Natural Gas Contracts: Sale of the Product -Drafting and Negotiating an Agreement for

Purchase of Natural Gas Products

Advanced Oil and Gas Short Course

Sponsored by

University of Houston Law Foundation

Houston, TX – June 11-12, 2009 – Hilton University of Houston Hotel

Dallas, TX – June 18-19, 2009 – Cityplace Conference Center

Arthur J. Wright1722 Routh Street, Suite 1500

Dallas, Texas 75201214.969.1303

Arthur.Wright@tklaw.com(999905 000003 Dallas 2497293.1)

Arthur J. Wright1722 Routh Street, Suite 1500

Dallas, Texas 75201214.969.1303

Arthur.Wright@tklaw.com(999905 000003 Dallas 2497293.1)

2

The Man - Andy WeissmanThe Man - Andy Weissman

Gas MarketGas Market

09/07/06 to 09/07/0809/07/06 to 09/07/08► IS GAS MARKET HEADED FOR PRICE CRASH?IS GAS MARKET HEADED FOR PRICE CRASH?► Absent a Monster Hurricane – we had oneAbsent a Monster Hurricane – we had one► LNG Imports UpLNG Imports Up

Did not happen; US oversupplied in 2008Did not happen; US oversupplied in 2008 Storage will be at record levelsStorage will be at record levels

► Record storage and productionRecord storage and production► Coldest Winter in 10/11 yearsColdest Winter in 10/11 years► Prices headed downPrices headed down

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FracsFracs

Time for the Fracs of LifeTime for the Fracs of Life

US Petrochemical plants dyingUS Petrochemical plants dying No consumer; Ethane rejected!No consumer; Ethane rejected! Industrial demand bottomedIndustrial demand bottomed Cheap oil – cheap NGLsCheap oil – cheap NGLs Frac spreads cause NGLs to go into gasFrac spreads cause NGLs to go into gas 1-2 Bcfd additional supply1-2 Bcfd additional supply

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CanadaCanada

Production 2007 - 16 BcfdProduction 2007 - 16 Bcfd

► 2010 – 10 Bcfd2010 – 10 Bcfd► 2014 with unconventional gas – 16 Bcfd2014 with unconventional gas – 16 Bcfd

Canadian potential growthCanadian potential growth

► CoalbedCoalbed - 660 trillion cubic ft.- 660 trillion cubic ft.► Shale Shale - 600 trillion cubic ft.- 600 trillion cubic ft.► TightTight - - 565 trillion cubic ft.565 trillion cubic ft.

Total all sources:Total all sources: - 2,150 trillion cubic ft.- 2,150 trillion cubic ft.

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Canada Canada (cont’d.)(cont’d.)

British Columbia, Muskwa shale and Horn River British Columbia, Muskwa shale and Horn River and Montreal Quebec shale may replace Albertaand Montreal Quebec shale may replace Alberta

► Horn River 15-150 wells by end of 2010Horn River 15-150 wells by end of 2010► EOG, Nexen, Devon, EnCana and Apache are playersEOG, Nexen, Devon, EnCana and Apache are players► Montreal (tight gas) 240-300 wells by end of 2010Montreal (tight gas) 240-300 wells by end of 2010► Issues – Pipelines, gas volatility and people to man rigsIssues – Pipelines, gas volatility and people to man rigs► 6/30/08 – Horn River two wells produce 5 & 6 MMcfd day6/30/08 – Horn River two wells produce 5 & 6 MMcfd day

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Canada Canada (cont’d.)(cont’d.)

Utica Shale (4,000 ft.)Utica Shale (4,000 ft.)► Talisman drilled well in QuebecLorraine shale below UticaTalisman drilled well in QuebecLorraine shale below Utica► Forrest testing wells also (269,000 acres)Forrest testing wells also (269,000 acres)

Triangle Petroleum:Triangle Petroleum:► 516,000 acre shale play Nova Scotia516,000 acre shale play Nova Scotia► 68,000 acre shale play New Brunswick68,000 acre shale play New Brunswick

Mackenzie pipeline:Mackenzie pipeline:► Planned to be on-line 2009Planned to be on-line 2009► No approvals givenNo approvals given► Earliest date 2014Earliest date 2014► Needed? – US market supply up!Needed? – US market supply up!

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US ShalesUS Shales MarcellusMarcellus

► 8/25 Range8/25 Range 100 wells drilled100 wells drilled 25 horizontal25 horizontal last 4 wells – 4.9 Mcft per daylast 4 wells – 4.9 Mcft per day 850,000 acres – reserves850,000 acres – reserves 15 Tcf to 22 Tcf15 Tcf to 22 Tcf

► Water procurement and disposal a keyWater procurement and disposal a key► 2 years or longer – moratorium in NY2 years or longer – moratorium in NY

Atlas Energy – 580,000 acresAtlas Energy – 580,000 acres 80 mostly vertical wells, 60 MMcfd production80 mostly vertical wells, 60 MMcfd production

► Atlas – 2 stage vertical fracAtlas – 2 stage vertical frac Doubles per well productionDoubles per well production Also drilling horizontalAlso drilling horizontal Atlas plans 100 horizontal wells in New Albany Shale through Atlas plans 100 horizontal wells in New Albany Shale through

2009.2009.CNX - Marcellus horizontal well rate of 6.5 MMcfdCNX - Marcellus horizontal well rate of 6.5 MMcfd

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MarcellusMarcellus► CHK says no rapid expansion as in Barnett due to CHK says no rapid expansion as in Barnett due to

regulatory, topographic, water and infrastructure issuesregulatory, topographic, water and infrastructure issuesHow big? Too earlyHow big? Too early

Gothic Shale Colorado – Bill Barrett Corp.Gothic Shale Colorado – Bill Barrett Corp.

Pearsall Shale in Maverick CountyPearsall Shale in Maverick County► Encana, TXCO, and Anadarko hold positions Encana, TXCO, and Anadarko hold positions

in Far West Texas Play in Far West Texas Play

Equitable developing Huron and Cleveland shalesEquitable developing Huron and Cleveland shales

US Shales US Shales (cont’d.)(cont’d.)

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US Shales US Shales (cont’d.)(cont’d.)

HaynesvilleHaynesville► 8 weeks production – wells show no significant decline8 weeks production – wells show no significant decline► 8-11 Devon announces8-11 Devon announces

73 Tcf under their 483,000 acres73 Tcf under their 483,000 acres

Goodrich Petroleum flows Goodrich Petroleum flows ► 7 MMcfd Panola County Well7 MMcfd Panola County Well

CHK – Haynesville CHK – Haynesville ► has 440,000 acreshas 440,000 acres► potential reservepotential reserve

20 trillion cubic feet20 trillion cubic feet Barnett is 2 trillionBarnett is 2 trillion

► Spent 2005 to evaluateSpent 2005 to evaluate data from 450 wells studieddata from 450 wells studied

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ShalesShales Haynesville - 12/08/08 - Exco announces 23 Mcf Haynesville - 12/08/08 - Exco announces 23 Mcf

well – Petrohawk announces wells 23 to 30 Mcfwell – Petrohawk announces wells 23 to 30 Mcf

Woodford 9/22/08Woodford 9/22/08► production 550 Mcft (Barnett 3.6 Bcft)production 550 Mcft (Barnett 3.6 Bcft)► Newfield – 40% of productionNewfield – 40% of production► BP buys CHK acreage (25% - 1.75 billion)BP buys CHK acreage (25% - 1.75 billion)► 4,100 ft. laterals4,100 ft. laterals► Devon (6 rigs), Continental (5 rigs), XTO (5 rigs), Antero (4 Devon (6 rigs), Continental (5 rigs), XTO (5 rigs), Antero (4

rigs), BP (4 rigs) and Newfield (12 rigs)rigs), BP (4 rigs) and Newfield (12 rigs)► Woodford wells 7.1 MMcfd and 6.7 MMcfdWoodford wells 7.1 MMcfd and 6.7 MMcfd

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Shales Shales (cont’d.)(cont’d.)

North Louisiana has CBM at 2,500 ft. - 4,000 ft. that Equals to North Louisiana has CBM at 2,500 ft. - 4,000 ft. that Equals to Powder River playersPowder River players► Geomet, EnerVest, Southwestern and SamsonGeomet, EnerVest, Southwestern and Samson

FayettevilleFayetteville► 08/08/08 Southwest Energy – 500MMcf/d (200 in 2007)08/08/08 Southwest Energy – 500MMcf/d (200 in 2007)

22 rigs running22 rigs running 80 acre spacing80 acre spacing 619 wells619 wells 554 horizontal554 horizontal

10/27/08 - Petrohawk announces S. TX play in Eagle Ford 10/27/08 - Petrohawk announces S. TX play in Eagle Ford Shale – two wells 15 miles apart over 9.1 million cubic ft Shale – two wells 15 miles apart over 9.1 million cubic ft equivalentequivalent

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Shales Shales (cont’d.)(cont’d.)

12/03/08 - Energen chases Conasauga and 12/03/08 - Energen chases Conasauga and Chattanooga shales without CHKChattanooga shales without CHK

Tristone is assuming $8.50 gas shale production to Tristone is assuming $8.50 gas shale production to go fromgo from6.8 Bcfd to 19 Bcfd by 20186.8 Bcfd to 19 Bcfd by 2018► Short term Haynesville and Fayetteville will dominateShort term Haynesville and Fayetteville will dominate► Montney, Marcellus, Utica and Horn River – thickerMontney, Marcellus, Utica and Horn River – thicker

may require stacked horizontal well boresmay require stacked horizontal well bores more gas per well boremore gas per well bore

Shale productionShale production► 1998 – 1 Bcfd1998 – 1 Bcfd► Today – 5 BcfdToday – 5 Bcfd► Compounded rate over 20%Compounded rate over 20%

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Shales Shales (cont’d.)(cont’d.)

Deutsche Bank-Study Shale initial 1st year Deutsche Bank-Study Shale initial 1st year declines 65-75%declines 65-75%► Flattens out in 3rd/4th year (10-15%) (MI)Flattens out in 3rd/4th year (10-15%) (MI)

2000 1 Bcfd in Antrum and Devonian Shales2000 1 Bcfd in Antrum and Devonian Shales Appla - 84% of ShaleAppla - 84% of Shale 2007 4 Bcfd Plus2007 4 Bcfd Plus Marcellus and Horn River will trump BarnettMarcellus and Horn River will trump Barnett

► One CommentatorOne Commentator Haynesville to pass Barnett in 5 yearsHaynesville to pass Barnett in 5 years Shale plays most significant discovery in 50 yearsShale plays most significant discovery in 50 years 21 Shale basins21 Shale basins

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Shales TechnologyShales Technology

Technology – Horizontal Laterals Technology – Horizontal Laterals ► Contact more shale – longer lateralsContact more shale – longer laterals► Better fracing - high frac rates and “packers” – 20 stagesBetter fracing - high frac rates and “packers” – 20 stages► Fluids out of cracks and flow backFluids out of cracks and flow back► Decrease drilling time – use of coiled tubingDecrease drilling time – use of coiled tubing► Better control of pressure and tool placementBetter control of pressure and tool placement► Dissolve calcite in rocks with chemicalsDissolve calcite in rocks with chemicals

WilliamsWilliams► Barnett – using sequential and simultaneous fracsBarnett – using sequential and simultaneous fracs

2 wells – one week job2 wells – one week job

ExxonMobilExxonMobil► 30 new technologies to extract oil from shale30 new technologies to extract oil from shale

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Shales TechnologyShales Technology (cont’d.)(cont’d.)6/30/086/30/08Encana TechnologyEncana Technology

Bighorn well costs - down $2.4 Mcf per wellBighorn well costs - down $2.4 Mcf per wellHaliburton “swellable packer”Haliburton “swellable packer”► reduces frac time and costs – 2-3 days vs. 30 daysreduces frac time and costs – 2-3 days vs. 30 days► fit for purpose rigs 20%-30% fasterfit for purpose rigs 20%-30% faster► Multi-well pads cut cost 15%Multi-well pads cut cost 15%

Barnett – EOG recovery Barnett – EOG recovery factor:factor:► 10-12% in 200410-12% in 2004► 20% in 200520% in 2005► 30% in 200730% in 2007► 50-55% late 200750-55% late 2007

XTO in Barnett:XTO in Barnett:► 28 days to drill well 200528 days to drill well 2005► 20 days to drill well 200720 days to drill well 2007► 16-17 wells permits per rig vs. 1216-17 wells permits per rig vs. 12

CHKCHK► 14 days to drill well and 1.5M cost14 days to drill well and 1.5M cost

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Shales TechnologyShales Technology (cont’d.)(cont’d.)

BreakevenBreakeven ► Marcellus -Marcellus - $3.17$3.17► Haynesville -Haynesville - $4.73$4.73► Fayetteville - Fayetteville - $5.00$5.00► Barnett (Core) - Barnett (Core) - $5.00$5.00

PlusPlus

$35 Billion to develop Haynesville$35 Billion to develop Haynesville► Break even 10% pretax IRR Break even 10% pretax IRR

Barnett – Core $5.12; Barnett – Core $5.12; ► Non-Core $6.32Non-Core $6.32► Fayetteville $5.07Fayetteville $5.07► Haynesville $4.73Haynesville $4.73► Marcellus $3.17Marcellus $3.17► Woodford $6.11Woodford $6.11

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PricesPrices

Market supplied without Marcellus or Horn River Market supplied without Marcellus or Horn River andand

LNG to increase to avoid flooding lucrative Asian LNG to increase to avoid flooding lucrative Asian and European markets.and European markets.

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Prices Prices (cont’d.)(cont’d.)

01/10/08 – Raymond James forecasts $6.50 for 200801/10/08 – Raymond James forecasts $6.50 for 2008

03/19/08 – Raymond James – says prices to fall in summer 03/19/08 – Raymond James – says prices to fall in summer

06/09/08 – Raymond James up forecast for 2008 to 10 MMBtu vs. 8 MMBtu06/09/08 – Raymond James up forecast for 2008 to 10 MMBtu vs. 8 MMBtu

08/31/08 – EIA says shale production could reduce LNG demand in US08/31/08 – EIA says shale production could reduce LNG demand in US

09/10/08 Raymond James drops price projection09/10/08 Raymond James drops price projection► for 4 Qtr. $7.50 vs. $10for 4 Qtr. $7.50 vs. $10► Wall Street consensus $11 plusWall Street consensus $11 plus

09/10/08 – EIA – If hurricane, onshore supply will prevent run-up in prices09/10/08 – EIA – If hurricane, onshore supply will prevent run-up in prices

10/15/0810/15/08► 50% Gulf Production shut in50% Gulf Production shut in► Future prices drop 50% from 7/08Future prices drop 50% from 7/08► 200 Bcf goes to pipe and storage pressure200 Bcf goes to pipe and storage pressure

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Prices Prices (cont’d.)(cont’d.) Gas StorageGas Storage

► 06/14/09 - Storage at 2,213 Bcf – 31% above year-to-year and normal06/14/09 - Storage at 2,213 Bcf – 31% above year-to-year and normal 20% plus above normal injections20% plus above normal injections Start of season – 20% plus above 5 year averageStart of season – 20% plus above 5 year average Near record ’08-09 winter heating seasonNear record ’08-09 winter heating season

EIA Reserve largest gain since 1977 (year began review)EIA Reserve largest gain since 1977 (year began review)► 12/22/08 – EIA by 2030:12/22/08 – EIA by 2030:

Natural gas prices will allow production to equal 24 trillion CftNatural gas prices will allow production to equal 24 trillion Cft Electricity production to rise by 25% andElectricity production to rise by 25% and

natural gas to 22% of productionnatural gas to 22% of production Electric growth majority gas and renewablesElectric growth majority gas and renewables Hybrid vehicles 38% of marketHybrid vehicles 38% of market

Rex MaintenanceRex Maintenance► Rockies gas below $1.00 (45¢)Rockies gas below $1.00 (45¢)

Third quarter 08 worst for commodities since 1970Third quarter 08 worst for commodities since 1970

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PipelinesPipelines

Rex brings gas to Mid ContRex brings gas to Mid Cont

TX / NM markets cannot go eastTX / NM markets cannot go east

Haynesville shaleHaynesville shale

TX and Gulf Gas prices to drop relative to Rockies TX and Gulf Gas prices to drop relative to Rockies and LAand LA

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Pipelines Pipelines (cont’d.)(cont’d.)

MLPs need creditMLPs need credit► Model -Model -

Cash flow to distributionCash flow to distribution Large capital needs debt or stock (dilution)Large capital needs debt or stock (dilution) Demand Strong for servicesDemand Strong for services Producers drilling new fields not HBPProducers drilling new fields not HBP No Pipe in areaNo Pipe in area

MLPsMLPs► Outspending Cash Flow with distributionsOutspending Cash Flow with distributions

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Pipelines Pipelines (cont’d.)(cont’d.)

MidstreamsMidstreams Cut backs Cut backs Maturity of debtMaturity of debt MLP’s need capital - where?MLP’s need capital - where? MLP’s - who will build infrastructure?MLP’s - who will build infrastructure? E&PE&P

► spend drilling money on pipe?spend drilling money on pipe?► pay private equity for pipe?pay private equity for pipe?

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Pipelines Pipelines (cont’d.)(cont’d.)

2007-2008 Ziff study – Mackenzie and Alaska gas2007-2008 Ziff study – Mackenzie and Alaska gas

MacKenzieMacKenzie► $33 Billion for 6 Bcfd$33 Billion for 6 Bcfd

AlaskaAlaska► $20 Billion for 1 Bcfd vs. LNG $10 Billion for 1 Bcfd$20 Billion for 1 Bcfd vs. LNG $10 Billion for 1 Bcfd► What about $5.00 gas?What about $5.00 gas?

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LNGLNG LNG – 4 built in ’90’s and ’80’s – Everett, MA; Cove Point, MD; LNG – 4 built in ’90’s and ’80’s – Everett, MA; Cove Point, MD;

Elba Island, GA and Lake Charles, LAElba Island, GA and Lake Charles, LA► Two idle; two little activityTwo idle; two little activity► US surplus supply / low pricesUS surplus supply / low prices► Freeport and Cheniere permits to export US gasFreeport and Cheniere permits to export US gas

4 New US facilities in 2009 to receive gas – most without supply4 New US facilities in 2009 to receive gas – most without supply► Freeport opens – no supply – one tanker scheduled – 08/09Freeport opens – no supply – one tanker scheduled – 08/09► Cheniere for sale – no dedicated supplyCheniere for sale – no dedicated supply

19 New “trains” at 12 plants to produce LNG19 New “trains” at 12 plants to produce LNG

Winter “world” 08-09 LNG prices 24-30 MMBtuWinter “world” 08-09 LNG prices 24-30 MMBtu► Algeria outage in LNG plantAlgeria outage in LNG plant► Freeport LNG – set to EXPORT!Freeport LNG – set to EXPORT!► US LNG not needed until 2012 or beyondUS LNG not needed until 2012 or beyond► Wood Mackenzie says LNG could be 14% of US supply after 2012 Wood Mackenzie says LNG could be 14% of US supply after 2012

and 20% in 2020and 20% in 2020

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LNG LNG (cont’d.)(cont’d.)

LNG – 2008LNG – 2008► 17 counties import17 counties import► 29 importers – 2012 - US has storage29 importers – 2012 - US has storage

Tankers – usually 8 built per yearTankers – usually 8 built per year► 57 in 2008 and 42 in 2009 and 40% larger57 in 2008 and 42 in 2009 and 40% larger

New Exxon “QMax” Technology increases shipNew Exxon “QMax” Technology increases shipcapacity 80% - decrease energy consumption 40% per unitcapacity 80% - decrease energy consumption 40% per unit

Pritchard Capital forecasts LNG surgePritchard Capital forecasts LNG surge► U.S. prices $3/McfU.S. prices $3/Mcf► Qatar production cost in penniesQatar production cost in pennies► Plus $2 Mcf to transportPlus $2 Mcf to transport

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Production/ReservesProduction/Reserves

EIA reports: 2007 – 46.1 TcfEIA reports: 2007 – 46.1 Tcf► record high reserve additions doubled 19.5 Tcf produced; record high reserve additions doubled 19.5 Tcf produced;

highest 31 yearshighest 31 years► 13% increase over 2006 reserves13% increase over 2006 reserves► 2007 Shale - 9% of US reserves:2007 Shale - 9% of US reserves:

50% increase year to year50% increase year to year TX - 17% gain - 13.3 TcfTX - 17% gain - 13.3 Tcf Rockies - 26% gain - 6.2 TcfRockies - 26% gain - 6.2 Tcf

Horizontal rigsHorizontal rigs► 133 – 2005133 – 2005► 600 - 2008600 - 2008

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Production/Reserves Production/Reserves (cont’d.)(cont’d.)

2006 plus 2.1 Bcf/d + 4.7%2006 plus 2.1 Bcf/d + 4.7%

2007 plus 2.5 Bcf/d + 5.3%2007 plus 2.5 Bcf/d + 5.3%

2008 plus 3.5 Bcf/d + 7% (TX ½ - Barnett)2008 plus 3.5 Bcf/d + 7% (TX ½ - Barnett)

Last drop 2002 – 2 Bcf/d – 3.8% - 400 fewer rigsLast drop 2002 – 2 Bcf/d – 3.8% - 400 fewer rigs

US has 2,247 Tcf of gasUS has 2,247 Tcf of gas► 118 years at 2007 demand118 years at 2007 demand► Every EIA projection exceeded by actual productionEvery EIA projection exceeded by actual production

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World Turned Upside DownWorld Turned Upside Down

JAPAN – Ten years from commercial production JAPAN – Ten years from commercial production Methane HydratesMethane Hydrates

US Federal Waters “100s” of Tcfs of gas in US Federal Waters “100s” of Tcfs of gas in Methane HydratesMethane Hydrates

North slope 85.4 Tcf in Methane HydratesNorth slope 85.4 Tcf in Methane Hydrates

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World Turned Upside Down World Turned Upside Down (cont’d.)(cont’d.)

In 1In 1stst half 08 half of gas consumed was from wells drilled in half 08 half of gas consumed was from wells drilled in last 40 monthslast 40 months

In 2006, was 48 monthsIn 2006, was 48 months

US unconventional gas 10 times recoverable volume US unconventional gas 10 times recoverable volume conventional gasconventional gas

Worldwide – translate US shale lessons?Worldwide – translate US shale lessons?

Ziff forecastsZiff forecasts

► Unconventional Gas “53%” of production by 2020Unconventional Gas “53%” of production by 2020

► N.A. production 87 Bcfd in 2020 vs. 70 Bcfd in 2000N.A. production 87 Bcfd in 2020 vs. 70 Bcfd in 2000

► Shales the keyShales the key

30

NGLsNGLs

NGLs-the heavier components of the natural gas NGLs-the heavier components of the natural gas streamstream

► C2C2 ETHANEETHANE► C3C3 PROPANEPROPANE► iC4iC4 ISO – BUTANEISO – BUTANE► nC4nC4 NOR – BUTANENOR – BUTANE► C+5C+5 COMMONLY CALLED NATURAL COMMONLY CALLED NATURAL

GASOLINEGASOLINE

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NGLs NGLs (cont’d.)(cont’d.)

Comparison of Gas and NGL ValueComparison of Gas and NGL Value

¢/GALLON¢/GALLON MMBTU/GALLONMMBTU/GALLON $/MMBTU$/MMBTU

► NATURAL GASNATURAL GAS ------ ------ 2.0222.022► ETHANEETHANE 19.3319.33 .066320.066320 2.912.91

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NGLs NGLs (cont’d.)(cont’d.)

Uses for Natural Gas LiquidsUses for Natural Gas Liquids ComponentComponent:: primary usesprimary uses EthaneEthane: petrochemical feedstock for the manufacture of : petrochemical feedstock for the manufacture of

ethylene, which is the building block for the manufacture of ethylene, which is the building block for the manufacture of polyethylene, styrene and many other products.polyethylene, styrene and many other products.

PropanePropane: liquid fuel for homes, industry and transportation : liquid fuel for homes, industry and transportation (60%); petrochemical feedstock (23%); and farm use, exports and (60%); petrochemical feedstock (23%); and farm use, exports and miscellaneous (17%).miscellaneous (17%).

Iso-butaneIso-butane: refinery feedstock for the manufacture of alklylates : refinery feedstock for the manufacture of alklylates and mtbe which are used as high-octane blending components in and mtbe which are used as high-octane blending components in motor gasoline.motor gasoline.

Normal-butaneNormal-butane: refinery feedstock for direct gasoline blending or : refinery feedstock for direct gasoline blending or isomerization (66%); petrochemical feedstock (24%); and fuel isomerization (66%); petrochemical feedstock (24%); and fuel (10%). Diminishing use for direct gasoline blending with EPA (10%). Diminishing use for direct gasoline blending with EPA RVP limitations.RVP limitations.

Natural gasolineNatural gasoline: primarily used as a blending agent in motor : primarily used as a blending agent in motor gasoline. Also, refinery and petrochemical feedstock. gasoline. Also, refinery and petrochemical feedstock.

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NGLs NGLs (cont’d.)(cont’d.)

Keepwhole and ‘At Risk’ ContractsKeepwhole and ‘At Risk’ Contracts "Producer (seller, buyer, etc.) is "keptwhole" on the "Producer (seller, buyer, etc.) is "keptwhole" on the

Btu valve of the gas delivered to the plant." Risk is Btu valve of the gas delivered to the plant." Risk is borne 100% by the processor.borne 100% by the processor.

Processor is "at risk" as to financial relationship Processor is "at risk" as to financial relationship between the raw material value (the keepwhole value) between the raw material value (the keepwhole value) and finished product value (NGL prices). and finished product value (NGL prices).

Netback PricingNetback Pricing

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NGLs NGLs (cont’d.)(cont’d.)

NGLs from crude is competitionNGLs from crude is competition Crude drives NGL pricesCrude drives NGL prices Unconventional gas fewer NGL’sUnconventional gas fewer NGL’s MARKET PROBLEMSMARKET PROBLEMS

► Price FluctuationsPrice Fluctuations► Conflict of InterestConflict of Interest

CONFLICT ENCOURAGESCONFLICT ENCOURAGES► Inefficient PlantsInefficient Plants► Low Plant PricesLow Plant Prices

35

NGLs NGLs (cont’d.)(cont’d.)

► REMEDIESREMEDIES "Drop out" Clause"Drop out" Clause Look at Plant StatementsLook at Plant Statements Are fuel/shrinkage unusually high?Are fuel/shrinkage unusually high? Avoid processor net backsAvoid processor net backs

OrOr

Conway Kansas or M. BellviewConway Kansas or M. Bellview Avoid netback at plant or countyAvoid netback at plant or county Negotiate fixed charges/fuel, etc., up front. Negotiate fixed charges/fuel, etc., up front.

36

NGLs NGLs (cont’d.)(cont’d.)Humble Oil and RefiningHumble Oil and Refining

Humble Oil and Refining Company and Pan American Petroleum Corporation just completed an audit of Humble Oil and Refining Company and Pan American Petroleum Corporation just completed an audit of Champlin's books covering our Carthage Plant operations for the period from August 1, 1955, through December Champlin's books covering our Carthage Plant operations for the period from August 1, 1955, through December 31, 1957. Since commencement of processing at the Carthage Plant in 1946, these two companies have audited 31, 1957. Since commencement of processing at the Carthage Plant in 1946, these two companies have audited the operation of this plant for themselves and on behalf of others four separate tines starting in the year 1950.the operation of this plant for themselves and on behalf of others four separate tines starting in the year 1950.

During this most recent audit (just completed in 1958) a question was raised for the first time as to the language During this most recent audit (just completed in 1958) a question was raised for the first time as to the language in the processing agreements as compared to the actual procedure used by Champlin for the allocation of plant in the processing agreements as compared to the actual procedure used by Champlin for the allocation of plant liquids which procedure was agreed upon and set forth in a letter agreement dated June 8, 1948, between the liquids which procedure was agreed upon and set forth in a letter agreement dated June 8, 1948, between the Panola County Royalty Owners Association to The Chicago Corporation dated June 11, 1952.Panola County Royalty Owners Association to The Chicago Corporation dated June 11, 1952.

The procedure used in allocating plant liquids, since this agreement was made with the Royalty Owners The procedure used in allocating plant liquids, since this agreement was made with the Royalty Owners Association, is fully reflected in the Gas and Liquid Production and Disposition Report. After a review of the Association, is fully reflected in the Gas and Liquid Production and Disposition Report. After a review of the matter, Humble agrees with Champlin that this procedure, which has been in actual use since 1948 and as matter, Humble agrees with Champlin that this procedure, which has been in actual use since 1948 and as adjusted slightly in 1952, is most equitable; and after reviewing the entire matter, Pan American expresses no adjusted slightly in 1952, is most equitable; and after reviewing the entire matter, Pan American expresses no disagreement with the procedure.disagreement with the procedure.

Certainly, a prime requisite for a fair and equitable allocation of liquid products derived from a commingled Certainly, a prime requisite for a fair and equitable allocation of liquid products derived from a commingled stream of gas is that the allocation method and procedures for each and every source of gas be identical. We stream of gas is that the allocation method and procedures for each and every source of gas be identical. We have, therefore, been employing the procedure worked out with the Royalty Owners Association consistently have, therefore, been employing the procedure worked out with the Royalty Owners Association consistently during all this time, and all parties have been fully advised of the allocation through the monthly reports during all this time, and all parties have been fully advised of the allocation through the monthly reports mentioned above.mentioned above.

We take this opportunity of advising you that it will be our practice to continue to employ the aforementioned We take this opportunity of advising you that it will be our practice to continue to employ the aforementioned procedure as to all producers connected to our plant. If you have any question as to the procedure as procedure as to all producers connected to our plant. If you have any question as to the procedure as heretofore employed, and which we propose to continue, or as to any other matters pertaining to our processing heretofore employed, and which we propose to continue, or as to any other matters pertaining to our processing agreement with you, we will be glad to discuss the matter with you. Unless we hear from you to the contrary agreement with you, we will be glad to discuss the matter with you. Unless we hear from you to the contrary within thirty (30) days, we will consider that our suggestion for continuing this procedure meets with your within thirty (30) days, we will consider that our suggestion for continuing this procedure meets with your approval. approval.

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NGLs NGLs (cont’d.)(cont’d.)Plant AllocationsPlant Allocations► No formulas followedNo formulas followed► Audit formulas for liquid downstreamAudit formulas for liquid downstream► Audit residue gas streamAudit residue gas stream► Audit measurementAudit measurement► 85% netback can be better than 90%85% netback can be better than 90%► Fixed allocation -- not actual Fixed allocation -- not actual

Processing ContractsProcessing Contracts► Fee for ServiceFee for Service► Percent of ProceedsPercent of Proceeds► Fee and % of ProceedsFee and % of Proceeds► Keep WholeKeep Whole

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NGLs NGLs (cont’d.)(cont’d.)

Processing Key IssuesProcessing Key Issues► Duty to ProcessDuty to Process

UneconomicUneconomic UnprofitableUnprofitable Good FaithGood Faith

► Keepwhole RightsKeepwhole Rights► When is 85% of the liquids (NGLs) better than 90%When is 85% of the liquids (NGLs) better than 90%► Conflict of InterestConflict of Interest► Fuel and Shrinkage – IncentiveFuel and Shrinkage – Incentive

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NGLs NGLs (cont’d.)(cont’d.)

““Trigger Words”Trigger Words”► EconomicEconomic – prudent and thrifty in management; intended – prudent and thrifty in management; intended

to save money; efficientto save money; efficient► ProfitableProfitable – the return on a business after expenses; an – the return on a business after expenses; an

advantageous gain or return; income; payment for a advantageous gain or return; income; payment for a commodity in excess of cost (American Heritage College commodity in excess of cost (American Heritage College Dictionary – 3rd Edition.)Dictionary – 3rd Edition.)