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A Brave New WorldDynamic Challenges Facing

Kansas Oil & Gas Industry

Edward P. Cross, P.G., M.B.A.President

Kansas Independent Oil & Gas Association

KDHE Bureau of WaterGeology Section SeminarSedgwick County Extension Education CenterWichita, KansasSeptember 6, 2012

What Powers the U.S.What Powers the U.S.

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Are we about to enter the age Are we about to enter the age of of

fossil fuels?fossil fuels? New & evolving technologiesNew & evolving technologies

Horizontal drillingHorizontal drilling Hydraulic fracturingHydraulic fracturing

Oil & Gas fastest growing manufacturing Oil & Gas fastest growing manufacturing sectorsector

Crude Oil Imports ~ 45%Crude Oil Imports ~ 45%

Natural gas reserves measure in centuriesNatural gas reserves measure in centuries

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Are we about the enter the Are we about the enter the age of fossil fuels?age of fossil fuels?

About 20 new onshore oil fieldsAbout 20 new onshore oil fields Led by independent oil and gas industryLed by independent oil and gas industry Increase nation’s oil output by 25% within decadeIncrease nation’s oil output by 25% within decade $1 trillion to U.S. economy$1 trillion to U.S. economy 1.3 million new jobs this decade1.3 million new jobs this decade

USGS ~ U.S. has 26% of world’s technically USGS ~ U.S. has 26% of world’s technically recoverable oil reserves & 30% of natural gas recoverable oil reserves & 30% of natural gas reservesreserves

U.S. largest natural gas producer - 2U.S. largest natural gas producer - 2ndnd largest largest coal producer - 3coal producer - 3rdrd largest oil producer in world largest oil producer in world

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Energy IndependenceEnergy Independence

Nixon’s “Project Independence” - Nixon’s “Project Independence” - 19731973

Prospects of achieving energy Prospects of achieving energy independence are now very realindependence are now very real

Import 45% todayImport 45% today Independents drill 95% of wells in U.S.Independents drill 95% of wells in U.S. An American Oil & Gas RenaissanceAn American Oil & Gas Renaissance

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Despite Growth in Renewables, World Consumption Despite Growth in Renewables, World Consumption

of Oil and Gas Will Continue to Increaseof Oil and Gas Will Continue to Increase

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Source: EIA, International Energy Outlook, 2012

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Brave New World FactBrave New World Fact

IEA projects global energy demand IEA projects global energy demand increase by 45% from 2010-2035increase by 45% from 2010-2035 Not unconstrainedNot unconstrained Assumes significant efficiency improvementsAssumes significant efficiency improvements

Per Capita Energy UsePer Capita Energy Use Developing world up to only 50% of Developing world up to only 50% of

industrialized world levelindustrialized world level Industrialized world conserve down to same Industrialized world conserve down to same

levellevel World energy production increase by 40% to World energy production increase by 40% to

meet demandmeet demand

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More Than Fuel:More Than Fuel:Petroleum is a Part of Your Everyday LifePetroleum is a Part of Your Everyday Life

MaterialsMaterials: asphalt, linoleum, synthetic : asphalt, linoleum, synthetic rubberrubber

Liquids:Liquids: antifreeze, refrigerants antifreeze, refrigerants PlasticsPlastics: soccer balls, helmets, telephones, : soccer balls, helmets, telephones,

rollerblades, milk jugs, computersrollerblades, milk jugs, computers Synthetic fabricsSynthetic fabrics: nylon, polyester: nylon, polyester AgricultureAgriculture: fertilizers, pesticides, food : fertilizers, pesticides, food

preservativespreservatives MedicalMedical: heart valves, vitamin capsules, : heart valves, vitamin capsules,

anesthetics, artificial limbs, bandagesanesthetics, artificial limbs, bandages

KIOGAExxonMobil Global Energy Outlook, 2011

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Crude Oil Market Crude Oil Market StructureStructure

OligopolyOligopoly OPEC Cartel Collude to Influence Market OPEC Cartel Collude to Influence Market

PricesPrices

U.S. Producers are Perfect CompetitorsU.S. Producers are Perfect Competitors Price-takers not Price-makersPrice-takers not Price-makers Cost Structure Optimization Determines Cost Structure Optimization Determines

ProfitProfit

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OPEC Market DynamicsOPEC Market Dynamics

Quantity

P2

P1

S2

S1

D

When supply is lowered from S1 to S2, price rises from P1 to P2

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The Perfect Competitor

Output

D,MR

ATC

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Firm

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Output (in millions)

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Kansas Oil & Gas Producers are Perfect Competitors

Price-takers not price-makers. Internal cost structure determines profitability.

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Effect of Supply Constraints on Perfect Competitor

Output

D2,MR2

ATC

MC

Firm

Output (in millions)

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S2

Market

D1,MR1

S1

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00 2 10 2 34 6 8 10 12 14 16 18 20

Kansas Oil & Gas Producers Strive to Improve Operating Efficiencies

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What is Marginal Oil & What is Marginal Oil & GasGas

Lower edge of profitabilityLower edge of profitability High CostHigh Cost Low YieldLow Yield

10 barrels of oil per day or less10 barrels of oil per day or less

60 thousand cubic feet (Mcf) per day or less60 thousand cubic feet (Mcf) per day or less

When plugged, resource often lost foreverWhen plugged, resource often lost forever

Need policies to enhance American Need policies to enhance American production and reduce dependence on production and reduce dependence on foreign suppliesforeign supplies

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Who are Independents?Who are Independents?

Small BusinessesSmall Businesses

Drill and produce crude oil and natural Drill and produce crude oil and natural gasgas

Not integratedNot integrated Sell crude oil and natural gas to purchasersSell crude oil and natural gas to purchasers Price-takers not price-makersPrice-takers not price-makers Do not generate and market end-productsDo not generate and market end-products

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Who are Independents?Who are Independents?

Independents drill 95% of wells in U.S.Independents drill 95% of wells in U.S.

Independents produce 67% of America’s Independents produce 67% of America’s oil and natural gas oil and natural gas

Independents produce 92% of Kansas’ oil Independents produce 92% of Kansas’ oil and 63% of Kansas’ natural gasand 63% of Kansas’ natural gas

America’s Oil & Natural Gas IndustryAmerica’s Oil & Natural Gas Industry

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Kansas Oil & Gas Industry Kansas Oil & Gas Industry StatisticsStatistics

First Oil Well = 1860 First Oil Well = 1860 Miami CountyMiami County

First Natural Gas Well = 1873First Natural Gas Well = 1873 Montgomery CountyMontgomery County

Current # of Oil Wells = 40,850Current # of Oil Wells = 40,850

Current # of Gas Wells = 18,639Current # of Gas Wells = 18,639

Current # of Injection Wells = Current # of Injection Wells = 15,42815,428

Current Total # of Wells = 74,654Current Total # of Wells = 74,654

Current # of Operators = 2,113Current # of Operators = 2,113

Current Oil ProductionCurrent Oil Production 41.6 Million Barrels Annually41.6 Million Barrels Annually 114,000 Barrels per Day114,000 Barrels per Day Increased 5 of last 6 yearsIncreased 5 of last 6 years Ranked 9Ranked 9thth Among 31 Oil Among 31 Oil

Producing StatesProducing States

Current Natural Gas ProductionCurrent Natural Gas Production 313 Billion Cubic Feet Annually313 Billion Cubic Feet Annually 860 million Cubic Feet per Day860 million Cubic Feet per Day Ranked 9Ranked 9thth Among the 32 Natural Among the 32 Natural

Gas Producing StatesGas Producing States

Drilling Permits Issued in 2012 = Drilling Permits Issued in 2012 = 4,0334,033

195 MSL Permits195 MSL Permits Permits Issued in 2011 = 5,441Permits Issued in 2011 = 5,441

72 MSL Permits72 MSL Permits

Number of Active Drilling Rigs = Number of Active Drilling Rigs = 142142

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Kansas Oil & Gas Kansas Oil & Gas FieldsFields

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Kansas Oil & Gas Industry Kansas Oil & Gas Industry StatisticsStatistics

$4.8 billion Industry$4.8 billion Industry

Supports 67,000 Kansas Jobs and $2.7 billion in family Supports 67,000 Kansas Jobs and $2.7 billion in family incomeincome

Invests over $1 billion in rural Kansas annuallyInvests over $1 billion in rural Kansas annually

Average Daily Oil Well Production = 2.79 BOPDAverage Daily Oil Well Production = 2.79 BOPD 72% of Total Kansas Crude Oil Production from Marginal Wells72% of Total Kansas Crude Oil Production from Marginal Wells 94% of Total Kansas Oil Wells94% of Total Kansas Oil Wells

Average Daily Natural Gas Well Production = 46 Mcf/DayAverage Daily Natural Gas Well Production = 46 Mcf/Day 74% of Total Kansas Natural Gas Production from Marginal Wells74% of Total Kansas Natural Gas Production from Marginal Wells 81% of Total Kansas Natural Gas Wells81% of Total Kansas Natural Gas Wells

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Kansas Oil & Gas Industry Kansas Oil & Gas Industry TaxationTaxation

Severance Tax up nearly 69% since 2000Severance Tax up nearly 69% since 2000 Oil tax collections up 121% over last 2 yearsOil tax collections up 121% over last 2 years

Ad Valorem Tax up 171% since 2000Ad Valorem Tax up 171% since 2000 Oil tax collections up 40% over last 2 yearsOil tax collections up 40% over last 2 years

Average effective tax rate = 11.61%Average effective tax rate = 11.61% Reduce ROI by 26.5%Reduce ROI by 26.5%

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Conventional Oil & Gas Conventional Oil & Gas DevelopmentDevelopment

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Unconventional PlaysUnconventional Plays

Reservoir - seal - and source rock are all Reservoir - seal - and source rock are all one in the sameone in the same

Mississippian Limestone Mississippian Limestone PlayPlay

One of newest oil plays in U.S.One of newest oil plays in U.S.

Emerging PlayEmerging Play

Northern OK and southern KSNorthern OK and southern KS $1.2 - $1.5 billion Capex plans$1.2 - $1.5 billion Capex plans 270-500 BOE per day in first 30 days270-500 BOE per day in first 30 days $3 - $3.5 million drilling & completion costs$3 - $3.5 million drilling & completion costs 4,500 feet vertical and 4,500 feet lateral4,500 feet vertical and 4,500 feet lateral Could add up to 13% to Kansas productionCould add up to 13% to Kansas production

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Energy PolicyEnergy Policy

Trapped by zero-sum game philosophy for Trapped by zero-sum game philosophy for energyenergy

World will need 45% more energy by 2035World will need 45% more energy by 2035 U.S. will need 16% more energy by 2035U.S. will need 16% more energy by 2035

We must abandon policies that pit one We must abandon policies that pit one resource against anotherresource against another

North American energy independent by 2030 North American energy independent by 2030 with right leadership and policieswith right leadership and policies

Horizontal drilling & hydraulic fracturing Horizontal drilling & hydraulic fracturing essential to realize this energy independenceessential to realize this energy independence

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Perceptions Become Perceptions Become EntrenchedEntrenched

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Hydraulic FracturingHydraulic Fracturing

KansasKansas First HF operation in 1947First HF operation in 1947 Vast majority of wells fracedVast majority of wells fraced

NationalNational 60%-80% of wells drilled in next decade60%-80% of wells drilled in next decade Over 1.2 million fracs since 1947Over 1.2 million fracs since 1947

Not single verified or documented instance of harm Not single verified or documented instance of harm to groundwaterto groundwater

Why is HF NecessaryWhy is HF Necessary To To stimulatestimulate oil and gas production to increase oil and gas production to increase

Net Present Value (NPV) of a well through:Net Present Value (NPV) of a well through: Accelerating income through increasing production ratesAccelerating income through increasing production rates Reducing well life operating expensesReducing well life operating expenses Increasing total cumulative productionIncreasing total cumulative production

Hydraulic FracturingHydraulic Fracturing

Brief video animation of horizontal Brief video animation of horizontal drilling & hydraulic fracturingdrilling & hydraulic fracturing

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Policy ConsiderationsPolicy Considerations America is home to vast natural resourcesAmerica is home to vast natural resources

More oil, coal, & natural gas than any country in worldMore oil, coal, & natural gas than any country in world Enough energy resources to provide affordable, reliable Enough energy resources to provide affordable, reliable

energy for decades, even centuries to comeenergy for decades, even centuries to come

America sitting on enough oil and natural gas America sitting on enough oil and natural gas reserves to replace Persian Gulf imports for the reserves to replace Persian Gulf imports for the next 50 years!next 50 years!

Policies supporting oil and natural gas would result Policies supporting oil and natural gas would result in more high-paying jobs, more tax revenues, in more high-paying jobs, more tax revenues, stronger economic growth, and energy securitystronger economic growth, and energy security

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Key Challenges facing the Key Challenges facing the Kansas Oil & Gas IndustryKansas Oil & Gas Industry

Obama Administration FY 2013 Budget ProposalObama Administration FY 2013 Budget Proposal Repeals oil & gas tax provisions that will result in Repeals oil & gas tax provisions that will result in

$3.9 billion negative impact on the Kansas economy$3.9 billion negative impact on the Kansas economy Reduces Kansas jobsReduces Kansas jobs Increases dependence on foreign energy suppliesIncreases dependence on foreign energy supplies

Hydraulic FracturingHydraulic Fracturing 60-year old technology60-year old technology Ably and aggressively regulated by StatesAbly and aggressively regulated by States Mixture 99.5% water and sandMixture 99.5% water and sand

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Political EnvironmentPolitical Environment

Actual Energy LandscapeActual Energy Landscape Take time to understand factsTake time to understand facts Obstacles to making energy affordable and reliableObstacles to making energy affordable and reliable

Energy Bills often based on incorrect assumptionsEnergy Bills often based on incorrect assumptions Revolutionary technology just around cornerRevolutionary technology just around corner Energy is scarce and becoming scarcerEnergy is scarce and becoming scarcer

Obama Administration Policies damaging nation’s Obama Administration Policies damaging nation’s energy securityenergy security On a course for less energy – not moreOn a course for less energy – not more Disparity compellingDisparity compelling

Political EnvironmentPolitical Environment

Recent pollsRecent polls 90% of Americans knew more O&G development 90% of Americans knew more O&G development

= more American jobs= more American jobs 70% supported increased domestic production70% supported increased domestic production Never bad idea to listen to American peopleNever bad idea to listen to American people

Cannot stay trapped by zero-sum energy Cannot stay trapped by zero-sum energy strategystrategy

Must make choices to move in right directionMust make choices to move in right direction

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Thank YouThank You

www.kioga.orgwww.kioga.org

Kansas Independent Oil & Gas AssociationKansas Independent Oil & Gas AssociationEdward Cross, PresidentEdward Cross, President

kiogaed@gmail.comkiogaed@gmail.com

785-232-7772785-232-7772