.1178 0.0118 $1.815 $0.182

Gasoline

Total NGL E 0.0843 F $0.998

„ Step 2: Divide F by E to get composite NGL price ($/mmbtu): $11.84

„ Step 3: Subtract natural gas price from composite NGL price: $11.84 – Gas Price = Frac Spread

„ Step 4: Adjust spread for transportation, operating costs, and plant processing fuel.

Source: Targa Resources and Tudor, Pickering, Holt

39
 Appendix – Midstream Terminology
„ Conditioning mode – Processing mode when NGL economics are unfavorable whereby the processor removes
only the minimal amount of NGLs, saving on fuel and other operating expenses. Most keep whole contracts
now contain conditioning language in the event frac spreads go negative.
„ Ethane rejection mode – Process of keeping ethane in the gas stream (rejecting it from processing) because
economics dictate the btus will receive a higher price for gas than liquids.
„ Fee Based – Midstream contract – gathering, processing, fractionation, etc. – where services are conducted on
a fee/unit basis.
„ Frac spread - Value of natural gas liquids after they are processed out of natural gas, in excess of the price of
the gas itself (i.e. gross margin on NGLs).
„ Fractionation – process of splitting the raw NGLs into marketable products.
„ Keepwhole – Contract type whereby processor keeps 100% of the liquids and keeps the producer whole by
compensating them for the btus on a gas-equivalent basis.
„ Naphtha - a distillation product from petroleum or coal tar containing certain hydrocarbons. Naphtha is used
primarily as feedstock for producing a high octane gasoline component (via catalytic reforming). It is also used
in the petrochemical industry to produce olefins in steam crackers and in the chemical industry for solvent
(cleaning) applications.
„ Natural gas condensate – Output of the processing of wellhead gas.
„ NGLs (Natural Gas Liquids) – Portions of natural gas that are liquefied via gas processing. They include ethane,
propane, butane, and natural gasoline.
„ NGL shrink – Reduction in gas available for sale as a result of removing NGLs from the gas stream.
„ Percent of proceeds – Processing contract where processor receives a percent of the outlet stream – either
gas, NGLs, or a combination.

40
Analyst Certification:

We, Becca Followill, Dave Pursell and Anson Williams, do hereby certify that, to the best of our knowledge, the views and opinions in
this research report accurately reflect our personal views about the company and its securities. We have not nor will we receive direct
or indirect compensation in return for expressing specific recommendations or viewpoints in this report.
________________________________________________________________________________________________________
Important Disclosures:

The following analysts were involved in creating or supervising the content of this message; Becca Followill, Dave Pursell, and Anson
Williams. None of these analysts (or members of their household) have a long or short position in the securities mentioned in this
report.

Analysts’ compensation is not based on investment banking revenue and the analysts are not compensated by the subject companies.
In the past 12 months, Tudor, Pickering, Holt & Co. Securities, Inc. has received investment banking or other revenue from Equitable
Resources and Questar. In the next three months we intend to seek compensation for investment banking services from the companies
mentioned within this report.

This communication is based on information which Tudor, Pickering, Holt & Co. Securities, Inc. believes is reliable. However, Tudor,
Pickering, Holt & Co. Securities, Inc. does not represent or warrant its accuracy. The viewpoints and opinions expressed in this
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For detailed rating information, distribution of ratings, price charts and other important disclosures, please visit our website
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41