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Professional Logistics Group

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Shale Development: Frac Sand Logistics and

Rail Supply Chain Impacts

Prepared for: Southwest Association of Rail Shippers

San Antonio, TX | February 23, 2012

»  Boutique consulting firm specializing in transportation, logistics, and supply chain   Established in 2001   Over 80 clients and 200 engagements

»  Headquarters in Chicago USA, with team members throughout the US and with “on the ground” experience in:   North America / Europe / South America / Asia / Middle East

»  Consulting services   Strategy & optimization   Assessments & benchmarking   Transportation assets & infrastructure   Logistics operations   M&A/investments/private equity

»  Specializing in the logistics of   Oil & gas   Chemicals & plastics   Wind energy & project cargo   Bulk commodities (minerals, mining, agricultural)   Industrial & consumer goods

About Professional Logistics Group

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  Viewed as a cost center   Non-strategic   Afterthought   Minimal investment

Spectrum of Logistics Sophistication – Shipper Organizations

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»  Senior management approach to logistics:

»  Corresponding outcomes:

  Senior level engagement   Capital commitments   Technology commitments   Integral to commercial success

  Disadvantaged cost structures   Asset inefficiency   Infrastructure inefficiency   Unable to leverage logistics for

commercial advantage

  Advantaged cost structures   Efficient users of rail and other options   Mode and carrier competitive options   Able to leverage logistics for

competitive advantage

HIGH LOW

Exacerbating Factors: Gold Rush Conditions

»  Other recent energy “boom” events with major transportation impacts

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»  Common characteristics   New technology breakthroughs and/or dramatic market shifts   Speed to market is paramount   Rush of capital and new players   Low-end spectrum conditions compounded

Shale Driving Growth in Natural Gas and Crude Oil Production

»  1,989 rigs in operation as of 10 February 2012

»  Rush of capital into the industry

»  Domestic oil production at eight-year high

»  700% increase in shale gas production since 2007

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Long-Term Shale Development Outlook is Positive

»  Strongest growth in natural gas, crude oil, and non-hydro renewables through 2020

»  Domestic production forecasted to reduce total energy imports over time

»  Shale projected to account for nearly half of all US natural gas production by 2035

»  However, expect periodic market turbulence

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Benefits Go Beyond Energy

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»  Shale development a “net win” for United States

  Highly advantaged NGL cost structure vs. rest of world (ethane vs. naphtha)

  Creates strong, long-term export market for US polyethylene and other petrochemicals

  Jobs creation

  Trade deficit reduction

Source: American Chemistry Council

Shale Play Product Flows Outbound

»  Natural Gas   Majority via pipelines, some trucks

»  Natural Gas Liquids (NGLs)   Requires processing (fractionation)   3-9 gallons/MCF (thousand cubic feet)

–  Ethane 63% –  Propane 22% –  Butane 8% –  Pentane 5% –  Other 2%

»  Crude Oil   Bakken play as a model   Strong potential for Utica play

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Shale Development Driving Growth in Crude-by-Rail Activity

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Year WellsProduc.onbbl/day

RailCL/DayShippedat15%‐23%share

2010 2300 320,000 66

2011 4000 535,000 170

2013projected 5000 700,000+ 250

Wells BBL’s/Day Rail Car CL/Day

»  Bakken crude oil metrics and future projections

Source: Progressive Railroading, North Dakota Pipeline Authority, PLG analysis

Crude Handled by Railroad C

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Quarterly Data

STCC 13111 Source: US Rail Desktop 10

Traffic Flows Inbound - Shale Plays

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»  Per well:

  Frac sand (multiple grades)   15-30+ carloads   Most desirable product originates in Wisconsin

and Minnesota

 OCTG (oil country tubular goods)   4-6 carloads equivalent

 Water   3-5 million gallons   Locally-sourced

 Chemicals   Various origins   Equivalent of two carloads

Correlation of Operating Rig Count and Sand Shipments

0

500

1,000

1,500

2,000

2,500

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

2007 Avg. 2008 Avg. 2009 2010 2011

Ope

ra.ngOnsho

reRigs

Carloa

ds

QuarterlyData

Opera<ngOnshoreRigs

STCC 14413 Source: US Rail Desktop, Baker Hughes 12

All Sand Handled by Railroad C

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Quarterly Data

STCC 14413 Source: US Rail Desktop 13

All Sand Forwarded by Railroad C

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STCC 14413 Rail traffic data source: US Rail Desktop; map source: Bruce Brown, PhD., Wisconsin Geological and Natural History Survey

»  Red areas indicate “optimal” frac sand sources   Well rounded grains   Nearly 100% quartz   Other areas produce sand too angular or contaminated

with other minerals or fragments

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All Sand Received by Railroad

STCC 14413 Source: US Rail Desktop 15

Car

load

s

Changes in Rail Shipment Pricing Q3 2011 vs. Today - Sand

$‐

$0.010

$0.020

$0.030

$0.040

$0.050

$0.060

$0.070

$0.080

$0.090

$0.100

RawUnitTrain ProcessedUnitTrain ProcessedManifest RawUnitTrain ProcessedUnitTrain ProcessedManifest

High

low

Average

RateperTon‐MileToday(excludingfuelsurcharge)

RateperTon‐Mile3Q2011(excludingfuelsurcharge)

UnitTrains1000‐1200Miles

Manifest600‐1300Miles

Source: PLG analysis 16

Sand Railcar Market Conditions

»  New-build market may have peaked   3Q 2011: 8-10 month backlog; 4-6 month backlog today   ~10,000 cars on backorder; trending downward   Major RFQs mostly played out   Some new-builds sent straight to storage due to declining

natural gas prices

»  Lease market also at or near peak   Mild downward pressure on lease rates   Fewer spec orders; now mostly deal-specific

»  Long-term horizon   Construction revival may renew tight conditions for

small cube hoppers   Trend towards unit trains will improve cycle times and

utilization   Fewer sub-optimal cars (i.e. grain) in sand service   “Bust” scenarios due to gross overbuilding (i.e.

centerbeams) unlikely

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Systemic Challenges – Sand Logistics

»  Who controls and/or pays for freight   Model still not fully evolved   Fragmentation among key players –  Sand producers –  Oilfield services companies –  E&P companies

»  Sand sourcing   NIMBY issues in mining areas   New market entrants with varying levels of

capitalization, reliability

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»  Bulk truck supply   Equipment availability   Driver shortage   Dry bulk tank construction backlog

(~15 months)

Recent Market Turbulence

»  Price fluctuations create whipsaw effect in number and location of drilling rigs   Shift in drilling activity from dry gas to NGLs and crude

»  Logistics planning uncertainty   Inventory/grade (mesh) dislocation   Difficulty in distribution network planning (transload, storage, delivery)   Asset utilization and deployment   Capex

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Layers of Inefficiency Within the Frac Sand “Ecosystem”

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»  Natural order of varying levels of logistics management sophistication…   Non-strategic view of logistics   Secondary consideration

»  …compounded by gold rush conditions...   Speed to market is paramount   New market players, sources of capital

»  …compounded by systemic challenges…   Fragmented control of logistics spend and operations   Sand sourcing   Bulk trucking constraints

»  …compounded by market turbulence….   Unpredictable demand volumes and locations   Inventory, asset slack-action

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Evolution of a Gold Rush

»  Maturation and stabilization of boom markets are inevitable

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»  Common characteristics of boom market maturation   Declining demand and/or weakened pricing, plus margin compression   Smaller/weaker/less sophisticated players exit, largely due to non-product related factors   Aggregation of volume and market power accrues to larger, better capitalized players   Standardization of transportation methods, practices, procurement   Logistics becomes an important platform for competition

Logistics Cost as a Percentage of Product Value

»  Frac sand is highly sensitive to logistics costs relative to past energy “booms”

Ethanol 8%

Wind turbine 12%

Representative logistics costs for example sand price of $180/ton

Rail Freight Rate: 28%

Rail Fuel Surcharge: 2%

Railcar Lease: 2%

Trucking & Transload

to Drill Site: 22%

Destination Transload: 4% Processed Sand: 42%

Frac sand 58%

Source: PLG analysis 22

Getting Ahead of the Curve

»  Like other “gold rushes” before it, market will evolve and mature

»  Transportation buying power/leverage will accrue to fewer, more efficient, and sophisticated buyers

  Becomes a key competitive advantage when gold rush stabilizes

»  Opportunity exists for to establish competitive advantage now

  Move “up” the logistics sophistication spectrum   First-mover and vertical integration are key

»  Recommendations for transportation and service providers

  Understand your customers’ business   Deliver value and think entrepreneurially   Anticipate change

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Thank You! For follow up questions and information, please contact:

Graham Brisben, President +1-708-386-0700 / gbrisben@prologisticsgroup.com

Jean Arndt, Vice President-Operations +1-630-505-0273 / jarndt@prologisticsgroup.com

Jeff Dowdell, Senior Consultant +1-732-995-6696 / jdowdell@prologisticsgroup.com

Gordon Heisler, Senior Consultant +1-215-620-4247 / gheisler@prologisticsgroup.com

Jeff Rasmussen, Senior Consultant +1-317-379-5715 / jrasmussen@prologisticsgroup.com

Mike Spahis, Senior Consultant & Project Leader +1-214-392-7263 / mspahis@prologisticsgroup.com

This presentation is available at: WWW.PROLOGISTICSGROUP.COM 2424