MARIO KHATER

ASSESSING THE ECONOMIC FEASIBILITY OF SHALE GAS

A North American Perspective
An Economic Insight into Production Decline Curve Analysis

Mémoire présenté
à la Faculté des études supérieures et postdoctorales de l'Université Laval
dans le cadre du programme de maîtrise en économique
pour l'obtention du grade de Maître es arts (M.A.)

DÉPARTEMENT D'ÉCONOMIQUE
FACULTÉ DES SCIENCES SOCIALES
UNIVERSITÉ LAVAL
QUÉBEC

2013

© Mario Khater, 2013

Résumé

Ce mémoire étudie la faisabilité économique de la production de gaz de shale à partir de cinq

formations géologiques différentes (le Marcellus, le Barnett, le Haynesville, le Montney et
l'Utica) dispersées aux États-Unis et au Canada. Depuis 1990. le progrès technologique,
notamment en termes de forage horizontal et de fracturation hydraulique, a permis la
production économique du gaz naturel à partir de shales et a amélioré les perspectives à long
terme pour l'approvisionnement en gaz naturel en Amérique du Nord. l'Energy Information
Administration (EIA) prévoit que d'ici 2046 près de 50% de l'approvisionnement en gaz naturel
américain proviendra du gaz de shale; d'autres chercheurs estiment que l'approvisionnement
en gaz naturel en Amérique du Nord, sous forme de gaz de shale, durera plus de 100 ans. Ainsi,
ce gaz non conventionnel est censé révolutionner les perspectives futures du développement
énergétique. Cependant, une fois exploité, sa mise en valeur reste incertaine vue que sa
rentabilité économique est vulnérable et dépend de plusieurs facteurs économiques et
géologiques. Notre projet déterminera l'état général de la production de la ressource via
l'interprétation des courbes de déclin et l'analyse des économies de seuils de rentabilité et aura
deux volets: (1) technique et (2) économique. Premièrement, dans la partie technique, on
analyse les courbes de déclin afin de prédire comment est ce que les réserves de gaz de shale
sont estimées dans l'industrie. Deuxièmement, dans la partie économique, qui, par l'évaluation
des tendances à la baisse de la production de gaz de shale, nous permettra d'identifier les
divers agrégats qui rendent cette production, économiquement rentable. En conclusion, on
développe un modèle logistique de déploiement des puits pour le shale d'Utica illustrant
l'impact potentiel des volumes de gaz produits, le temps de déploiement des puits, le nombre
de puits forés, ainsi que des redevances versées sur la rentabilité économique du projet.
Abstract

This thesis analyzes the economic feasibility of producing shale gas from five different shale
formations (Marcellus, Barnett, Haynesville, Montney, and Utica) dispersed in the United States
(U.S.) and Canada. Since 1990, advances in technology, mainly horizontal drilling and hydraulic
fracturing have allowed economic production of natural gas from shales and boosted the long-
term outlook for the supply of natural gas in North America. The Energy Information
Administration predicts that by 2046 almost 50% of the U.S. natural gas supply will come from
shale gas; other researchers estimate that the natural gas supply in North America, in the form
of shale gas, will last more than 100 years. Thus, shale gas is thought to be the game changer of
the course of future energy development trends; however, its economic profitability is
vulnerable and depends upon several economic and technical factors. Our study is conducted
through Decline Curve Analysis and breakeven economics and has two facets: (1) technical and
(2) economic. First, the technical part consists on investigating Production Decline Curve
Analysis in order to understand how shale gas reserves are estimated in the industry. Second,
comes the economic part, which by assessing steep initial decline trends of gas production from
five major shale plays, focuses on identifying both geologic and economic aggregates that
render shale gas production, economically profitable. Finally, to better understand the
economic functionality of producing shale gas, we develop a logistic growth model of wells
deployment for the Utica shale that depicts the potential impact of volumes of gas produced,
wells deployment time, number of wells drilled, and royalties paid on the project economics.

iii
Acknowledgments

I would like to thank many persons who contributed to the accomplishment of my master
degree project.

First of all, I would like to express my gratitude to my supervisor, Pr Patrick Gonzalez. I am

thankful for your valuable insights and directions that gave me needful guidance to complete
the research and write my thesis. I also thank you for being there during my entire project. I
thank you for your patience and persistence with the help and assistance that you offered me. I
also thank you because you made the most difficult tasks so easy to accomplish and to
understand.

I would also like to thank my friend Rana Daher for all the support, help and encouragement
she gave me.

Finally, I thank my beloved family who supported me during all my life; I would not be able to
succeed without you. I thank you for believing in me. I thank you for the love and care you gave
me. I thank my mother Norma for all the efforts she made for me. I thank you for being there
for me and with me at all times despite the great distances that separated us. I also thank my
father Elia for the trust and the guts you built in me and the great generosity and modesty that I
carved through you. I thank my three brothers Georges, Rami and Hicham for their love and
support. Finally, to my cousin Ziad, I thank you for the infinite generosity, the kindness and the
gracious hospitality that you extended to me during my entire stay at your place.

IV
"Natural gas is the best transportation fuel. It's
better than gasoline or diesel. It's cleaner, it's
cheaper, and it's domestic. Natural gas is 97%
domestic fuel. North America. "

Thomas B. Pickens (1928-)

"Natural gas is the future. It is here."

B i l l Richardson ( 1 9 4 7 - )

To my beloved family,
Table of contents

Résumé II
Abstract Ill
Acknowledgments IV
List of Figures VIM
List of Tables IX
Abbreviations X
Table of conversion X
Introduction 11
Literature Review 13

Chapter I: Shale Gas and Production Decline Curve Analysis 14

1.1. Definition: What is Shale Gas? 14
1.2. How Shale Gas is produced? 15
1.2.1. Horizontal Drilling 15
1.2.2. Hydraulic Fracturing 16
1.3. Understanding Production Decline Curve Analysis 17
1.3.1. History of Reserves Estimates Calculation Methods 17
1.3.2. PDCA in unconventional reservoirs 20
1.3.2.1. Exponential truncation of hyperbolic equations 21
1.3.2.2. Multiple transient hyperbolic exponents 21

Chapter II - The economics of shale gas wells 23

2.1. Model, Methodology, Variables 25
2.1.1. Cash flow analysis 25
2.1.1.1. Explaining the model variables 25
2.1.2. Sensitivity analysis 27
2.1.3. Decision making parameters 28
2.1.3.1. Net Present Value 28
2.1.3.2. Internal Rate of Return (IRR) 29
2.1.3.3. Payout Period 30
VI
2.2. Shale plays and model assumptions: 30
2.2.1. Barnett 31
2.2.2. Marcellus 35
2.2.3. Haynesville 37
2.2.4. Montney 39
2.2.5. Utica 41
2.3. Economic discussion 42
2.4. A logistic distribution model of wells deployment (Utica Shale) 46
2.4.1. Model and Assumptions 47
2.4.2. Economic discussion 50

Conclusion 54
Appendix 55
References 88

VII
List of Figures

Figure 1: Conventional, tight, and shale gas and oil 14

Figure 2: Stages of a shale gas production process 16
Figure 3: DCA, rate versus cumulative gas production 21
Figure 4: Energy trends in the U.S 23
Figure 5: Natural gas production by source, 1990-2030 (tcf) 23
Figure 6: Shale Gas Production Economics (Banks 2008) 24
Figure 7: Comparison of number of wells drilled (per year) 46
Figure 8: Truncation of hyperbolic equations 56
Figure 9: Arps Type curves 56

VIII
List of Tables

Tables 1, 2 (a, b, c, d, and e): Shale plays models parameters and expected ranges 31-41
Table 3: Sensitivity Analysis Results 43
Table 4: Estimating gas reserves using Arps equations 58
Table 5: Quebec's New Royalty Regime (NRR) 61

IX
Abbreviations

bcf billion cubic feet

EIA Energy Information Administration

EUR Estimated Ultimate Recovery

FYP First Year Price

GP Gas Produced

IRR Initial Rate of Return

md Millidarcy

Mmcf Million cubic feet

NPV Net Present Value

OGIP Original Gas in Place

PDCA Production Decline Curve Analysis

RF Recovery Factor

TRR Technically Recoverable Resources

mcf Thousand cubic feet

tcf trillion cubic feet

U.S. United States

Table of conversion

tcf bcf Mmcf mcf

1 ryryry -. rk/-ki*m r.r\r\ -, r\r\ry #^rk^^ ryryry

X,yJyJ\J,\J\J\J,\JU\J
1,UVU 1,UUU,UUU

lbcf 0,001 1,000 1,000,000

IMmcf 0.000001 0.001 1,000

lmcf 0.000000001 0.000001 0.001

Introduction

Shale gas reservoirs differ from conventional gas reservoirs in the fact that it is the process of making a
well ready for production that forms the reservoir (T.A. Blasingame 2008). Since their permeability is
very low, a multi-stage conductive platform is required between the well completion and the reservoir
to attain commercial economic rates. To achieve the latter, massive multi-stage hydraulic fracture
techniques are used to boost the interconnectivity between the fractures of the well (Gaskari R. and
Mohaghegh 2006). The linkage and spacing of the induced fracture networks are still generally not very
well understood. Therefore producing companies are grandly motivated to enhance their understanding
of these characteristics and this for two reasons: (1) to get more reliable and accurate production and
reserve estimates, and (2) to ameliorate their interpretation of the available data in order to enhance
their field development strategies and drill, economically, more fruitful wells (M. Y. Soliman, Johan Daal
and al. 2012).

In general, shale gas plays present various challenges to analysis that conventional reservoirs simply do
not imply. Their very low permeability makes conventional production almost impossible; thus every
well in a shale play must be hydraulically fractured to achieve economical production (Holditch S. A.
2006; Sunjay 2012).

As for the techniques applied to estimate potential recoverable reserves contained in underground
shale reservoirs, Production Decline Curve Analysis (PDCA) was seen as the most successful
characterization technique because it is practical, reliable, and relatively costless (Poston 2005). PDCA is
a traditional graphical procedure that monitors and predicts gas production decline rates over time. It is
relatively costless because, once compared to other characterization techniques, (1) it is mainly based
on extrapolation techniques (a simple assessment of past performance production data of pre-
established wells), and so (2) previous production decline trends will be projected in order to predict
future potential behavior of newly discovered wells.

Among various methods that can be used within the industry to estimate Gas In Place1 (GIP) in a
particular shale formation, those advanced by Arps (1945) and Fetkovich (1987) are thought to be the
most popular ones2. They were originally designed to forecast and predict production capacities of
conventional reservoirs and vertical wells but once applied solely to the estimation of unconventional
gas reservoirs they encounter major key issues and provide unreliable results (Lisa Dean P. Geol. and Eng
2008). Since 2006, shale gas reservoirs started to be widely explored and developed in North America,
notably in the U.S., with advances in technology, such as multi-fractured horizontal wells and directional
drilling, being the key drivers for success.

'The estimated gross quantity of gas contained within every shale gas play or reservoir.
*The first successful horizontal drilling act that contributed the most to the launching of the North American Shale Gas
Revolution was driven by a small private company, Mitchell Energy; it took place in the North Texas Barnett Shale region,
and it dates from 1991 (Wikipedia).

11
Nowadays, shale plays that have been exploited had numerous and complex reservoir and production
characteristics that rendered the mathematical estimation of gas produced from horizontal wells
deceptive because it often leaded to unreasonable production estimates (Fekete associates Inc. 2004).
The characterization process of shale plays in terms of future production capabilities is divided into two
basic elements: (1) the evaluation of the reservoir technical properties (permeability, GIP, etc.) and, (2)
the prediction of future production trends of newly discovered wells, being a crucial part of the
characterization process, enabling producing companies to estimate existing volumes of Technically
Recoverable Resources3 (TRR) in shale plays and eventually to assess the economic profitability of every
well drilled (within that play). To this end, this project proposes a base case economic model that
facilitates the tasks of evaluating and assessing the profitability of shale gas investments.

Essentially, the assessment of shale plays economics goes through two key stages: the technical
(estimating gas reserves) and the economic (William M. Gray, Troy A. Hoefer and al. 2007). From this
perspective, our study combines theory modeling and empirical testing in an application field that is
novel to the energy economics literature.

The first chapter of our project is entitled: "Shale Gas and Production Decline Curve Analysis". At first, it
will be question to present a brief literature review of the economics of extracting natural gas from
shale followed by an attempt to advance answers to three basic questions: (1) What is shale gas? (2)
How shale gas is produced? (3) How shale gas reserves are estimated by operators using PDCA?

Later on, comes the second chapter of our project, through which, by analyzing various production
decline scenarios of some major shale plays in the U.S. and Canada (Marcellus, Haynesville, Barnett,
Montney, and Utica), we identify the economic thresholds that will render shale gas projects
economically productive and will hence allow us to detect the economic parameters that impact the
productivity of a shale gas reservoir. Our second chapter is entitled "The Economics of Shale Gas Wells".
The latter offers a microeconomic insight into PDCA and the analysis is done following a 2-step
methodology: (1) Cash flow analysis (to assess the economic feasibility of the project), and (2) Sensitivity
analysis (to monitor how the economics of the project will vary under various cost-production
development scenarios). To note that the results found will be stated in terms of NPV (Net Present
Value), IRR (Internal Rate of Return) and Payout Periods.

Additionally, since the Utica shale is still in its early stages of development, a simple logistic model that
describes the relationship between volumes of gas produced, royalties, and wells deployment time on
the scale of the industry will also be proposed. The latter will depict how annual royalties collected (by
the government) are positively correlated with continuous drilling activities and how these royalties will
tend to dramatically fall post-deployment time.

'The volume of gas which is recoverable using available exploitation and production technology without regard to cost,
which is a fraction of the estimated GIP.

12
Literature Review
How gas reserves are estimated from unconventional reservoirs plays a central role in assessing the
economic feasibility of shale plays (Larry Lake, John Martin and al. 2012). Five years ago, an increasing
number of authors, with or without academic affiliations, started to investigate and to evaluate the
economic profitability of shale plays (Andrew Potter, Helen Chan and al. 2008; Al-Reshedan 2009; Jeff
Ventura, Aubrey k. McClendon and al. 2009; Bailey 2010; Kaiser 2010; Lin 2010; Jason Baihly, Raphael
Altman and al. 2011; Kaiser 2012; Larry Lake, John Martin and al. 2012; Mason 2012). However, the
assessment of shale plays economics is volatile and the calculated results depend upon the reliability of
the assumptions made (in terms of gas price, drilling and completion costs, etc.) before the launch of the
analysis. Whilst some assumptions are common to all shale plays, some others are specific to every
shale play. The latter varies based on several criteria's, such as: geographical locations, reservoirs
physical properties, proximities to market hubs, etc. In our project, we outline, for every shale play, a
specific set of assumptions (Chapter II) and we make a logical interference into the existing literature on
shale gas economics by proposing a flexible economic model that fits all types of shale plays.

Part of the theory developed in this project relies on financial analysis formulas that appraise the
impacts of the model input-parameters (economic and geologic) variations on the expected financial
outputs of the investment. This methodology has been used, among others, by Lin (2010), Bailey (2010),
and Kaiser (2012) to test the economics of the Utica, the Barnett and the Hayneville plays, respectively.
The typical focus of this literature is to test the economic feasibility of every shale play under different
development and market scenarios. In contrast, our study uses cash flow sensitivity analysis to forecast
the total stream of financial earnings that could derive from the development of every shale play as well
as to study how these anticipated financial outcomes could, over time, increase or decrease based on
prevailing economic conditions. Moreover, we introduce a logistic growth model that assesses the
impact of wells deployment on both volumes of gas produced and annual royalties paid within the
industry in the Utica shale.

Finally, the evaluation of the economic profitability of shale plays is related to a stream of technical work
that deals with the estimation of future gas reserves from unconventional formations (Lisa Dean P. Geol.
and Eng 2008; Liu Wendy 2008; Jason Baihly, Raphael Altman and al. 2011). The existing literature on
shale gas economics is limited in a several number of ways. Mainly, it has not evaluated the economic
profitability of producing shale gas while taking into account the fact that it is of a central importance to
understand how volumes of gas, that will be in later years, produced and sold, are estimated in the first
place, nor has it presented a clear economic explanation of the methods and technical variables that are
used within the industry to estimate gas reserves from unconventional formations.

13
Chapter I: Shale Gas and Production Decline Curve Analysis

Normally, shale gas plays contain both free (contained within the natural fractures of shale) and
adsorbed gas (accumulated on a solid material such as the organic particles in a shale reservoir)4. The
latter is rarely commercially produced however the former is the major contributor to economic
production. Gas production from shale gas wells is often estimated using traditional decline curves
(PDCA) developed by Arps in 1945 and is mainly characterized by high initial production rates, steep
decline rates and long term steady low production rates, thereafter.

1.1. Definition: What is Shale Gas?

Shale gas is natural gas trapped in an organic-rich, fine-grained underground rock called shale (Gonzalez
2012). Shale gas is found in shale formations. It is produced from the fractures and micropores spaces of
shales. By shales we mean those underground sedimentary rocks composed of clay and fragments of
other minerals such as quartz and calcite (SCGNC 2006). Shale gas is normally generated during
underground burial, when heat and pressure crack the organic accumulations. During the process of
generation, some of the oil-gas, with high permeability, succeeds to flow and migrate to less deep
wellbores (relatively close to the surface), forming the so-called conventional reservoirs, while some
other, shale gas (with low permeability), for example, do not succeed to escape the organic matter and
still trapped within the shale formation. The latter is the so-called unconventional reservoirs (Holditch S.
A. 2006).

Oil-rich_shale Gas-rich shale

Figure 1: Conventional, tight, and shale gas and oil. Adapted from EIA (2011) and Kaiser (2012).

Hence, given that typical shale reservoirs are buried few kilometers deep in the ground and are largely
distributed over extensive geographic zones rather than concentrated in specific locations, gas shales
are usually known as resource plays or reservoirs (Larry Lake, John Martin and al. 2012).

"Source: Schlumberger Oilfield Glossary.

14
The NEB Report (2009) states that the volume of natural gas, contained within every shale play depends
of the thickness and geographic extent of the reservoir. Thus, volumes of GIP increase -the thicker is the
reservoir- as the geographic extent of the reservoir grows.

Finally, low permeability indicates the restricted capacity for shale gas to flow easily through shale
formations, the reason why, usually, unconventional reservoirs development require more complex
stimulation techniques to be economically produced than is the case with conventional reservoirs (T.A.
Blasingame 2008).

1.2. How Shale Gas is produced?

As noted earlier, shale gas will not easily migrate to any vertical well drilled through it because of the
low permeability of shales. Fortunately, recent advances in technology succeeded to solve this problem
(Jason Baihly, Raphael Altman and al. 2011). Every decision concerning the eventual commercial
development of shale gas requires, ex ante, several years of exploration, collection of data and trials.
The different stages that are linked to the exploration activities require the existence of an entity (e.g.
producing firm) that is ready (financially capable) to offer whatever huge, but necessary funding without
having any guarantee that the project will finally succeed (KPMG Global Energy Institute 2011).

Every entity proceeds to the development of shale gas according to its own methodologies and beliefs
but, in general, the process goes through five different stages of exploration and evaluation before it
comes to the stage of commercial development. Each one of these stages consists in collecting technical
information that, once analyzed and executed, will enable the producing firm to pass to the next stage
of the producing process. Since the majority of unconventional oil-gas plays are seen to be of low
permeability, their production process, once taking place, will require the adoption of specific methods
to increase the surface of the reservoir, in liaison with the well. As already pointed, two methods are
being currently used: (1) horizontal drilling, and (2) (multi-stage) hydraulic fracturing (tracking).

1.2.1. Horizontal Drilling

Firstly, the drilling has to be vertical. The depth of the vertical well is proportional to the depth of the
underground location of the shale formation. The former has to stay above the latter. The issue of -low
permeability gas production- being uneconomic is now offset by drilling horizontal wells, where the drill
bit (cutting tool) is directed from its free fall trajectory to follow a more horizontal path (upon an
increasing curvature) for one to two kilometers (can go to 2.5 km), thereby connecting the wellbore to
as much reservoir as possible (SCGNC 2006; M. Y. Soliman, Johan Daal and al. 2012).

The horizontal drilling enhances the likelihood of the wellbore to intersect with a much great number of
naturally existing fractures in the reservoir. The trajectory of the drill path changes with the changing of
the fracture trends in every zone. The arbitration between drilling horizontally or vertically is enhanced
access to the reservoir (increases the possibility of recovering more gas); however this is surely done at a
way larger cost. Lee (2011) points that drilling is challenging since drilling costs typically comprise half of

15
the cost of the wells and access to the reservoir is improved with horizontal drilling which may access a
longer productive zone within the reservoir than vertical wells, which the author qualifies as cheap.

1.2.2. Hydraulic Fracturing

Hydraulic fracturing techniques commonly known as "tracking" techniques are often used by oil and gas
industries to improve low permeability reservoirs (SCGNC 2006). Fluid (often water, sand, proppants and
chemicals) is pumped down the well until the pressure exceeds the rock strength and forces the
reservoir to crack (induced fractures).

Figure 2: Stages of a shale gas production process. Adapted from (NEB report, 2010).

The tracking fluid injected in the wellbore stimulates and helps to maintain the fractures open, which
are at the risk of closing again once induced pressure is diminished. There are two main factors that may
improve the ability of shale to fracture. The first one is the presence of hard minerals (silica, calcite,
etc.), which have grand capacities to induce large fractures in the underground shale as well as to
maintain the already existing natural fractures open. However, the second one depends on shale's
internal pressure (Holditch S. A. 2006).

Because of the low permeability of shales, much of the gas cannot escape during the process of
generation and builds up an over-pressure inside the rock itself. Therefore, the induced fracture
connections can go deeper into the formation because the shale is already closer to the breaking point
than in normally pressured shales. The Montney and Utica shales are both considered to be over-
pressured (Kim Page and Dave Hammond 2008). Moreover, by creating isolated areas all along the
horizontal section of the well, segments of the borehole can be tracked, one at a time, by using a

16
technique called multi-stage fracturing. Finally, shales can be re-fracked, over and over, years later, after
production has declined, and this, in order to levy, as much as possible, the Recovery Factor5 (RF) of GIP.

This technique allows the well to access more of the reservoir that may have been missed during the
initial hydraulic fracturing or to reopen fractures that may have closed due to the decrease in pressure
as the reservoir is gradually drawn off of water. Even with hydraulic fracturing, wells drilled into low
permeability reservoirs have difficulty communicating far into the formation, therefore, more wells
must be drilled (creating pools) to access as much gas as possible (reducing the gap between the GIP and
the Gas Produced, GP), normally four, but up to ten, horizontal wells per section (one square mile).
Loosely, in conventional reservoirs, the RF of natural gas can reach as much as 85% of the GIP (KPMG
Global Energy Institute 2011). However, in unconventional reservoirs in general and in shale gas
reservoirs in particular, the RF is typically expected to be nothing more than 20% of the GIP because of
its low permeability.

Cost wise, a horizontal well in the Montney shale will approximately cost 5 to 7 million dollars (Dan
Magyar and Colin Jordan 2009). However, in the Horn River Basin, as of 2009, a horizontal well costs up
to 8 million dollars6. Horizontal wells in the Utica Shale are expected to cost 4 to 7 million dollars (Lee
2010). Vertical wells targeting conventional shale gas, like in the Antrim Shale (Michigan, U.S.), are way
cheaper; the resource is shallow, and wells drilled cost less than $250,000 each7.

1.3. Understanding Production Decline Curve Analysis

Production decline curve analysis is one of the most commonly used tools in reservoir and petroleum
engineering for the analysis of production data (Adam Micheal Lewis 2007). Usually production rates
versus time data are matched to a theoretical model. Future production rates, GIP, and the time of
economic limit of a production well can all be predicted based on this history match. It is also possible
that an estimation of future economic profits of those wells can be done using this forecast. This section
of Chapter I provide an explanation of how gas reserves are estimated within the industry and how
PDCA will be useful to us in the fact that it will allow us to determine and to assess the economic
feasibility of producing shale gas.

1.3.1. History of Reserves Estimates Calculation Methods

Gas is accumulated in limited quantities within the earth (Patzek 2008). It was from the basic
understanding of this simple sentence that the earliest attempts to estimate ultimate recovery reserves
began.

The first PDCA plot was drawn by Lombardi in 1915. The decline curve represented the production rate
behavior versus time, of a large oil field reservoir in California. The second early attempt, in what may
concern PDCA, was initiated by Requa, also in 1915, to show the decline percentages for various oil

The ratio of recoverable gas reserves to the GIP in a shale gas reservoir.
6
Maguire V. "The Horn River shale play - Why it works", 4th B.C. Unconventional Gas Conference, April 2010.
'www.marcellusshales.com/shaleplays.html

17
fields in California. Later in the early 20th century, another but more complicated version of the PDCA
methodology was advanced by Lewis and Beal in 1918 (Robert C. Hartman, Pat Lasswell and al. 2008).
They proposed a more advanced method (production rate behavior versus cumulative production rate
versus time) that incorporates the uncertainty relying behind the use of the production decline method,
and this was done by the adoption of a probabilistic estimate that is able to generate a wide range of
potential outcomes rather than to focus on a single result8.

Johnson and Bollens (1927) were the first to advance a method for calculating future production based
on observation. It was from their equation that the form of PDCA used today was born. Arps observed
that when the ratio of production rate over change in production rate was constant, the curve plotted as
a straight line on a semilog paper, and declined exponentially. Out of this observation came out the
most widely used method for estimating gas reserves (Lee 2010):

(11)
qt = qi X exp(--)
Where:
a = exponential decline constant.
q t = is a constant and denotes the initial production rate in year 0.

Equation (1.1) is referred to as exponential growth or decay. Using the Arps methodology, once it is
assumed that a gas well continues to behave today in the same manner as it used to behave yesterday
then, the model can easily be applied to forecast the total production of the well and when represented
on a semilog graph, the exponential model takes the form of a straight line (Arps 1944). However, in
some cases, the Arps plot curvature did not follow a straight line trajectory on a semilog paper, but
instead the decline path changed over time at a constant rate. This is most commonly the case of wells
with hyperbolic nature (where well's production data concaves upward)9 and Arps formulated a new
mathematical equation that fits this particular attitude of some wells:

qt = q i a + bD i t)- 1 ' b (1.2)

Dt = constant and denotes the initial decline rate, 1/time at t = 0.

b = hyperbolic exponent (0 < b < 1).

Later on, in the late 20th century, appeared the Fetkovich methodology which is originally nothing but an
extension of the Arps methodology (Al-Reshedan 2009). Fetkovich (1980) shows that Arps equation
could be related to physics, and thus could have a physical meaning. Fetkovich states that q t denotes the
point at which the well first sees the reservoir boundary rather than the peak point of production (in the
case of Arps). More precisely, qt describes the transition flow10 inside the reservoir and denotes the
point where the boundary dominated flow stage begins to be observed when the pressure inside the
reservoir starts to decline (Fetkovich 1980; Fekete Associates Inc. 2012).

For more details on the early attempts at decline curves, see (Clark, 2011) in "Decline curve analysis in unconventional
resource plays using logistic growth models". University of Texas at Austin, August 2011.
'www.petrobjects.com
10
(Transition)Flow in a reservoir often goes from a transient flow state to a boundary-dominated flow state.

18
To note that, transient decline is only observed in wells with low permeability or during the early life of
well production. By transient decline, we mean when the pressure inside the reservoir is not constant or
steady yet, and the size of the reservoir has no effect on the well performance. On the contrary, when a
boundary dominated flow state occurs, the pressure inside the reservoir declines at a constant rate and
the reservoir acts like a tank, the reason why, in the existing literature, the Arps methodology is
sometimes referred to as a tank type model. The latter denotes the internal energy of gas which is the
primary drive mechanism that moves it towards the surface (free gas).

As gas is produced from the reservoir, the pressure inside the reservoir will tend to decline steeply over
time (loss in reservoir pressure is the main cause behind the steep decline in shale gas production)
(Adam Micheal Lewis 2007; Y. Cho., 0. G. Apaydin and al. 2012). For Fetkovich, the pressure flow n of a
reservoir can be used to determine the hyperbolic exponent b of the Arps methodology and the
mathematical relation can be written as follows:

2n (1.3)
b=
2n + l
Thus, b and n are positively correlated (n -* oo, b -» 1). However, certain production declines will not
yield a unique solution to the Arps equation so, when multiple solutions occur, the knowledge of n is
useful to predict the appropriate b value that most fits the situation:

b n Description of drive mechanisms

Undeterminable NA Any well in transient flow stage

Single phase liquid, high pressure gas, very

0
poor relative gas permeability, etc.

0.3 O-m/l-mCO Typical solution gas drive wells

0.4 < b < 0.5 Typical gas wells
0.5 Water drive in oil reservoirs

For Fetkovich, there are no b values greater than one. This phenomenon will never take place if the Arps
equation is used adequately. Or what happens if b > 1? Is the Arps PDCA method will still be applicable?

1.3.2. PDCA in unconventional reservoirs

PDCA consists on matching past production capacity trends with a model. If it can be assumed that the
future behavior of a reservoir will be the same as its past trends, the model could be used to estimate
GIP and ultimate gas reserves at some future reservoir abandonment pressure or economic production
rate (L. Mattar and R. McNeil 1998). Nowadays, several techniques have been developed to evaluate
wells performances in unconventional formations but unfortunately no single methodology has proven
to be capable of handling all types of data and reservoirs (Fekete associates Inc. 2004).

Early attempts at PDCA required finding plotting techniques or functions that would linearize the
production history of a gas reservoir. Linearization was essential because linear functions are simple to

19
analyze and to manipulate mathematically, so the future production capacity of a well or reservoir could
then be extrapolated. By definition, decline curves are plots that describe the relationship between "gas
production rate" and "time", or between "gas production rate" and "cumulative gas production". In
general, decline curves are often illustrated based on the Arps hyperbolic rate-time decline equation
(1.3). And, depending on the value of the hyperbolic exponent b, equation (1.3) can take three different
forms, and the decline curve will take three different shapes: linear (exponential), when b = 0;
hyperbolic (curved), when 0 < b < 1 and harmonic (tends to be steadier), w h e n i = l . Refer to
appendix (A.l. Decline Curves). To note that the most attractive feature in the Arps equation is that it is
easy to set up, to use and to analyze (Adam Micheal Lewis 2007). However, this methodology has its
failings and as a result, it sometimes provides inaccurate gas production estimates. Concretely, it
overestimates gas reserves contained within low permeability reservoirs. The National Petroleum
Council Report on unconventional gas in 2008 defined shale gas reservoirs as any reservoir with
permeability less than 0.1 millidarcy11 (md). The Barnett and Bakken shales are two examples of shale
reservoirs with an average permeability below 0.1 md (Holditch S. A. 2006).

Why PDCA (Arps) do not fit with unconventional reservoirs? The problem is largely of a mathematic
nature. With b > 1, Arps's method overestimates gas reserves and gas cumulative production becomes
infinite, however, this is simply unreliable because the amount of hydrocarbons in the ground is finite.
Despite its shortcomings, the Arps equation is still largely used within the industry. When used for
economic purposes, gas production is truncated at an uneconomic production rate and the results
forb > 1 are best represented on a semilog plot of gas flow rate versus cumulative production (Figure
3). The existence of b > 1 in unconventional reservoirs is mainly due to the extended transient flow
regime that characterizes low permeability shale formations. However, the inaccuracies that result
when using the Arps hyperbolic decline equation to estimate gas reserves from low permeability
formations (b > 1) were grandly identified and serious efforts have been made to develop new
techniques that replace the Arps methodology and correct its shortcomings.

Among others, we limit our curiosity to just two of the methods that were developed, notably: (1) The
exponential truncation of hyperbolic equations method, and (2) The multiple transient hyperbolic
exponents' method.

Figure 3: DCA, rate versus cumulative gas production. Adapted from (Fekete associates Inc. 2005).

A darcy (d) and millidarcy (md) are units of permeability. They are used in petroleum engineering and geology.
20
1.3.2.1. Exponential truncation of hyperbolic equations

Developed by Maley in 1985 (Satinder Purewal, James G. Ross and al. 2011). This method suggests that
at some point of the production life cycle of a shale gas reservoir, the hyperbolic decline (0 < b < 1) has
to switch to an exponential decline (fa = 0). Maley proposes the use of two separate models to
implement this methodology. The latter has no physical meaning and its only purpose is to prevent the
issues of having explosive solutions in the estimates when using the Arps methodology. Refer to
appendix (A.l. Decline Curves).

Furthermore, from an economic point of view, Maley (1985) points that after 15 or more years of gas
production from a certain shale play or reservoir, the monetary value of gas produced will tend to have
a discounted zero value in today's dollars. The latter is confirmed by the fact that most producing
companies consider the first 10 years of the life cycle of a well to be the most important because the
majority of the EUR will be produced during this period and will, eventually, drive the project economics.

1.3.2.2. Multiple transient hyperbolic exponents

Spivey and al. were the first ones to suggest using multiplefavalues. They showed thatfawill change
over time. During the early stages of production in a tight gas reservoir, the dominant flow regime is a
linear flow. This flow regime correspond to fa = 2. Thus, based on a report launched by Fekete Inc., we
can associatefa= 2 to nothing but an upper limit to the potential volume of gas that can be produced
from a shale play. Typicalfavalues often range between 0.3 and 0.8 bcf (Lisa Dean P. and Eng 2008).

Under a flow regime, afavalue of 2 might occur during the early life of the well (transient flow regime).
This is mainly the case of gas production trends in the Bakken shale12. However, with time,fatends to
decrease, and so when a transition into a boundary dominated flow regime occurs, the flow of
production data will fit with afavalue of 0.25. Thus, the typical extreme lower and upper bounds of fa
values are thought to be 0.25 and 2. Finally, if enough production data, concerning wells that were
previously drilled in a certain area, is available, the multiple transient hyperbolic exponents method
could yield to better and more pragmatic (less arbitrary) results than the exponential truncation
method.

Now that we have explained some of the most important technical concepts that characterize the
processes of estimating and producing shale gas reserves from unconventional formations, we proceed
in our analysis to the assessment of shale plays economics.

u
Wikipedia 2012. Bakken formation, http://en.wikipedia.org/wiki/Bakken_formation (visited: 10 November).

21
Chapter II - The economics of shale gas wells
The understanding of the technical differences that separate the economics of extracting shale
(unconventional) gas deposits from those of extracing conventional gas deposits is essential to the
pursuit of our analysis. Relatively, shale gas plays are characterized by lower finding risk and higher
economic risk (Andrew Potter, Helen Chan and al. 2008). Since the late twenieth century, it is mainly the
U.S. experience in terms of producing shale gas that proved the likelihood of this unconventional
resource, relatively to other conventional sources of energy (coal, nuclear, etc.), to become the
potential game changer for the energy industry worldwide. F igures 4 and 5 show the potential supply
trends of six different, conventional and uncoventional, sources of energy between 2006 and 2030 in
the U.S. as well as the largest source of U.S. natural gas supply between 1990 and 2030, respectively.

■ Other__renewables
■ Hydropower
■ Nuclear
■ Coal
■ Natura l_Gas
■ Liquid_F uei

2006 2010 2015 2020 2025 2030

Figure 4: Energy trends in the U.S. (Deo 2007).

15
•••«•-•Onshore_Conventional J

mmk*mmm»Onshore_Unconventional J ^ ^ ^ ^ ^ ^ ^

10

^^>^C
1 1 ■ 1 1 1

1990 2000 2007 2020 2030

Figure 5: Natural gas production by source, 1990-2030 (U.S.). Adapted from (Gonzalez 2012).

Hence, the vastness of shale formations signifies that there is a little risk associated with finding the
hydrocarbon in place (GIP), however, the likelihood of commercial development is highly dependent on
the decision to drill pilot wells which is commensurate to a commitment to complete the well (William
M. Gray, Troy A. Hoefer and al. 2007).

23
Thus, these wells must be fractured even before the economic viability of the well can be determined.
Moreover, given the fact that shale gas production deplete rapidly and the depletion often takes place
during the early life of the well, a conventional well might produce 30 to 40 bcf of gas over its life
whereas a shale gas well would produce nothing but a fraction of this amount (Larry Lake, John Martin
and al. 2012). Those rapid initial decline rates characteristic of unconventional reservoirs are, at some
extent, decisive of the economic profitability of shale gas production. Therefore, the ability to
understand these variables as well as their respective impacts on the economic feasibility of shale plays
is vital to our, next to come, economic analysis.

When production profiles in major gas regions are examined, what we generally see is a rising output
that peaks after a certain period of time, and then starts to decline to reach finally its economic limit (to
be defined later), even though there may still be a huge amount of the resource remaining in the ground
(Banks 2008). As showing in figure 6, after the decline phase, the play reaches its economic limit. At this
stage, no further production, nor economic or financial returns can still be expected. The reservoir (play)
is said to be out of pressure and no more gas can further be economically produced (Fekete associates
Inc. 2005).

Q(t)
à
Decline

Build-Up / I Economiclimit
\ / 1
/ Plateau
> Time
! 1 "
1 / Ts. Clean-up

i additional investment

'
Costs
Figure 6: Shale Gas Production Economics (Banks 2008)

Kaiser (2010) defines the economic limit of a reservoir as the time when the net revenue (gross revenue
net of royalty) of the field is equal to the field production cost (including taxes, operating and
transportation costs). To further extend the plateau, it may have a positive effect on the amount of gas
that can still be recovered, however, on the basis of reserves that have been recovered in a particular
deposit or field, it is uneconomical to attempt to prolonge the plateau indefinitely (Banks 2008).

Commonly, the biggest challenge in a shale gas investment is the capacity of operators to determine the
EUR of a shale reservoir. Since decline analysis is relatively simple, it was and will be adopted. Decline
curve analysis and EUR predictions are found in the public domain. Also, our analysis will be limited to
wells with publicly available data and will not include production improvements from workovers nor
recompletions or re-fracks.

24
The first section of chapter II describes and explains the model, the methodology, and the model
economic parameters. The second section presents a comparative assessment of the economic
profitability of producing shale gas from five different shale plays (Barnett, Haynesville, Marcellus,
Montney, and Utica). Finally, the third section of our chapter introduces a logistic model that computes
various wells deployment scenarios within the industry in the Utica shale. Finally, conclusions and
recommendations will be advanced based on the results found.

2.1. Model, Methodology. Variables

Our study is conducted through decline curve analysis and breakeven economics. More precisely, the
profitability of shale gas production will be examined through cash flow sensitivity analysis. The main
purpose of evaluating the economics of shale gas projects is to calculate financial revenues that derive
from the production and the commercialization of shale gas under multiple development scenarios of
the industry. The same methodology is used by Lin (2010), Kaiser (2012), and Larry Lake, John Martin
and al. (2012).

2.1.1. Cash flow analysis

The importance of applying a cash flow analysis when assessing the economic feasibility of producing
shale gas is that it allows us to simulate and to test the impact of technical and financial inputs (to be
mentioned throughout the analysis) characteristics of shale gas economics on the anticipated financial
returns of the project.

Kaiser (2012) and Lake and al. (2012) point that the economic profitability of shale gas investments
should be tested by computing the total stream of after-tax net cash flows generated by the project. The
after-tax net cash flow is the difference between the estimated financial profits and the estimated
financial charges of the project over t periods, denoting the life span of the project. In our project, we
suppose that t = 20 years. Mathematically, the latter can be written as follows:

NCFt = TNRt - R0Yt + CAP_EXt + 0P_EXt + Inc_Tax t (1.4)

Where:

NCFt denotes the after-tax net cash flow of the project (can be positive or negative), in year t, TNRt
denotes Total Nominal Revenues in year t, ROYt denotes Royalties paid in year t, CAP_EXt denotes
Capital Expenditures paid in year t, 0P_EXt denotes Operating Expenditures paid in year t, and finally,
Inc_Taxt denotes the corporate income tax rate paid in year t.

2.1.1.1. Explaining the model variables

When assessing the economic profitability of an investment project, a cash flow analysis consists on
computing the total stream of potential financial outcomes that could potentially be generated once the
project is brought on-line. The same logic applies to the assessment of the economics of shale gas
production.

25
Total Nominal Revenues in year t, TNRt denotes the potential financial profits that derive from the
launching of a shale gas project. The latter will be equal to the natural gas price p paid in year r
multiplied by the volume of gas produced q t during the same year.

TNRt = p x q t (15)

To note that q t is estimated using Arps hyperbolic equation (1.2). Thus, if we replace q t by its value in
equation (1.5), we obtain:

TNRt = V X Qi X (1 + bDit)~b (1.6)

Where p and q t are two constants denoting natural gas price and initial production rate, respectively
and (1 + bD t t) * is a function of time that we represent a s / ( t ) . As a result, equation (1.6) can be
rewritten as:

TNRt = p x q ( x f t = y x / ( t ) (1.7)

Equation (1.7) shows that if p increases by two points (all other variables held constant), so will do
TNRt. Any variation of y implies that TNRt and q t will vary proportionally (linearly) over time. The value
of y will depend upon two factors: (1) the economic environment under which firms choose to operate
and (2) the geologic properties of shale plays. To mention that we compute p using the publically
available Henry Hub13 average prices forecasts. These forecasts show that average natural gas prices will
range between 2 and 8 dollars per mcf between 1990 and 2030.

As for Royalties R0Yt. It represents a prospective cost to producing companies, generally a variable
fraction 9 or financial charge to be paid to the government or to the land owner, per unit of production.
Mathematically, ROYt can be written as:

ROYt = d x q t (1.8)

Royalties can be found in the public domain and differ from a country (region) to another. Royalties in
the U.S. and Canada vary between 15 and 35% relatively to the amount of gas produced and sold
(Andrew Potter, Helen Chan and al. 2008). In Quebec (in the case of the Utica shale), the yearly fraction
of royalties that is to be paid to the government is largely dependent on annual volumes of gas
produced and prevailing natural gas prices. Quebec's new royalty regime defines a range of 5-35% for
royalty rates.

The larger the volume of gas produced (the higher the price of gas), the bigger the fraction of royalties
that will be paid and vice versa (Ministères des Finances 2011). Royalty rates specific to every shale play
will be defined later.

13
The Henry hub is a distribution hub on the natural gas pipeline system in Erath, Louisiana, owned by Sabine Pipe Line
LLC. The pricing is based on natural gas futures contracts traded on the New York Mercantile Exchange (NYMEX). Réf.:
Wikipedia.com.

26
Lake and al. (2012) points that in a shale gas project, drilling forms 60% of the total costs of producing
shale gas and completion forms the remainder 40%. Kaiser (2012) states that capital expenditures
consist of land acquisition, drilling and completion costs, pipeline infrastructure, etc. Kaiser (2012) also
mentions that those costs are the main costs in a shale gas production project. Hence, in our project,
capital expenditures, CAP_EXt will only consist of drilling and completion costs. In the analysis, we
suppose that CAP_EXt is a fixed cost or an initial investment cost that will be paid once at the launch of
the project (t = 0, CAP_EXt = CAPJEX). Capital expenditures specific to every shale play will be
specified later.

Operating expenditures or more precisely Lease Operating Expenditures (LOE) are defined as being the
costs that are associated with work physically performed at the work site (Kaiser 2012). In our project,
for simplicity purposes, we do not distinguish between the production of dry(cheaper)-wet(more
expensive) gas and we consider OP_EXt as being a yearly (variable) cost, per unit of production. Finally,
the corporate income tax rate or simply the Income tax rate Inc_Taxt is a yearly amount of money (a
fraction <p of NCFt) that is paid to the government once the production process of the resource has
started. Mathematically, Inc_Taxt is computed as follows:

Inc_Tax t = <pNCFt (1.9)

In our project, we suppose an average taxation rate of 25% (Utica and Montney) (Lin 2010) and a range
of 30-50% (U.S. plays) (Kaiser 2012). In our analysis, we intentionally ignore some other types of costs,
such as: intangible costs, allowances, depletions costs, and we assume that those costs are directly
included in the initial investment cost (CAP_EX) the reason why capital expenditures specific to every
shale play will be partially majorated in order to include those costs.

2.1.2. Sensitivity analysis

In most cases, in addition to the cash flow analysis, a sensitivity analysis of the project economics is
necessary to examine how the uncertainty in the model output can be allocated to various sources of
uncertainty in the model input (and vice versa). In our model, we define a base case development
scenario (average scenario, P50) for every shale play from which we launch our sensitivity analysis by
introducing an expected range for every shale gas input parameter. Thus, the average scenario (in terms
of production performance) will, at a certain extent, form the median of the expected range defined.
We also introduce two extreme case scenarios, an optimistic one (high development scenario, P10) and
a pessimistic one (low development scenario, P90), for every shale play, which are certainly less likely to
happen. In our study, we only use this nomenclature to categorize and represent well's production
performances in terms of IP rate, Di rate and EUR.

More precisely, we define a set of P10, P50, and P90 scenarios for every shale play tested in our model
to represent wells with the best, average, and worst production performances, respectively.

This measure will allow us to define an upper and a lower bound for the calculated Net Present Value
(NPV) in every case (see, decision making indicators), allowing us eventually to compare the breakeven
economics of every shale play tested in our model.

27
To note that the sensitivity analysis will be applied to all three types of wells in every shale play. P10
profiles (wells) will obviously lead the most favorable economics and P90 the least favorable and the
results differential found will enable us to define profitability windows specific to every shale play. The
input ranges defined will vary from a shale play to another. Larger expected parameters ranges (inputs)
will be associated to larger amounts of uncertainty in the results (outputs) found.

Finally, the sensitivity analysis allows us to test the robustness of the results obtained in the cash flow
analysis. The sensitivity analysis input parameter combinations used are mainly three: (1) Gas Price and
IP rate (2) Gas Price and CAP_EX, and (3) Gas Price and CAP_EX to test the impact of -First Year Gas Price
(FYGP)- on P50 NPV project economics. The rest of the input parameters will be considered as static
over time. The outputs found in every case will be represented in Matrix-Tables and will be stated in
terms of NPV ($million), IRR (%), and Payout Period (years).

2.1.3. Decision making parameters

The economic indicators that will serve as decision making tools are three: (1) the NPV, (2) the IRR, and
(3) the payout period (or the economic limit of every shale play).

2.1.3.1. Net Present Value

The NPV is the after-tax net stream of discounted cash flows (DCFt) generated by the project. It uses
the time value of money to evaluate long term projects. It computes the excess or shortfall of cash
flows, in present value terms, once financial charges are met. Thus, it can serve as an investment
decision making tool. Generally, the investment options of a prudent company are three: Growth (Go),
Shutdown (No-Go) or temporary abandonment (conditional), respectively if the NPV is positive,
negative, or nil. Mathematically, the NPV can be represented as:

NPV = DCFt (1.10)

t=o

n
n NCFt I1-11)
DCF
>Lrt t==
t=0
t=o 1+r •

And so, from equations (1.4), (1.10), and (1.11), we can write:
n
1
NPV = -CAP EX + [TNRt ~ (ROYt + 0P_EXt + Inc_Taxt)] x (1.12)
t=o

After rearranging equation (1.12) and replacing every variable by its expression, the mathematical
formula for the NPV can finally be represented as follows:

p - (c + 9 qt ) X qt .
NPV = (1 - <p) -^ - - CAP_EX (1.13)
v(l + rY
t=o

28
Where:

NPV denotes the after-tax net present value, (1 - <p) denotes the Inc_Taxt rate to be paid in year t as a
fraction of the before-tax NPV generated in the same year; the latter is equal to the term showing in the
second parenthesis (...) on the right side of the equation, denotes the discount factor (r denotes
the interest rate), p - c + 9q t x q t denotes the marginal profit of producing (X + 1) mcf of shale gas,
and c + 9q t computes all the variable costs (including operational costs, royalties, etc. as a function of
qt) that the shale gas production process may imply.

Moreover, our analysis supposes one additional assumption stating that income taxes will only be paid if
V is positive. V denotes the before-tax NPV. This assumption implies that the after-tax NPV will
potentially have two values depending on whether V is positive or strictly negative:

1-cpV if V>0
NPV = and (1.14)
V if V< 0

By developing and simplifying some of our model formulas, we made the correlational relationship
between our model input (Gas Price, IP rate and CAP_EX) and output parameters (NPV) clearer to see.
To note that the results of our NPV sensitivity analysis are all calculated based on both equations (1.13)
and (1.14).

2.1.3.2. Internal Rate of Return (IRR)

The IRR is often used in capital budgeting and can be defined as the discount rate for which the
NPV = 0. Mathematically, the IRR is the annualised effective discount rate required for the NPV of a
stream of cash flows to equal zero therefore, equation (1.11) can be rewritten as follow:

n
NCFt
NPV (1 15)
= TT7^T = 0
-
t=o
Knowing that the IRR is not affected by the CoC (Cost of Capital) and the CoC is a benchmark against
which the IRR can be evaluated, comparing XhelRRto the CoC should only be made when making
investment decisions. The calculated IRR denotes the maximal acceptable value of CoC for the project's
NPV to be profitable. If the IRR > CoC the project is said to be profitable NPV > 0 . However, if the
IRR < CoC NPV < 0 , the project should not be undertaken. So, whilst a higher CoC has zero impact on
the IRR, investment decisions will be rarely seen as profitable when using the IRR as an indicator of
assessing those investment decisions.ln our project, for simplify reasons, we suppose that a single firm
(Y) is exploiting all shale plays subject of our study and we assume that its CoC is about 10% (relatively
to its debts and equities)14.

4
Brealey R., Myers S. & Marcus A., Fundamentals of Corporate Finance, 3rd Edition, McGraw-Hill, 2001.

29
In conclusion, investment decisions based on the calculated IRR will depend upon the cost of capital
and the corporate objective of the firm as well as on its financial situation (financial exposure, solvability
& debt to equity ratios, etc.).

2.1.3.3. Payout Period

On an after-tax basis, payback period is simply the time T required by the producing company to recover
all the prepaid financial charges that are associated with the project, mainly royalties and drilling and
completion costs (Kaiser 2010). However T is uncertain and varies based on market and economic
conditions. Thus, it's positively correlated with increases in gas prices and production levels, and vice
versa. So, while taking into account market and economic conditions, payback or payout periods denote
the earliest time required m for the cumulative cash flow to recover well costs.

Mathematically, the payout formula can be written as follows:

m
T years = DCF t =0 (1.16)
t=o

where DCFt denotes the vector of net cash flows in year t t = 1, ...,20 years.

2.2. Shale plays and model assumptions

In this part of chapter II, a brief description of every shale play subject of our study will be proposed. We
also define shale plays model input parameters and their expected ranges. Our choice of the inputs and
their expected ranges will be justified throughout the analysis. The expected performances of every
shale play are summarized in Tables 1 (a, b, c, d, and e). The latter are collected from the public domain
and from various other academic sources.15

Tables 2 (a, b, c, d, and e) summarize the input parameters of shale plays and their expected ranges. To
add that our analyis is simply built on a after-tax basis and doesn't assess the impact of income taxes on
the economic feasibility of shale plays and its only aim is to assess the economic feasibility of producing
shale gas from various shale plays under multiple development scenarios.

15
Engelder 2007; Andrew Potter, Helen Chan and al. 2008; Dan Magyar and Colin Jordan 2009; Jeff Ventura, Aubrey k.
McClendon and al. 2009; Bailey 2010; Lin 2010; Kaiser 2012; Larry Lake, John Martin and al. 2012; Mason 2012.

30
2.2.1. Barnett

The Barnett shale is a geological shale formation located in the Forth Worth Basin, Texas, U.S. The
formation is known as a tight gas reservoir indicating that the gas is buried almost 7000 feet deep and
cannot be easily extracted. Its estimated geographical extent is about 5000 square miles. The first
attempts of producing shale gas from the Barnett formation date from 1981. However, the effective
production of shale gas took place in 1999. This particular shale formation has been considered to have
significant underground gas reserves with almost 44 tcf of TRR and 327 tcf of GIP (Gonzalez P. and al.
2012). Tables l.a and 2.a present the expected performances for Barnett wells and its shale gas model
parameters and their expected ranges, respectively.

Barnett (Texas, U.S)

Table l.a Wells production performance
Variable Code Unit P90 P50 P10
Initial production rate IPjrate Mmcf/d 2 3.5 5
Initial Decline rate ID_rate % per year 72 72 72
Estimated Ultimate Recovery EUR bcf per year 1.5 2 2.5
Table 2.a Development scenarios
Low Average High
Capital expenditures CAP_EX $million 4.5 3.5 2.5
Operational expenditures OP_EX $/mcf 1.5 1.25 1
Royalty rate Disc_rate %peryear 25 25 25
Gas price GP $/mcf 2 5 8
Discount rate Disc_rate % per year 10 10 10
Corporate tax rate IncJTax % per year 30 30 30

In Table l.a, we define a set of initial production rates for Barnett wells based on three production
performance scenarios. We assume that P10 wells will have an IP rate of 5 Mmcf/day, P50 wells will
have a 3.5 Mmcf/day IP rate, and finally P90 wells will have an IP rate of 2 Mmcf/day. Our set of IP rates
is somehow justified by the fact that a typical Barnett well will have an IP rate of approximately 3.5
Mmcf/day (Jeff Ventura, Aubrey k. McCiendon and al. 2009).

And so, P10 and P90 wells are basically set by defining a standard deviation of about +1.5 relatively to
P50 wells (median). The first year decline rate for Barnett wells is assumed to be the same for all well
performances and is set to 72%. The latter is merely higher than the decline rate used in Bailey (2010)
(66%) and merely lower than the one used by Ventura (2009) (73%). Decline rates for the rest of the
years are calculated using Arps equations. We also set a conservative range of EUR for every production
scenario.

31
Often, typical Barnett wells have an EUR of 2.5 bcf per year (Jeff Ventura, Aubrey k. McClendon and al.
2009). However, in our project we suppose that P10 wells will have an EUR of 2.5 bcf/year and P50 and
P90 wells will have 2 and 1.5 bcf/year of EUR, respectively. In Table 2.a we set a range for every input
parameter that characterizes the potential development scenario of the industry. We suppose that
CAP_EX will range between [2.5, 4.5] in million of dollars (2.5 is the minimum value that CAP_EX can
take and 4.5 is its maximum possible value).

The average CAPJEX scenario (3.5 million$) is set only to be used in the Gas Price,IP rate sensitivity
analysis. CAP_EX is assumed to be the lowest under the high development scenario (P10) because it is
representative of the long run supply curve (growth) of the industry as a whole under which production
average costs will tend to decrease over time (know-how, advances in technology, economies of scale,
etc.) as long as the general level of gas produced and the marginal productivity of capital are increased.
This assumption is mainly representative of both external economies16 (positive externalities) and
economies of scale (cost advantages) long run concepts in the economic theory where factors of
production (capital, technology) will increasingly be incorporated into the production process leading to
higher production levels and eventually to lesser costs per unit produced. This particular assumption
applies to all shale plays subject of our study. To note that in our project CAP_EX scenarios are
majorated to include some other costs such as: intangible costs, depreciation, etc. Ventura (2009) points
that capital expenditures for typical Barnett wells are about 2.3 million$ (horizontal wells only). We also
define a range of operating expenditures for the Barnett play of [1,1.5] dollar per mcf of gas produced.

A similar range of 0P_EXt for the Barnett play can be found in (Bailey 2010), (Andrew Potter, Helen
Chan and al. 2008) and (Jeff Ventura, Aubrey k. McClendon and al. 2009). We also assume that the
royalty rate for the Barnett play is 25% on an annual basis17. Finally, the tax on income was found in the
public domain and was somehow randomly set. For the Barnett play, we assume that the Inc_Taxt is
about 30% per year.

16
Bourguinat Henri. Economies et déséconomies externes. In: Revue économique. Volume 15, n"4. 1964. pp. 503-532.
http://www.persee.fr/web/revues/home/prescript/article/reco_0035-2764_1964_num_15_4_407615.
17
http://blumtexas.tripod.com/barnettshalegas.html

32
2.2.2. Marcellus

The Marcellus formation is a sedimentary formation located in North Eastern America. It extensively
passes throughout the northern Appalachian basin and runs across the states of New York,
Pennsylvania, Virginia, Ohio, and Maryland. Its estimated geographical extent is 95000 square meters.
Typical Marcellus shale wells have initial production rates of about 4 Mmcf/day and EUR of 4.4 bcf. The
estimated TRR in this particular shale formation is 280 tcf and the GIP is estimated to be of about 1500
tcf (Engelder 2007; Jeff Ventura, Aubrey k. McClendon and al. 2009; Gonzalez P. and al. 2012).

Before 2000, when the drilling started in the Marcellus formation, few experts thought that the
Marcellus shale would become a major source of natural gas. At first, wells drilled through it using
natural fractures systems produced gas in low quantities. Later on, with advances in technology,
Marcellus wells became economically productive and the Marcellus formation is now considered as the
giant gas field that will offset the future energy security concerns of the United States. Tables l.b and
2.b below present the expected performances for Marcellus wells and shale gas model parameters and
their expected ranges, respectively.

Marcellus (U.S)
Table l.b Wells production performance
Variable Code Unit P90 P50 P10
Initial production rate \P_rate Mmcf/d 3 4 5
Initial Decline rate IDjrate % per year 70 70 70
Estimated Ultimate Recovery EUR bcfperyear 3.5 4 4.5
Table 2.b Development scenarios
Low Average High
Capital expenditures CAPJEX $million 5.5 4 2.5
Operational expenditures OPJEX $/mcf 1.1 1 0.9
Royalty rate Disc_rate % per year 15 15 15
Gas price GP $/mcf 2 5 8
Discount rate Disc_rate % per year 10 10 10
Corporate tax rate IncJTax % per year 30 30 30

In Table l.b, we define a set of initial production rates for Marcellus wells based on three production
performance scenarios. We suppose an IP rate of 5 Mmcf/day for wells with highest production
performances, an IP rate of 4 Mmcf/day for wells with average production performances, and an IP rate
of 3 Mmcf/day for wells with lower production performances. The set of IP rates and EUR that are
associated to it can be found in Engelder (2007), Potter (2008) and Ventura (2009). We also assume that
the ID rate of typical Marcellus wells is 70% (Potter 2008). The latter applies to all development
scenarios.

35
In Table 2.b, we set a range for every input parameter that characterizes the potential development
scenario of the industry. We suppose that CAP_EX will range between [2.5, 5.5] million dollars. Potter
(2008) and Ventura (2009) assume that the average cost of drilling a single well in appalachia is almost 4
million$. Thus, in our project, we associate a 4 million$ CAP_EX to the average development scenario
of the industry and we set a standard deviation of+1.5 relateviley to the average scenario in oder to
define CAP_EX for high and low development scenarios, which are 2.5 and 5.5 million$, respectively.
Relatively to the case of the Barnett shale, we set lower operating costs for the Marcellus that range
between 0.9 and 1.1 $/mcf. Ventura (2009) sets operating costs in the Marcellus shale to 0.95$/mcf.
Generally, royalty rates are lower in appalachia relatively to other US shale plays. The majority of
Marcellus lands are freehold, with legislated royalties of 12.5 to 15% (Potter, 2008; Ventura, 2009). In
our project we adopt the upper bound royalty rate which is 15%. Finally, for simplicity reasons, we
assume that the tax rate on income is the same as it is the case for the Barnett shale (30% per year).

36
2.2.3. Haynesville

The Haynesville formation is a sedimentary formation that underlies thet states of Arkansas, Louisiana
and Texas from the south west to the northwest side of the United states. Its estimated geographical
extent is almost 9000 square miles. It contains 60 tcf of TRR. It came to scene and knew its boom in
2008. Since that date the Haynesville is seen as a major potential shale gas resource. Recently, some
experts have estimated that the Haynesville underground recoverable gas reserves are of the order of
250 tcf, and if true, the Haynesville would be considered as one of the largest natural gas fields in North
America (Gonzalez P. and al. 2012).

Tables l.c and 2.c showing below present the expected well performances for Haynesville wells and
shale gas model parameters and their expected ranges, respectively. Since 2008, the economics of the
Haynesville shale was extensively analyzed by several authors with or without economic and/or
academic affiliations, such as: Potter (2008), Kaiser (2010), Williams (2008), Kaiser (2012), and Lake and
al. (2012). In our project, the majority of Haynesville shale play model input parameters are found in
Kaiser (2012) and Lake and al. (2012).

Haynesville (U.S)
Table l.c Wells production performance
Variable Code Unit P90 P50 P10
Initial production rate IPjrate Mmcf/d 8 11 14
Initial Decline rate IDjrate % per year 85 85 85
Estimated Ultimate Recovery EUR bcfper year 4.5 5.5 7
Table 2.c Development scenarios
Low Average High
Capital expenditures CAPJX $million 10 8.5 6
Operational expenditures OPJ.X $/mcf 2 1.5 1
Royalty rate Discjrate % per year 25 25 25
Gas price GP S/mcf 2 5 8
Discount rate Discjrate % per year 10 10 10
Corporate tax rate IncJTax % per year 45 45 AS

We suppose that Haynesville P10, P50, and P90 wells have IP rates of 14 Mmcf/day, 11 Mmcf/day, and 8
Mmcf/day, respectively. Almost the same set of IP rates range can be found in Kaiser (2012), however,
our assumptions can be seen as relatively less optimistic. The same logic applies to the set of EUR that
we propose. Ventura (2009) supposes that the initial decline rate for Haynesville wells is 82%. As
showing in Table l.c, we assume a merely higher ID rate of 85% for all types of wells.

In Table 2.c, we assume that capital expenditures for Haynesville wells range between 6 and 10 million
dollars. Kaiser (2012) points that capital expenditures for Haynesville wells range between 5 and 15

37
million dollars. The latter is justified by the fact that we assume a lower IP rate (14 Mmcf/d) for
Haynesville P10 wells than it's the case in Kaiser (2012) where P10 wells have a 16.1 Mmcf/d IP rate. For
operating expenditures, the same logic applies as it's the case for CAP_EX, however, we only set a
narrower range for OP_EXt and we assume that those costs will vary between 1 and 2 mcf/$.

We also assume a single, unchanging royalty rate of 25% for all Haynesville wells (Potter 2008; Ventura
2009; Kaiser 2012; Lake and al. 2012). Finally, we suppose a relatively high corporate tax rate of 45% per
year in the Louisiana region. The latter was set randomly from the range of corporate tax rates [35-50%]
found in Kaiser (2012) and could potentially affect or constraint the calculated Hayneville play NPV
project economics which should be understood.

38
2.2.4. Montney

The Montney formation is a 20,000 square feet natural gas field located in British Columbia, Canada, and
extends into Alberta (Gonzalez P. and al. 2012). Natural gas can be found in large quantities trapped in
this shale play. Hence, the Montney shale play is seen to be according to a report by investment advisor
Raymond James Ltd, "one of the largest economically viable shale gas deposits in North-America".
Moreover, according to the estimates of Halliburton, the Montney shale play probably contains 50 tcf of
GIP. Thus, since the early 2000', a lot of producing companies like Talisman, Encana, Enersight and
others showed huge interest in having land leases to start exploring and drilling for shale gas in this
particular area.

Tables l.d and 2.d below present the expected well performances for Montney wells and shale gas
model parameters and their expected ranges, respectively.

Montney (BC, Canada)

Table l.d Wells production performance
Variable Code Unit P90 P50 P10
Initial production rate IPjrate Mmcf/d 3 4.5 6
Initial Decline rate IDjate % per year 70 70 70
Estimated Ultimate Recovery EUR bcf per year 3 4.5 6
Table 2.d Development scenarios
Low Average High
Capital expenditures CAPJEX $million 9 7.5 5
Operational expenditures OPJEX $/mcf 2 1.5 1.5
Royalty rate Discjate % per year 23-35% 23-35% 23-35%
Gas price GP $/mcf 2 5 8
Discount rate Discjrate % per year 10 10 10
Corporate tax rate lnc_Tax % per year 25 25 25

The ranges of IP rates and EUR that are associated with Montney P10, P50, and P90 wells was somehow
arbitraty set and so, the results found should be understood. A 6 Mmcf/day IP rate that is associated to
Montney P10 wells was taken from a best-fit production decline curve of Montney wells production
performances presented during the Unconventional Gas Confernce, CSUG, 2009. Thus, IP rates and EUR
showing in Table l.d are not perfectly accurate and Montney wells could potentially register higher
initial production rates (and eventually have higher EUR) than those performances adopted in our
project. Moreover, all the other input parameters showing in both Tables l.d and 2.d was taken from a
conference article of Enersight and BOE solutions presented during the same unconventional gas
conference in 2009 (Dan Magyar and Colin Jordan 2009).

39
According to Enersight, drilling a well in the Montney play costs 5.8 million dollars, and so based on this
fact, we have set a range of CAPJEX scenarios between 5 and 9 million dollars for high and low
development scenarios, respectively. As already affirmed, CAPJEX are majorated for the only purpose
of incorporating some other types of unaccounted costs. The same logic applies to OP_EXt. According to
Enersight, those costs are strictly superior to l$/mcf simplifying our choice of setting a range of
operating expenditures. In our project, we assume that OP_EXt range between 1.5 and 2$/mcf.

For simplicity reasons, we assume that Montne/s natural gas is priced based on the Henry Hub, NYMEX
forecasts and not the AECO (Alberta Gas Trading Price). Magyar and Jordan (2009) points that the fiscal
model (in terms of royalty and tax regime) in Alberta range between 5 and 50% (an average royalty rate
of 22.5%). Thus, all along our analysis, we compute the economics of the Montney play while supposing
an average fixed royalty rate of 23% (-22.5%) under all development scenarios. Finally, our choice of
corporate income tax (federal tax) was at certain degree arbitrary given that the fiscal system differs
between British Columbia and Alberta, so we had to choose among 2 different federal tax rates. We
offset this problem by setting a somehow average tax rate of 25%18. Once again, the assumptions made
in the case of the Montney shale are somehow hazardous, especially those assumptions in terms of
federal taxes and royalty rates, and the results found should be understood.

"Magyar, D. and Jordan, C, 2009. "Exploring the economics of a Montney Shale Gas Development on Both sides of the
border - BC versus Alberta", Unconventional Gas Conference, CSUG, Well Spring.

40
2.2.5. Utica

The Utica shale basin is a sedimentary rock basin also known as "the Saint-Lawrence sedimentary basin"
located in Quebec, Canada. Since 2006, this particular shale formation started to gain real momentum
and to reveal some positive signs concerning its capacities to produce shale gas, economically. The latter
is estimated to have a geographical extent of about 2344 square miles and a GIP capacity of 25-160 bcf
per section (Lin 2010). Nowadays, the Utica shale is still in its early stages of development and its real
production capacities are still largely unknown. Tables l.e and 2.e below present the expected well
performance for Utica wells and shale gas model parameters and their expected ranges, respectively.

We assume a 6 Mmcf/day and a 2 Mmcf/day IP rates for Utica P10 and P90 wells, respectively. The
latter data computes the exact IP rates registered by St-Edward and Gentilly wells drilled in the Utica
formation, respectively. EUR ranges and initial decline rates can be found in (Lin 2010). Lin (2010) point
that capital expenditures (drilling and completion costs) in the Utica play are most likely to vary between
5 and 7 million dollars and operating expenditures will often range between 1 and 2$ per mcf.

Utica (Québec, Canada)

Table l.e Wells production performance
Variable Code Unit P90 P50 P10
Initial production rate IPjrate Mmcf/d
Initial Decline rate IDjrate %peryear
Estimated Ultimate Recovery EUR bcfperyear

Table 2.e Development scenarios

Low Average High
Capital expenditures CAPJX $million 7.5 6 5
Operational expenditures OPJEX $/mcf 2 1.5 1
Royalty rate Royjrate % per year 5-35% 5-35% 5-35%
Gas price GP $/mcf 2 5 8
Discount rate Discjrate % per year 10 10 10
Corporate tax rate lnc_Tax % peryear 25 25 25

Thus, we assume that CAP_EX vary between 5 and 7.5 million dollars which is logical and we adopt the
same range for OP_EXt as it is assume in Lin (2010). In our project, we use in our calculation Quebec's
new royalty regime. Previously royalty rates in Quebec varied between 10 and 12.5%. Presently,
according to the Ministères des Finances, royalty rates range between 5 and 35% depending on the
volume of gas produced and on prevailing natural gas prices19. Finally, the corporate tax rate is set

Quebec's new royalty regime will enter into force once the strategic environmental assessment {ÉES) that was
recommended by the BAPE has been completed and the legal and regulatory framework adapted to its conclusions.

41
randomly. We suppose that 25% is the yearly monetary fraction of gas produced and commercialized
that will go to the government.

Liu (2008) points that the combined federal and provincial income tax rate in Quebec amounts to 30.9%,
however, tax credits can eventually range between 20 and 40%. The latter shows that the fiscal regime
in Quebec is relatively more attractive when compared to other fiscal regimes in the U.S. and the rest of
Canada. The following part of our second chapter demonstrates and discusses the economic results of
our cash flow sensitivity analysis.

2.3. Economic discussion

Refer to Appendix (A.3. Results - Sensitivity Analysis). Technically, shale gas wells with high IP rates have
greater potentials to produce natural gas relatively to shale gas wells with lower initial production rates
(Jeff Ventura, Aubrey k. McClendon and al. 2009). Thus, based on our prefixed assumptions, Haynesville
wells will probably produce much more gas than it is the case for Marcellus wells, for example, and will
eventually register better economic performances. Nevertheless, higher initial decline rates mean that
the majority of cumulative gas production will come early in the life of the formation. Thus, the first 2
years of the life span of a gas well will be largely decisive of its economic feasibility. This is also mainly
the case of Haynesville wells.

The latter show the highest initial decline rates (85%) among other U.S. and Canadian shale plays.
However, this is not the case for Marcellus wells (and at a certain degree for Barnett wells), where,
whilst the production declines at a 70% rate after the first year, the latter will be associated to nothing
but to 7% of the total amount of gas that could be recovered.

Thus, longer reserve recoveries or lower recovery rates will largely impact the overall economics of the
play. In the case of Marcellus wells, much more time will be required to depict and evaluate the
production life cycle as well as the economic potential of the formation and this is mainly caused by the
existence of low recovery rates (Jeff Ventura, Aubrey k. McClendon and al. 2009). At this point, we
proceed by checking whether or not the results of our economic analysis will eventually come in
conformity with the above explanation of technical input parameters or else will show that the latter
characteristic of shale plays economics aren't the only basis that delineate the economic profitability of
gas wells. The first Gas Price, IP rate sensitivity analysis table studies the impact of various market
and production scenarios on NPV economics of shale plays average development profiles.

Table 3 (silver line) shows that at an average development profile (in terms of costs), Marcellus and
Utica wells will have the lowest breakeven price (3$/mcf) followed by Barnett, Montney, and Haynesville
wells, respectively. The viability of these results will depend upon the assumptions made at the launch
of the analysis. However, a study conducted by Deutsche Bank in 2010, assessing the economics of five
different shale plays (Marcellus, Hayneville, Barnett, Fayetteville and Woodford), shows somehow a
similar result where Marcellus wells are estimated to have the lowest breakeven price (3.17$ per mcf)
when compared to other shale plays.

42
In a low economic environment where natural gas prices range between 2 and 4$/mcf, Montney and
Haynesville wells fail to breakeven on a half-cycle basis. The rest of the plays succeed to breakeven but
the registered NPV economics will relatively be low, and at a maximum wells performance scenario, only
Barnett and Marcellus wells succeed to register IRR that exceed the pre-fixed 10% cost of capital of the
producing company. More precisely, the IRR will be greater for the Marcellus than for other U.S. shales
and this will most probably derive from the existence of premium natural gas pricing due to location and
relatively low royalties in Appalachia. The same conclusion can be found in the Deutsche Bank report in
2010 and in Ventura (2009). The second Gas Price, CAP_EX sensitivity analysis assesses three wells
production performance profiles (P10, P50, and P90) NPV economics of shale plays under various
economic environments. Results found are summarized in Table 3 (blue line).

In a low economic environment, 2 $/mcf gas price, no value is created under most CAP_EX scenarios for
all shale plays except for Marcellus P10 wells that could be brought in for less than 3 million dollars. For
P50 wells, profitability windows shrink and all shale plays fail to breakeven at a 2$/mcf gas price. At a
gas price of 4$/mcf, zero value is created for most shale plays except for Marcellus and Barnett P50
wells that can be brought in for less than 3.5 and 4.4 million dollars, respectively. However, at a gas
price of 6$/mcf, and under average CAPJ2X scenarios, almost all shale plays P50 wells succeed to
breakeven and to create value. Thus, a 6$/mcf represents a favorable economic environment and as
long as producing companies can maintain its drilling and completion costs at an average rate all shale
plays P50 wells will be marginally profitable.

Table 3: Shale plays breakeven prices ($ per mcf), under various input-parameters combinations:

Sensitivity_Analysis_Results:

*AII the results (breakeven prices) computed in this table are rounded.
The combinations of Shale_plays:
input_para meters tested: Marcellus Barnett Haynesville Montney Utica
(Gas Price, IP rate ):
3* 4* 6* 5* 3*
-under average cost scenario-

(Gas Price, CAP_EX):

1. P10 production profiles 2* 3* 4*

2. P50 production profiles 3* 4* 5*

3. P9Q Production profiles 4* e* 7* 8*

-Impact of First Year Price (FYP)-

1. FYP (3$/mcf) and the rest

2* 3*
varies between 2 and 8$/mcf

2. FYP (8$/mcf) and the rest

2* 4* S• 6*
varies between 2 and 8$/mcf

43
In a somehow moderate economic environment where gas prices range between 3 and 5 dollars per
mcf, most shale plays P10 wells succeed to breakeven if wells come at average CAP_EX scenarios. More
precisely, at 5$/mcf, value is created for Marcellus, Barnett, and Utica P10 wells under all CAP_EX
scenarios and for almost all Haynesville and Montney P10 wells except those that can't be brought in for
less than 10 and 8 million dollars, respectively. Finally, for all CAP_EX scenarios depicted, all shale plays
P10 wells succeed to breakeven when gas prices range between 6 and 8$/mcf. At a 6$ per mcf gas price,
almost all Barnett and Marcellus P50 wells succeed to breakeven on a full CAP_EX cycle. However, the
rest of shale plays P50 wells only succeed to breakeven under average CAP_EX scenarios. Moreover, at
8$/mcf gas price and higher, all shale plays P50 wells succeed to breakeven and to create value. Table 3
(blue line) summarizes the breakeven prices of all shale plays P10, P50, and P90 wells, respectively.

Our analysis also shows that, under the most (Gas price, CAP_EX) optimistic scenario, all shale plays
P10 wells succeed to breakeven in less than a one-year period. Furthermore, under the same optimistic
scenario, our sensitivity analysis results show that Marcellus P10 wells project economics register the
highest IRR (=120%) followed by Barnett (=93%), Hayneville (55%), Utica (54%), and Montney (50%) P10
wells. Finally, in a moderate economic environment where natural gas price is 5$/mcf, all shale plays
P90 wells fail to breakeven and to make money except for Marcellus wells that can be brought in for less
than 4.5 million dollars (exceeds the average development profile in terms of costs) which is most likely
unachievable.

In a more optimistic economic environment, where natural gas prices range between 6 and 8$/mcf, all
shale plays P90 wells succeed to breakeven (with relatively low NPV project economics) under low
CAP_EX scenarios except for Utica P90 wells that fail to breakeven under all CAP_EX scenarios, none of
shale plays P90 wells succeed to breakeven and to create value under high CAP_EX scenarios except for
Marcellus wells, and only few succeed to breakeven under average CAP_EX scenarios (Haynesville,
Marcellus and Barnett).

Given the fact that shale gas production rates will decline steeply once the well is brought on-line; one
of the most important factors that will delineate the potential profitability of shale gas wells is the price
of the commodity during the first year of production (Kaiser 2012). In our last sensitivity analysis table,
we endeavor to assess the impact of first year prices (FYP) on all shale plays P50 wells NPV project
economics. We propose two (Gas Price, CAPJEX) scenarios where first year gas prices are 8$/mcf and
3$/mcf, respectively. The prices for the following years range between 2 and 8$/mcf. All other model
assumptions are the same as in Gas price, CAPJEX sensitivity analysis for P50 wells.

Comparing results, we realize that profitability windows will increasingly expand for all shale plays when
gas prices are inferior to 8$/mcf. For example, Haynesville P50 wells register a NPV of 6 million$ at a
price of 8$/mcf when CAP_EX are 6 million$. Taking the same Gas Price, CAP_EX combination, at a
first year gas price of 8$/mcf, Haynesville P50 wells almost register the same NPV level (5.9 million$).
However, if we consider the (5$, 6million$) combination, we realize that the NPV increases from 1.4$
million to 3.1$ million which is approximately an increase of 121% in NPV due to the first year price
differential.
Similarly, if we consider the case where the first year price is 3$/mcf (same CAP_EX scenario), we realize
that the NPV decreases from -0.5 to -1.7 million$ which is approximately a decrease of 240% in NPV and
this decrease is also due to the first year price differential.

The same logic applies to all shale plays P50 NPV project economics whilst the impact can differ from
one play to another and the increase or decrease in NPV will depend upon several factors where the
most important one is the initial decline rate. Therefore, it's most likely that the FYP will have the largest
impact on Haynesville P50 wells project economics (with the highest initial decline rate of almost 85%).
More precisely, the cumulative production curve of Haynesville wells shows that more than 25%
2
(— x 100) of GIP will be recovered during the first-year life span of the well and almost more than 73%
6.5
48
(TT X 100) 0T GIP will be recovered in a 10-year period. Refer to appendix (A.4. Type Curves under 3
6.5
different production scenarios). Hence, it's logical to say that higher or lower FYP will have the largest
impact on Haynesville wells NPV project economics (relatively to other shale plays). Table 3 (red line)
summarizes the impact of both 8$ and 3$/mcf first year prices on shale plays P50 wells breakeven prices
and shows the incremental value they provide.
On one hand, at a first year price of 8$ per mcf, all shale plays P50 wells succeed to breakeven under
high and average CAP_EX scenarios. Profitability windows for all shale plays expand and almost all shale
plays P50 wells succeed to breakeven at a price of 2$ per mcf under low CAPJEX scenarios at the
exception of both Montney and Utica P50 wells which breakeven at a price of 3$ per mcf.

Moreover, the analysis shows that at a FYP of 8$ per mcf Marcellus and Haynesville P50 wells show the
highest NPV increases followed by Utica, Barnett, and Montney P50 wells, respectively. On the other
hand, at a 3$/mcf FYP, the economic results are at a certain degree disastrous. Most of shale plays P50
wells fail to breakeven in a moderate economic environment under average CAP_EX scenarios except
for Barnett and Marcellus P50 wells which breakeven at a price of 4$ and 2$/mcf, respectively. Under
high CAPJEX scenarios, most of shale plays P50 wells fail to breakeven even under favorable economic
environments and only Barnett and Marcellus P50 wells succeed to breakeven at a price of 6$/mcf or
higher. Finally, at a 3$/mcf FYP, the profit window shrinks enormously for most P50 wells and even
those wells that succeed to breakeven will relatively generate insufficient economic returns to recover
the well and stimulate drilling and investment activities.

45
2.4. A logistic distribution model of wells deployment (Utica Shale)

Economic performance is determined by several factors and to ensure a rigorous and pragmatic
assassement, it is necessary to incorporate all relevant variables that contribute to the delineation of the
economic profitability of shale plays. Among several economic and technical parameters, the pace of
drilling or the rhythm at wich drilling activities are set is a crucial factor that forms the basis of an
economic shale play once the first gas well is brought on stream. The results of our cash flow sensitivity
analysis have proved that some shale plays could be more profitable than other plays, however, this
doesn't mean that the latter are less economic than those with highest NPV. Usually, to ensure the
profitability of their investments, producing firms tend to maintain high average gas production rates
over time.

To do so, a target number of wells (to be drilled) is set on a yearly basis, so that high production rates of
continuously new wells brought on stream offset decreasing production rates of previously drilled wells.

900 I Utica

800 - I Fayetteville

700 • * Barnett

600 -
500
400
300
200
100
= * = .
0
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Figure 7: Comparison of number of wells drilled (per year).

Source: IHS Energy, Mackie Research [Fayetteville (2004-2009), Utica (2010)]

For the Utica shale, the latter is still in its early stages of development and the pace of drilling activities
in it are still very slow when compared to other shale plays. Refer to Figure 7. To date, more than 4,000
wells were brought on-line in the Fayetteville play, up to 13,000 wells were identified by the rail road
commission in the Barnett play, and even more than 1,200 wells were drilled in the Haynesville well (a
relatively new shale play and could be compared to the Utica shale), and only few wells were drilled in
the Utica play (Bailey 2010). Generally, the Utica shale is seen to have robust economics, however,
nowadays, producing companies are still at a certain degree suspicious about its capacities to produce
shale gas economically. This fact is aggraved by the absence of both social acceptance and oilifield
services in the province, and the existence of remaining large quantities of unproven reserves (Andrew
Potter, Helen Chan and al. 2008; Lin 2010).

46
All things considered, we establish a model that simulates the impact of volumes of gas produced,
revenues, and royalties on the scale of the industry, through wells deployment scenarios in the Utica
shale. The following section describes the model and the assumptions related to it.

2.4.1. Model and Assumptions

The model presumes that all wells performances will be mainly dependent on the variables, initial
production rates, hyperbolic exponent, initial decline rates and natural gas prices, that we applied in our
cash flow analysis. Moreover, the model assumes that zero wells are drilled in year 0 and all wells are
drilled post-deployment time. The latter is variable, however, at first, we assume that it is equal to 10
years. Besides, our simulation model represents royalty rates as a positive function of both volumes of
gas produced and prevailing natural gas prices overtime. This is justified because different generations
wells have different performances and productivities and eventually will be subject to different royalty
rates.

Our model uses a logistic growth model to allocate the deployment of X wells over T periods.
Historically, the logistic function (curve) or growth model was developed20 and used in 1838 to model
the S-shaped behaviour of growth of some population P over time t. The curve is designed so that it
goes through three different stages: (1) the initial stage of exponential growth, (2) the saturation stage
of growth where the curve goes through an inflexion point at which it changes from being concave
upwards to concave downwards or vice versa, and finally (3) the maturity stage where the growth stops
and the curve takes the shape of an horizontal line21.

In our model, we search to calculate a logistic function that computes the number of wells to be
deployed over n periods (years). We assume that the percentage of completed wells versus time follows
a logistic function F:

P = T_—;—r < 117 >

1 + exp — t
Generally, the logistic function has no predetermined boundaries between which the calculated
probabilities can vary the reason why we truncate our model by defining a lower and an upper bound
for it - z , + z .The function equals 0% when t < - 6 and almost 100% when t > 6.

Afterwards, we associate the values n = 1 and n = T - 1 to the lower and upper limits —z, +z of our
logistic distribution model, respectively. The below function depicts the time-based rhythm following
which the wells are going to be established. It takes into account the target number of wells -to be
drilled- during a predetermined time horizon T.

2n-T
m n =z——— (118)

20
Logistic model was initially developed by Belgian mathematician Pierre Verhulst in 1838.
21
McGinley and Lloyd (2010). "Logistic Growth" In: Encyclopedia of Earth. Eds. Cutler J. Cleveland (Washington, D.C:
Environmental Information Coalition, National Council for Science and the Environment). [Retrieved November 28, 2012]
"http://www.eoearth.ore/article/Loeistic growth."

47
z is determined while we assume that the first well will be established in year 1, and so our equation can
be written as:

= 1 (1.19)
1 + exp z

From the above, z = ln X — 1 and X = 1. The first well is established in year 1.

The continuous exponential trend of wells drilled could be computed using the below equation. We
affect a negative sign torn n , so the term inside the parenthesis becomes positive, which is logical
because the rate at which the wells are going to be drilled over time will be increasingly positive before
it reaches a peak point when a decision to stop drilling has been taken. After replacing z by its value (see
equation(1.18)), equation (1.19) can be rewritten as:

2n - T T-2n T-2n
exp —m n = exp —z———
T-2 = exp z———
T-2 = exp zT-2

X-l T-2n M,_-

expH — m n = —— (120)
T-2

And so, our cumulative distribution function of wells drilled, F n,T,X can now be computed as follows:

X
F n,T,X = j _ ^ (1.21)
1+ X - l TT

Where n, T and X denote the total number of periods of the project, the depolyment time of wells and
the target number of wells (to be) drilled, respectively. However, equation (1.21) presents some limits
and needs to be specified. If X = 1 and as already noted the first well will be established in year one
(n = 1):

1
F n,T,X = T=2 = 1
(1.22)
1+ 1-1 T=2

This result is viable if and only if T = 2n. If T = nand the first well will be established in year 1, our
cumulative distribution function wil not hold and will be undefined:

1 1
F n,T,X = f=I=nT (1-23)
1+ 1-1T=Î

An so, to avoid this issue we impose F n,T,\ = 1 .

If n > T our model will be meaningless because all the wells are already established and in this case we
impose that F n,T,X = X . H T = 1, we obtain:

X
Fn,l,X = 1 + x _l2n_, (1-24)

48
And so, F 0.1..Y = X - 1 and F l,l,Jf = 1. The latter means that all the wells but one are established
in year 0 and the remainder is established in year 1.

Thus, to avoid having all wells build in year 0 we impose that F 0,1, A" = 0 and F 1,1,X = 1. Therefore,
zero wells will be built in year 0 and the first well will be established in year 1. If T = 2, we have an issue
of a mathematic nature similar to when we had to impose thatT = 2n. In this case i f n = l , the
cumulative distribution function is:

X
F l.T.X = j_2 (_25)
1+ X-lT=2

Resulting in F 1,T,X = leven if T = 2 (using l'Hôpital's rule). So, the first well is build in year 1 and the
rest of the wells are build in year 2. Using Excel and Visual Basic (VB), we simply program our model by
including the input variables in a way that only half of the wells (relatively to the total target number of
wells) will be build in year 1. To note that our programming (using VB) was calibrated in a manner that
one well is established in year 1. Thus, it would have been preferable if we could specify a minimum
percentage of wells X > 1 to be drilled in year 1. However the latter couldn't be done and the total
number of wells drilled in year 1 was randomly set.

Finally, our choice of a logistic distribution model was arbitrary but precise. The latter is extensively used
in different areas. It is oftenly used as a tool for modelling continuous variables in linear regressions.
Moreover, we figured out that the evolution of the number of wells that we have observed in other
shale plays could also be depicted using a similar logistic-based function, what justifies our choice of the
model.

49
2.4.2. Economie discussion

We define a scenario of wells deployment that corresponds to the below input parameters (reference
scenario). By simulating some of the model key input variables: Gas Price (GP), Target number of wells
X , deployment time T , etc. we attempt to describe how those input variations will potentially impact
average royalty rates, annual royalties paid, and volumes of gas production, respectively.

Reference scenario: n = 20 years, T = 10 years, X = 250 per year, IP rate = 8641 Mmcf per month, b = 1.2,
ID rate = 5.41% per month, and natural gas price = 8$/mcf. Figures (a), (b) and (c) represent volumes of
gas produced over a 20-year period, annual amounts of royalties paid to the government and wells
count and cumulative distribution of wells, repectively. Figure (d) is computed from figures (a), (b) and
(c). It summarizes the evolution of average royalty rates over time.

(a) (b)
Annual_volume (bcf) Annual_royalties(M$)
1000

2016 2026 2036

Wells (annual count Royalties_Average_rate

and cumulative distribution) 35.0%

2000 30.0%

1500

1000

2016 2018 2020 2022 2024 2026 2036

(c) (d)

Figures (a) and (b) show that volumes of gas produced and annual royalties will both be bell-shaped
under F 20,10,1500 deployment scenario (or any deployment scenario). This conclusion is somehow
logical. Annual royalties paid increase with volumes of gas produced, so everytime more wells are
brougth on-line, volumes of gas produced will grow at a constant rate and so will do annual royalty
rates. The more gas is produced, the more royalties will be paid and vice versa. However, it's important
to mention that the increase will not be necessary proportional. Volumes of gas produced will increase
based on the rate at which drilling is taking place (number of wells drilled per year and the marginal

50
productivity of every additional well drilled) and the increase in annual royalties will largely depend of
the marginal productivity of every X + l well brought on stream.

In our analysis, we suppose that prices are constant over time and the decrease in average royalty rates
(and eventually, in annual royalties paid) will probably be due to the decrease in volumes of gas
produced overtime. Therefore, because gas production from shale plays deplete rapidly during the early
life of the well, to maintain an average constant rate of gas production, more wells need to be drilled on
annual basis, so that every new well brought on stream will offset the production decline of previous
wells.

The variable n (total number of years) represents the bottom diameter xaxis of the bell-shape for
both figures (a) and (b) so, every time n increases the diameter of "the bell" will also increase in the
same proportion. We also remark, from both figures (a) and (b), that volumes of gas produced and
annual royalties paid increase for a certain period of time, peak, than decrease before going steady for a
long period of time at low production growth rates. The area that separates the start of the production
and the peak point is mainly representative of our choice of T (deployment time). Thus, both volumes of
gas produced and annual royalties paid peak after 10 years of gas production when drilling activities are
terminated. However the curvarture of the figures is determined by our choice of both variables T and
T
X. In our case, 1500 wells are deployed over a 10-year period. The fraction - is determinant of the top
T
shape of both figures (a) and (b). If — * 0, the peak point of the bell will tend to be sharp, however,
T
if—» 1, the latter will rather be rounded and the distribution will correspond to a more normal bell-
shaped function. Refer to Fig. (e) and (g). Therefore, the shape and curvarture of both figures will be
affected by howXandTwill be eventually allocated in proportion ton.X will probably be decisive of
the rate at which volumes of gas produced and annual royalties paid increase. Under all cited conditions,
the diameter of the bell will always remain unchanged denoting the total number of years (n).

Wells (annual count

and cumulative distribution)
2000

1500

1000

500

0 -
2016 2018 2020 2022 2024 2026 2028 2030

(e) (f)

In figure (c), the S-shaped curve represents the cumulative distribution function of wells (over time) that
derives from our logistic model. Wells deployment are set to be drilled over a 10-year period.

51
The drilling starts in 2016 and ends in 2026, and the S-shaped curvature is dependent on how the
deployment of wells will be modelled. In our case, we suppose that the majority of wells will come in
years ranging between t + 2 < T < t - 2 and so, if t = 1 denotes the year 2017 (2016 doesn't count
because zero production is available at t = 0), the majority of wells will be brought on stream during
2019 < T < 2024 what justifies the S-shape of our cumulative distribution function of wells as well as
the existence of horizontal lines at the start + 2 years and at the end — 2 years of figure (c). As
T
pointed above, for the case of both figures (a) and (b), when —► 1, the cumulative distribution function
will also be affected and will tend to have a more perfectly rounded (normal) S-shaped curve. Refer to
figures (f) and (h). Finally, figure (d) simply denotes that as long as drilling activities are continuously
increasing, volumes of gas produced will also increase, and average royalty rates paid will tend to be
high, however, when drilling activities stop and gas production starts to sharply decline, average royalty
rates will also tend to decrease to finally reach a 10% minimum value in year 20.

Wells (annual count

and cumulative distribution)
2000

1500

1000

500

0
2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036

(g) (h)

Finally, we prove that when T - * n , annual royalties will form an average steady and continuous (over
n) source of financing to the government relatively to the case when T « n. To prove it, we assume an
average natural gas price of 6 $/mcf, X = 1500 wells, T = 6 years, and n = 20 years.

52
We notice that annual royalties peak at 800 million$, however if we follow the linear trend showing in
figure (i) we realize that average annual royalties have a maximum value of 250 million$ at the start of
production (year 2016) and decline over time to reach a 0% value after 20 years of production (year
7*

2036). In this case, (- = 0.3), government could benefit from high royalty returns for a short period of
time before the latter decrease dramatically.
However, if the governement is willing to benefit and to maintain relatively high average rate of returns
from annual royalties throughout the life cycle of the project, drilling activities have to be allocated
differently so t h a t - -» 1. See linear trend in figure (j), where T = 15 years. The latter shows that annual
royalties maintain an approximate constant average level of 100 million$ (in annual royalties) over the
life cycle of the project. In this case, the government will continuously receive almost the same
relatively high average of annual royalties during almost all the life cycle of the project. Moreover, if
more (less) wells were to be brought on stream, the linear trend will tend to shift parallelly to the top
(bottom) and at a certain degree to the right (left) in both cases.

Lastly, our analysis proves that total governemental revenues from annual royalties as well as their
cumulative distribution over time will depend in particular on both (among others) the number of wells
(X) that will be brought into production and the way the deployment time (T) of wells will be allocated
relatively to the total number of periods of the project (n). The main idea behind this is that royalty
rates increase with volumes of gas produced, however, in shale gas, we showed that volumes of gas
production tends to deplete rapidly during the early life of every well drilled therefore the only means
remaining for operators to maitain steady growth rates of gas production and thus realtively high
average royalty rates over n is by continuously drilling more and more wells (increasing X) and ensuring
that X will be normally distributed so that T -> n. As a result, if drilling activities (X) within the industry
were most likely to increase gradually over time, so will do annual royalties collected, and royalty
shares in governemental revenues will certainly remain modest until a real boost in drilling activities is
brought on track.

53
Conclusion
Our study is limited in some important ways and the results found should be understood: (1) the
viability of the results found depends upon the pre-fixed model assumptions, (2) we ignore certain costs
such as: depreciation (amortization), allowance costs, etc. (3) we do not differenciate between the
production of wet and dry gas while dry gas is cheaper to produce than wet gas (kaiser 2012), (4)
volumes of gas produced are unknown and are, hence estimated using Arps decline curves, therefore an
(over)under estimation of gas production can occur, and (5) drilling 8i completion costs, royalties, etc.
are all collected from the public domain and are known only approximately.

Although, despite the potential gaps that our study may include, our analysis shows that the economic
sustainability of shale gas production is largely sensitive to four main factors: (1) the geologic properties
of the play or reservoir, (2) technological advances, in terms of drilling and completion of wells, (3) the
path at which drilling activities are taking place, and (4) the economic environment under which firms
choose to operate. We examined the economics of producing shale gas from five different shale plays
using production decline curve analysis and breakeven economics and we defined the various conditions
under which wells in every shale play are expected to be profitable on an after-tax basis. We also
showed that the economic profitability of wells depend on the existence of both good economic and
geological (conditions) properties. This was proven by the fact that despite that Haynesville wells
presented better geologic properties than Marcellus wells; the latter had better economics than the
former due to the existence of high drilling and completion costs in Louisiana relatively to Appalachia.

Moreover, we examined the profit envelopes of Marcellus, Barnett, Haynesville, Montney, and Utica
wells, respectively under different development scenarios and the results came as follow: Marcellus and
Barnett P10 wells had the best economic performances under most development scenarios among the
five wells tested in our model. In a low economic environment, our analysis showed that most P90 and
P50 wells fail to breakeven on a full cycle basis except for Marcellus wells which can be brought on
stream for less than 4.5$ million. However, in a high economic enviroment most P10 wells (for all shale
plays) registered good economics and succeeded to breakeven under average CAP_EX scenarios. As for
our -First Year Gas Price- sensitivity analysis, we showed that at a first year high economic environment
all P50 wells succeeded to breakeven even under high CAPJEX scenarios. Consequently, we concluded
that first years of production are critical and significantly influence the marginal economics of shale
plays which are initially driven by the tradeoff between high initial production, steep decline, high
investment, and prevailing economic conditions (Kaiser 2012).

Finally, as for our logictic growth model, we showed that because the Utica shale is still in its relative
infancy, its economic success remains largely uncertain. However, even though it is still experimental
and presents higher risks relatively to other shale plays, we noticed that it is best situated in terms of
gas price realizations and royalties, and has a relatively easy topography; all togother, this suggest that
the latter could generate high average rate of returns if production growth and the path of drilling
activities increased and good well results were achieved (Andrew Potter, Helen Chan and al. 2008).

54
Appendix

A . l . Decline Curves p. 56

A.2. Quebec's New Royalty Regime (NRR) p. 61

A.3. Results - Sensitivity Analysis p. 62

A.4. Type Curves under 3 different production scenarios p. 86

55
A.l. Decline Curves
Historically, reservoir engineers used to rely on simple extrapolation techniques to estimate oil and gas
reserves from conventional formations. By extrapolation techniques, we mean the estimation of the
value of a certain variable outside a known range (forecasting future production) from values within that
range by assuming that the estimated future value will logically follow from the known past ones (based
on past production performances). Thus, it's simply question to predict future production performances
by extending past production trends to nelwy discovered wells.

Arps (1944) was the first to define a set of mathematical equations (three type curves) that could depict
how conventional reservoirs will futurely behave in terms of future production rates based on past
performance data. Mathematically, using the Arps technique to estimate shale gas reserves (from
unconventional reservoirs) is impossible (b > 1) because it often leads to unreliable results. Refer to
Table 4.

H«rmonk
Hyp»rbolic_d«clintJtruncatt-m.)
— Expontntial
Hyperbolic
Expont nti»l_d«clin« "

••••••i

1 • I u

Figure 8: Truncation of hyperbolic equations Figure 9: Arps Type curves

In our project, we offset this issue by using the "exponential truncation of hyperbolic equations" method
(Maley 1985). It mainly consists of converting (generally, at some arbitrary point) the production decline
curve from an hyperbolic trend to an exponential one, therefore constraining the EUR to be finite. For
alternative methods, see Spivey and al. (2001), Rushing and al. (2007), Cheng and al. (2008), and Valko &
Lee (2010).

We assume that the decline curve switches from an hyperbolic decline to an exponential decline when
the annual rate of decline in production falls to 7%. The same logic can be found in (Lake and al., 2012).
This assumption applies to all shale plays analyzed in our project. In general, Arps decline curves (type
curves) take three different shapes or curvatures based on the value of the hyperbolic exponent b:

q t = q\X 1 + bDit ~b"

Where:

qt = the production rate in year t;

q, = is a constant and denotes the initial production rate in yearO;
D; = is a constant and denotes the initial decline rate in year 0;

56
b = is a constant and denotes the hyperbolic exponent (the rate at which the decline rate changes over
time);
q -1 q = the time required to attain gas flow rate q;
Q*, = EUR;
Dt = decline rate in year t;
t = the time period for which the production is being estimated;
n = the backpressure slope and describes the drive mechanism inside the reservoir.

Table 4 summarizes all the equations that we used in our project to estimate volumes of gas produced
from every shale play subject of our study. The equations showing below was taken and adapted from
(Cook 2005; Wahyuningish 2008; and Fekete associates Inc., Analysis methods, 2010). In the existing
literature on decline curves, the current decline rate D, denotes the fractional change in rate per unit of
time frequently expressed in "percentage per year" once gas production has started, is defined as
follow:

D = - (Aq/qyt = -{Lq/W/q
From the latter, the exponential decline, where D varies at a constant rate and Dt is the initial decline
rate, is given by:

If D is considered to be either hyperbolic or harmonic an exponent b is incorporated into the equation

of the decline curve to account for the changing decline rate. The new equation is given by:

t7t 1 __
—= j- ->qt = qiX 1 + bDt t b
Qi
1 + bDt t b

For the hyperbolic decline and because D doesn't vary at a constant rate, the latter is given by:

D = Kxq b

q = Gas flow rate,

K = D i / (q b ) (a constant),

b = Constant that varies between 0 and 1.

And the relationship between D and Dt can be written as for 0 < b < 1:

Di
D =
1 + bDit
b = Q -+D = Di
Di
_ = 1 -» D =
1 + Dtt

57
Table 4: Estimating gas reserves using Arps equations

Parameters Conventional Reservoirs Unconventional Reservoirs

b 0 0<6<1 0=1 b>l

Type curves Exponential Hyperbolic Harmonic Hyperbolic then Exponential

i 1
tD qj x 1 + /bDjt H qi x 1 + Djt " Exponential truncation of
qt qt x e~ t
hyperbolic equations

C
* q) b - 1
<t~\<Ù
Di bDt

Same as f o r Ri 1
Qt | x ( l - e - ^ ) ^xlnCl + ^t)
(b > 1 )
W"« 1 + iJ.t 3 ?

limQ, - b -1 00
£-.00 * Di

dq
Dt
1 + bDt t
It

b
U
f\ ^ <~ ^ .-*■-.
JM
~ 2(1-6)

*These equations are conform to the existing literature in petroleum engineering on decline curves.

58
Having obtained the constants b,Di and qt from a curve fit of the production data, the flow rate, at any
time t, is given by:

i
qt = qiX 1 + bDt t b

The cumulative production Qt for the hyperbolic decline can be written as:
t

Qt= q s d s = j-j^-p-X (1-gt1^

o
Now if we replace q t by its expression and make some adjustments to the above equation, we obtain:

Qi 1
Qt =
D-T=T x x
m
Ui L D
1 + bDtt ~
This is true for 0 < b < 1 and b > 1. For b = 1 (hamonic decline), Q can be rewritten as:

Qt = Si x ]n i + £>.t

For the exponential decline b = 0 :

Qt = £x l~e- D*

Now, if limt_,œ Ç t , for different b values, Qm can be written as:

Fore > l t h e n :

For 0 < b < 1 then:

Qi
<3=o =
D; 1 - D

To add that in order to calculate q 1 (q) denoting the time required to attain gas flow rate q we
consider q t = q, and so:

For b = 0, we replace q by its expression and we obtain:

Di
eDi
1
q = Qi xe~ -»<r («7)=-r0.)

«T* q = —!
q q
Dt

59
The same logic applies for b > 0. It suffices to replace q by its expression and make some adjustments to
the equation to obtain:

(*7i
1-1 - —
g)"-1
q q = - bDi

Finally, the mathematical expression of the backpressure slope n developed by Fetkovich is given by:

2n b
b = 2n + 1r -» n = ■
2(1 - b)
For b > 1, n cannot be calculated and a problem of division will occur, however f o r 0 < b < l -» 0 <
n < oo.

60
A.2. Quebec's New Royalty Regime (NRR)

Table 5: Royalty rates table

Gas Volume

250 500 750 1000 1250 1500 1750 2000 2250 2500 2750 3000 3500 4000 4500 5000 5500 6000
3 5 5 5 5 8 11.4 14.8 18.2 21.6 25 25 25 25 25 25 25 25 25
4 5 5 6.1 9.5 13 16.4 19.8 23.2 26.6 30 30 30 30 30 30 30 30 30
5 5 7.7 11.1 14.5 18 21.4 28.2 31.6 35
24.8 35 35 35 35 35 35 35 35
6 9.2 12.7 16.1 19.5 23 26.4 33.2 35 35
29.8 35 35 35 35 35 35 35 35
7 11.7 15.2 18.6 22 25.5 28.9 32.335 35 35 35 35 35 35 35 35 35 35
8 14.2 17.7 21.1 24.5 28 31.4 34.835 35 35 35 35 35 35 35 35 35 35
Gas Price 9 16.7 20.2 23.6 27 30.5 33.9 35 35 35 35 35 35 35 35 35 35 35 35
10 19.2 22.7 26.1 29.5 33 35 35 35 35 35 35 35 35 35 35 35 35 35
11 21.2 24.7 28.1 31.5 35 35 35 35 35 35 35 35 35 35 35 35 35 35
12 23.2 26.7 30.1 33.5 35 35 35 35 35 35 35 35 35 35 35 35 35 35
13 25.2 28.7 32.1 35 35 35 35 35 35 35 35 35 35 35 35 35 35 35
14 27.2 30.7 34.1 35 35 35 35 35 35 35 35 35 35 35 35 35 35 35
15 29.2 32.7 35 35 35 35 35 35 35 35 35 35 35 35 35 35 35 35
*A FAIR AND COMPETITIVE ROYALTY SYSTEM - FOR RESPONSIBLE SHALE GAS PRODUCTION, Appendix, Table.12, p. 48,2011-12.

Some additional notes:

(1) The rate is 35% for small businesses during the exploration phase. A rate of 18.75% or 38.75% is
applicable for exploration in the Mid-North and Far North. The NRR is a non-refundable royalty credit for
exploration such as exists in other jurisdictions. It only applies if gas is being produced: it thus serves as a
production incentive.

(2) It helps to establish the industry and guarantees that the royalty system is competitive (i.e. granting
incentives, etc.) with those of other jurisdictions. The 5% royalty rate applies when prices for the
resource and production are low. The 35% royalty rate applies when prices and well productivity are
high.

(3) The NRR makes it possible to more efficiently collect a portion of the value of the resource, while
taking into account the economic parameters within which the industry operates.

(4) In the future, total revenues from royalties will depend on the number of wells brought into
production (250 wells each year). The government anticipates that development in the industry will be
gradual, and so there will be a gradual rise in revenues from royalties.

61
A.3. Results - Sensitivity Analysis

62
(Gas Price, CAP_EX) NPV (10%, $ mil I ion) Sensitivity Analysis (P10 profiles):

G4P_£X (Sjnillion)
CD Barnett play
Q
3 3.5 4

ro
3"

Marcellus play
2.5 3 3.5 4 4.5 5.5
0.2 -0.2 -0.7 -1.3 -1.7 -2.3 -2.7
16 -0.4 -0.9 -1.4
3.0 2.4 1.9 1.4 0.9 0.4 -0.03
4.3 3.8 3.3 2.8 2.3 1.8 1.3
5.7 5.2 4.7 4.2 3.7 3.2 2.6
7.0 6.5 6.0 5.5 5.0 4.6 4.0
8.4 7.9 7.4 6.9 6.4 5.9 5.4

Haynesville play
6.5 7.5 8 8.5 9.5 10
-2.2 -2.7 -3.2 -3.7 -4.2 -4.7 -5.2 -5.7 -6.2
-0.3 -0.8 -1.3 -1.8 -2.3 -2.8 -3.3 -3.8 -4.3
1.60 1 0.6 0.09 -0.4 -0.9 -1.4 -1.9 -2.4
J**}
3 CO
2 1.5 0.99 U..3 O.u -0.5
5.4 4.9 4.4 3.9 3.4 2.9 2.4 1.9 1.4
7.3 6.8 6.3 5.8 5.3 4.8 4.3 3.8 3.3
9.2 8.7 8.2 7.7 7.2 6.7 6.2 5.7 5.2

63
 Montney play
5.5 6 6.5 7.5 8 8.5
-1.8 -2.3 -2.8 -3.4 -3.9 -4.3 -4.8 -5.3 -5.8
-0.3 -0.8 -1.3 -1.8 -2.3 -2.8 -3.3 -3.8 -4.3
_BBB^B
0.7 0.2 -0.2 -0.7 -1.2 -1.7 -2.2 -2.7
1.2
2.8 2.3 1.8 1.3 0.8 0.3 -0.2 -0.6 -1.2
4.3 3.9 3.4 2.9 2.3 1.8 1.3 0.8 0.3
5.9 5.4 4.9 4.4 3.9 3.4 2.9 2.4 0.9
7.5 7 6.5 6 5.5 5 4.5 4 3.5

Utica play
5.5 6 6.5 7.5
-1.7 -2.2 -2.7 -3.2 -3.7 -4.2
-0.1 -0.6 -1.1 -1.6 -2.1 -2.6
1 -0.09 -0.5 -1
3.1 2.6 2.1
4.7 4.2 3.7 3.2 2.7 2.2
6.4 5.9 5.4 4.8 4.4 3.9
7.9 7.5 6.9 6.4 5.9 5.5

[Gas Price, CAP_EX) IRR {NPV = 0- %) Sensitivity Analysis (P10 profiles):

CAPJEX ($m i II ion)

c. Barnett play
2.5 3 3.5 4 4.5
*
a' ' -2.5 -7 -10.2 -12.5 -14.4
Vi-
12.1 4.7 -0.4 -4.2 -7
s 4 27.6 4.7 0.7
5 43.5 30.3 20.9 14 8.8
6 59.7 43.6 32.2 23.7 17.3
7 76 57 43.6 33.6 25.9
8 92.4 70.6 55.1 43.6 34.7

64
 Marcellus play
2.5 3 3.5 4 4.5 5.5
2.9 -2.8 -6.8 -9.7 -11.9 -13.6 -15.1
21.2 11.9 5.4 0.7 -2.8 -5.6 -7.8
40.4 27.6 18.5 12 6.9 2.9 -0.2
60.0 43.7 32.1 23.6 17.1 11.9 7.8
79.7 60 46 35.6 27.6 21.3 16.1
99.6 76.5 60 47.7 38.3 30.8 24.7
119 93 74.1 60 49.1 40.4 33.4

Haynesville play
6.5 7.5 8 8.5 9.5 10
-11.3 -12.7 -13.9 -14.9 -15.8 -16.6 -17.3 -18.0 -18.6
-1.7 -3.9 -5.8 -7.5 -8.9 -10.1 -11.2 -12.2 -13.0
8.7 5.5 2.7 0.4 -1.6 -3.4 -4.9 -6.2 -7.4
-Ly .o 15.4 11.8 8.7 6.1 3.8 1.8 0.0 -1.6
30.9 25.7 21.2 17.4 14.2 11.3 8.8 6.5 4.5
42.4 36.2 30.9 26.4 22.5 19.0 16.0 13.3 10.9
54.0 46.8 40.7 35.5 31.0 26.9 23.4 20.3 17.5 1

Montney play
5.5 6.5 7.5 8 8.5
-11.1 -12.7 -14.0 -15.2 -16.2 -17.0 -17.8 -18.5 -19.0
-2.0 -4.5 -6.6 -8.3 -9.8 -11.0 -12.2 -13.2 -14.0
7.8 4.2 1.3 -1.2 -3.3 -5.0 -6.6 -7.9 -9.0
18.0 13.4 9.5 6.3 3.6 1.3 -0.7 -2.5 -4.0
28.6 22.8 18.1 14.0 10.7 7.8 5.4 3.2 1.3
1
3QT 32 5 9fi 8 ■>2 l 18 1 \A CL. 1 6 9.0 6.7
50.2 42.3 35.7 30.3 25.6 21.6 18.1 15.0 12.4

65
 Utica play
5.5 6 6.5 7.5
-10.7 -12.4 -13.8 -15 -16 -17
-0.9 -3.6 -5.8 -7.7 -9.3 -10.6
9.7 5.8 2.6 0.0 -2.3 -4.2
20.7 15.6 11.5 8 5.1 2.6
32 25.8 20.7 16.4 12.8 9.7
43.6 36.2 30.2 25 20.7 17
55.2 46.7 39.7 33.8 28.8 24.5

(Gas Price, CAP_EX) Payout period (years) Sensitivity Analysis (P10 profiles):

CAP_EX (Smillion)

i
Barnett play
2.5 3 3.5 4 4.5
NA NA NA NA NA
3" 3.0 5.5 NA NA NA
3 1.8 2.5 4 5.5 10
1.2 1.8 2 3 4
1.0 1.2 1.5 2 2.2
<1 1 1.2 1.5 2
<1 <1 1 1.2 1.5

Marcellus play
2.5 3 3.5 4 4.5 5 5.5
2 7.0 NA NA NA NA NA NA
3 2.0 NA NA NA
4 1.5 2 2.5 3 4.5 7 NA
5 1.0 1.2 1.5 2 2.5 3 4.2
6 <1 1 1.2 1.6 2 2.2 2.5
7 <1 <1 1 1.2 1.5 1.8 2
8 <1 <1 <1 1 1.2 1.5 1.8

66
 Haynesville play
6 6.5 7 7.5 8 8.5 9 9.5 10
2 NA NA NA NA NA NA NA NA NA
3 NA NA NA NA NA NA NA NA NA
4 NA NA NA NA NA
5 2.5 3 4 4.5 5 6 8 >10 NA
6 1.5 2 2.5 2.8 3 3.5 4 5 6
7 1.0 1.5 2 2.5 2.8 3 3.2 3.5 3.8
8 <1 <1 1 1.5 2 2.2 2.5 2.8 3

Montney play
5 5.5 6 6.5 7 7.5 8 8.5 9
2 NA NA NA NA NA NA NA NA NA
3 NA NA NA NA NA NA NA NA NA
4 4.5 6 10 NA NA NA NA NA NA
5 2.5 3 3.8 4.5 7 9 NA NA NA
6 2.2 2.5 3 3.5 4.5 5 WËàjÈ 10
7 1.5 1.8 2 2.2 2.5 3 3.5 4 4.5
8 1.0 1.2 1.5 1.8 2 2.2 2.5 3 3.2

Utica play
5.5 6 6.5 7.5
NA NA NA NA NA NA
NA NA NA NA NA NA
4.0 5 7.5 >10 NA NA
2.0 2.5 3.5 4 5.5
1.8 2 2.2 2.5 3 3.8
1.2 1.5 1.8 2 2.2 2.5
<1 1 1.5 1.8 2 <2

(Gas Price, CAP_EX) NPV (10%, $million) Sensitivity Analysis (P50 profiles):

67
 CAPJEX (Smil l ion)
► Barnett play
2.5 3 3.5 4 4.5
-0.9 -1.4 -1.9 -2.4 -2.9
3 -0.1 -0.5 -1 -1.5 -2
3 0.7 0.2 -0.2 -0.7 -1.2
1.5 1 0.5 0.03 -0.5
2.3 1.8 1.3 0.8 0.4
3.1 2.6 2.1 1.6 1.1
3.9 3.4 2.9 2.4 2

Marcellus play
2.5 3 3.5 4 4.5 5.5
-0.3 -0.8 -1.3 -1.8 -2.3 -2.8 -3.3
0.2 -0.2 -0.7 -1.2 -1.7 -2.2
1.8 1.4 0.9 0.4 -0.1 -0.6 -1.1
2.9 2.4 1.9 1.4 0.9 0.4 -0.03
4.0 3.5 3.0 2.5 2.0 1.5 1.0
_■____■_
5.1 4.6 4.1 3.6 3.1 2.6 2.1
6.2 5.7 5.2 4.7 4.2 3.7 3.2

Haynesville play
6.5 7 7.5 8 8.5 9.5 10
-3.0 -3.5 -4.0 -4.5 -5.0 -5.5 -6.0 -6.5 -7.0
-1.5 -2.0 -2.5 -3.0 -3.5 -4.1 -4.5 -5.0 -5.5
-0.03 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0 -3.5 -4.0
0.9 0.4 -0.03 -0.5 -1.0 -1.5 -2.0 -2.6
2.9 2.4 1.9 1.4 0.9 0.5 -0.04 -0.5 -1.0
4.4 4.0 3.4 2.9 2.4 1.9 1.4 1.0 0.4
5.9 5.4 4.9 4.4 3.9 3.4 2.9 2.4 1.9

68
 Montney play
5 5.5 6 6.5 7 7.5 8 8.5 9
2 -2.6 -3.1 -3.6 -4.1 -4.6 -5.1 -5.6 -6.1 -6.5
3 -1.5 -1.9 -2.5 -3 -3.5 -4 -4.5 -4.9 -5.3
4 -0.3 -0.8 -1.3 -1.8 -2.3 -2.8 -3.3 -3.8 -4.3
5 0.8 0.3 -0.1 -0.6 -1.1 -1.6 -2.1 -2.6 -3.1
6 2 1.5 1 0.5 0.03 -0.4 -0.9 -1.4 -1.9
7 3.2 2.7 2.2 1.7 1.2 0.7 -0.3 -0.8
8 4.3 3.8 3.3 2.9 2.4 1.9 1.4 0.9 0.3

Utica play
5.5 6 6.5 7.5
-2.8 -3.3 -3.8 -4.3 -4.8 -5.3
-1.7 -2.2 -2.7 -3.2 -3.7 -4.2
-0.6 -1.2 -1.7 -2.1 -2.6 -3.1
■HWMM
-0.08 -0.5 -1 -1.6 -2
1.5 1 0.5 0.0 -0.5 -1
2.6 2 1.6 1 0.5 0.08
3.6 3.1 2.7 2.2 1.6 1.16 j

(Gas Price, CAP_EX) IRR (NPV = 0, %) Sensitivity Analysis (P50 profiles):

CAP_ EX ($n illion)

cr» Barnett play
2.5 3 3.5 4 4.5
8* 2 -10.6 -13.6 -15.8 -17.5 -18.8
3 -1.0 -6.0 -9.2 -11.7 -13.6
â 4 9.1 2.3 -2.4 -5.9 -8.5
5 1Q8 4 7 02 -3.2
6 30.8 19.8 12.2 6.6 2.3
7 42.0 29.0 20.0 13.1 8.0
8 53.3 38.3 27.7 19.9 14.0

69
 Marcellus play
2.5 3 3.5 4 4.5 5 5.5
* -4.0 -8.3 -11.4 -13.6 -15.4 -16.8 -17.9
3 10.1 2.9 -2.0 -5.6 -8.3 -10.4 -12.2
4 25.0 15.0 8.0 2.9 -0.9 -4.0 -6.3
5 40.4 27.6 18.6 11.9 6.9 2.9 -0.2
6 56.1 40.4 29.4 21.3 15.0 10.1 6.2
7 71.8 53.4 40.4 30.8 23.4 17.5 12.8
8 87.7 66.6 51.6 40.4 31.9 25.1 19.6

Haynesville play
6 6.5 7 7.5 8 8.5 9 9.5 10
2 -15.2 -16.3 -17.2 -18.0 -18.8 -19.4 -20.0 -20.6 -21.1
3 -7.9 -9.6 -11.0 -12.3 -13.3 -14.3 -15.1 -15.9 -16.6
4 -0.2 -2.6 -4.6 -6.4 -7.9 -9.2 -10.3 -11.3 -12.2
5 8.0 4.8 2.1 -0.2 -2.1 -3.8 -5.3 -6.7 -7.8
6 9.2 6.3 3.9 1.7 -0.1 -1.8 -3.3
7 25.3 20.5 16.5 13.1 10.1 7.5 5.3 3.2 1.5
8 34.2 28.7 24.0 20.0 16.5 8.5 6.4

Montney play
5.5 6 6.5 7.5 8 8.5
-15.5 -16.8 -18.0 -18.7 -19.5 -20.2 -20.8 -21.3 -21.8
-9.0 -10.7 -12.0 -13.5 -14.6 -15.5 -16.4 -17.0 -17.8
-2.0 -4.5 -6.6 -8.3 -9.8 -11.0 -12.2 -13.2 -14.0
5.3 2.0 -0.7 -3.0 -4.9 -6.6 -8.0 -9.2 -10.3
8.8 5.4 2.5 0.1 -1.9 -3.7 -5.2 -6.5
21.0 15.7 11.6 8.2 5.4 2.9 0.8 -1.1 -2.7
28.6 22.8 18.1 14.1 7.9 5.4 3.2 1.3

70
 Utica play
5.5 6.5 7.5
-17.0 -18 -19 -20 -20.6 -21.3
-10.6 -12.3 -13.7 -15 -16 -16.9
-4.2 -6.5 -8.5 -10 -11.5 -12.7
2.6 -0.5 3.1 -5.2 -7 -8.5
9.7 5.8 2.6 0 -2.2 -4.2
17.0 12.3 8.5 5.3 2.6 0.3
24.5 19 14.6 10.8 7.7 5

(Gas Price, CAPJEX) Payout period (years) Sensitivity Analysis (P50 profiles):

CAP_EX (Smil l ion)

Barnett play
Q
-_ 2.5 3 3.5 4 4.5
ro NA NA NA NA NA
NA NA NA NA NA
3 _B__H_________________B__j____|
:

0. NA NA NA
m. m—, j0< '■' ^ y . ■

4.0 8.0
2.5 3.5 5.5 _ H M |
10.0
NA
1.8 2.0 3.0 5.0 8.5
1.2 1.8 2.2 3.0 4.0
1.0 1.5 2.0 2.2 3.0

Marcellus play
2.5 3 3.5 4 4.5 5.5
NA NA NA NA NA NA
NA NA NA NA
NA NA
1.5 2 2.5 3.2
1 1.2 1.8 2 3 3.8
<1 1 1.2 1.5 2 2.5
1 <1 1 1.2 1.8 2

71
 Haynesville play
6.5 7 7.5 8 8.5 9.5 10
NA NA NA NA NA NA NA NA NA
NA NA NA NA NA NA NA NA NA
NA NA NA NA NA NA NA NA NA
5.5 9.0 NA NA NA NA NA NA
2.5 3.0 4.0 4.5 6.0 9.0 NA NA NA
1.8 2.0 2.5 3.0 3.5 4.5 5.0 6.5 8.5
1.0 1.5 1.8 2.0 2.5 2.8 3.0 4.0 5.0

Montney play
5.5 6 6.5 7.5 8 8.5
NA NA NA NA NA NA NA NA NA
NA NA NA NA NA NA NA NA NA
NA NA NA NA NA NA NA NA NA
5.5 8.5 NA NA NA NA NA NA NA
HB
3 4 5 7 >10 NA NA NA NA
2.0 3 3.5 4 5.5 7 >10 NA NA
1.8 2 2.5 3 3.5 4.5 5

Utica play
5.5 6 6.5 7.5
NA NA NA NA NA NA
NA NA NA NA NA NA
NA NA NA NA NA NA
NA NA NA NA NA
4 5 NA NA NA
2.5 3 4 5 8 >10
2.0 2.2 3 3.5 4.5 5.5

(Gas Price, CAP_EX) NPV(10%, $million) Sensitivity Analysis (P90 profiles):

72
CAP_EX (Smillion)
Barnett play
2.5 3 3.5 4 4.5
-1.6 -2 -2.6 -3 -3.6
-1.1 -1.6 -2.1 -2.6 -3.1
-0.7 -1.1 -1.7 -2.2 -2.6
-0.2 -0.7 -1.2 -1.7 -2.2
0.2 -0.3 -0.7 -1.2 -1.7
0.7 0.2 -0.3 -0.8 -1.2
1.2 0.7 0.2 -0.3 -0.8

Marcellus play
2.5 3 3.5 4 4.5 5.5
-0.8 -1.3 -1.8 -2.3 -2.9 -3.3 -3.8
-0.04 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0
-0.2 -0.7 -1.2 -1.7 -2.2
1.6 1.0 -0.4 -0.9 -1.4
2.4 1.9 1.4 0.9 -0.1 -0.5
3.3 2.7 2.2 1.7 1.2 0.7 0.2
1 4.0 3.5 3.0 2.6 2.0 1.6 1.0

Haynesville play
6 6.5 7 7.5 8 8.5 9 9.5 10
2 -3.8 -4.4 -4.8 -5.3 -5.8 -6.3 -6.8 -7.3 -7.8
3 -2.7 -3.2 -3.7 -4.2 -4.7 -5.2 -5.7 -6.2 -6.7
4 -1.60 -2.1 -2.6 -3.1 -3.6 -4.1 -4.6 -5.1 -5.6
5 -0.5 -1.0 -1.5 -2.00 -2.5 -3.0 -3.5 -4.0 -4.6
6 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.40 -3.0 -3.4
7 1.6 1.1 0.6 -0.4 -0.9 -1.4 -1.9 -2.4
8 2.6 2.2 1.7 1.2 lj, / Uiz. -0.3 -0.8 -1.3

73
 Montney play
5.5 6 6.5 7.5 8 8.5
-3.4 -3.9 -4.4 -4.9 -5.4 -5.9 -6.5 -6.9 -7.4
-2.6 -3.1 -3.6 -3.7 -4.6 -5 -5.3 -5.8 -6.6
-2.0 -2.3 -2.8 -3 -3.8 -4.2 -4.8 -5.5 -5.9
-1.0 -1.6 -2 -2.2 -2.7 -3.3 -3.7 -4.4 -5
-0.3 -0.8 -0.3 -1.8 -2.3 -2.9 -3.4 -3.9 -4.3
0.5 -0.03 -0.5 -1.3 -1.5 -1.9 -2.4 -3 -3.5
1.2 0.7 U._ -0.2 -0.7 -1.3 -1.9 -2.3 -2.7

Utica play
5.5 6 6.5 7.5
-3.9 -4.4 -4.9 -5.4 -5.9 -6.4
-3.3 -3.9 -4.3 -4.9 -5.3 -5.8
-2.8 -3.3 -3.8 -4.3 -4.8 -5.3
-2.3 -2.8 -3.3 -3.8 -4.3 -4.8
-1.7 -2.2 -2.7 -3.2 -3.7 -4.2
-1.2 -1.7 -2.2 -2.7 -3.2 -3.7
-0.6 -1.2 -1.6 -2.2 -2.7 -3.1

(Gas Price, CAP_EX) IRR (NPV = 0, %) Sensitivity Analysis (P90 profiles):

CAP_EX ($mill ion)

CD Barnett play
2.5 3 3.5 4 4.5
P *
2 -18.5 -20.4 -21.8 -23.0 -23.8
•Crv

-3
3 -13.2 -16.0 -17.7 -19.2 -20.3
S 4 -7.9 -11.4 -14 -15.8 -17.3
5 -2.4 -7.0 -10.1 -12.5 -14.3
6 3.3 -2.4 -6.3 -9.2 -11.4
7 9.2 2.3 -2.4 -6.0 -8.4
8 15.2 7.2 1.7 -2.4 -5.3

74
 Marcellus play
2.5 3 3.5 4 4.5 5 5.5
2 -10.5 -13.6 -15.9 -17.6 -19.0 -20.0 -21.0
3 -0.5 -5.6 -9.0 -11.6 -13.6 -15.2 -16.5
4 2.9 -2.0 -5.6 -8.3 -10.4 -12.2
5 21.2 11.9 5.5 0.8 -2.8 -5.6 -7.8
6 32.7 21.3 13.3 7.4 3.0 -0.5 -3.3
7 44.3 30.8 21.3 14.3 9.0 4.7 1.4
8 56.1 40.4 29.4 21.3 6.2

Haynesville play
6.5 7.5 8 8.5 9.5 10
-19.1 -20.0 -20.7 -21.4 -21.9 -22.5 -23.0 -23.4 -23.8
-13.8 -15.0 -16.0 -16.9 -17.7 -18.4 -19.1 -19.7 -20.2
-8.50 -10.2 -11.6 -12.7 -13.8 -14.7 -15.5 -16.3 -16.9
-3.0 -5.2 -7.0 -8.50 -9.8 -11.0 -12.0 -13.0 -13.8
2.8 0.1 -2.2 -4.1 -5.8 -7.5 -8.50 -9.6 -10.6
8.8 5.5 2.8 0.4 -1.6 -3.3 -4.8 -6.2 -7.4
15.0 11.1 7.9 5.2 2.8 0.7 -1.1 -2.7 -4.1

Montney play
5.5 6.5 7.5 8 8.5
-20.2 -21.0 -21.8 -22.5 -23.1 -24.5 -25.1 -25.9 -26.7
-15.5 -16.7 -18.0 -19.0 -19.4 -19.8 -20.4 -21.1 -21.8
-11.0 -12.7 -14.0 -15.2 -16.1 -16.6 -17.5 -18.2 -19.1
-6.6 -8.6 -10.3 -12.5 -13.0 -14.2 -15.0 -15.9 -16.5
-2.0 -4.5 -6.5 -8.3 -9.8 -10.5 -11.0 -12.8 -14.0
3.0 -0.2 -2.7 -4.8 -6.5 -7.6 -9.0 -10.2 -11.5
8.0 4.2 1.3 -1.2 -3.2 -5.2 -6.7 -8.0 -9.1

75
 Utica play
5.5 6 6.5 7.5
-23.7 NA NA NA NA NA
-20.1 -21.0 -21.8 -22.5 -23.1
-23.7
-17.0 -18.0 -19.0 -19.8 -20.6
-21.2
-13.7 -15.0 -16.3 -17.3 -18.2
-19.0
-10.6 -12.3 -13.7 -15.0 -16.0
-17.0
-7.4 -9.4 -11.1 -12.5 -13.7
-14.7
-4.1 -6.5 -8.5 -10.0 -11.5 -12.7

(Gas Price, CAPJEX) Payout period (years) Sensitivity Analysis (P 90 profiles):

CAP EX (Smil l ion)

CD :—► Barnett play
Q
to
2.5 3 3.5 4 4.5
3 .
JJ NA NA NA NA NA
n>
v> NA NA NA
NA NA
_r
NA NA NA NA NA
NA NA NA NA NA
7.0 NA NA NA NA
4.0 8.0 NA NA NA
3.0 4.5 9.0 NA NA

Marcellus play
3 3.5 4

76
 Haynesville p lay
6.5 7.5 8 8.5 9.5 10
NA NA NA NA NA NA NA NA NA
NA NA NA NA NA NA NA NA NA
NA NA NA NA NA NA NA NA NA
NA NA NA NA NA NA NA NA NA
■ ' _m __

7.0 >10 NA NA NA NA NA NA NA
4.0 5.0 7.0 >10 NA NA NA NA NA
3.0 3.5 4.0 5.5 7.0 >10 NA NA NA

Montney p lay
5.5 6 6.5 7.5 8 8.5
2 NA NA NA NA NA NA NA NA NA
3 NA NA NA NA NA NA NA NA NA
4 NA NA NA NA NA NA NA NA NA
5 NA NA NA NA NA NA NA NA NA
6 NA NA NA NA NA NA NA NA NA
•
M il
NA NA NA NA NA NA NA NA
* NA NA NA NA NA NA

Utica p lay
5.5 6 6.5 7.5
NA NA NA NA NA NA
NA NA NA NA NA NA
NA NA NA NA NA NA
NA NA NA NA NA NA
NA NA NA NA NA NA
NA NA NA NA NA NA
NA NA NA NA NA NA

(Gas Price, IP rate) NPV(10%, Smillion) Sensitivity Analysis:

77
IP rate (Mmcf/d)
Barnett play
2.5 3 3.5 4.5
-2.6 -2.4 -2.1 -1.9 -1.6 -1.4 -1.2
-2.1 -1.7 -1.4 -1.0 -0.7 -0.4 •0.1
-1.6 -1.1 -0.7 -0.2 0.2 0.6 1.1
-1.2 -0.6 0.0 0.5 1.1 1.7 2.2
-0.7 0.0 0.6 1.3 2.0 2.7 3.4
-0.2 1.3 2.1 2.9 3.7 4.5
1.1 2.0 2.9 3.8 4.8 5.7

Marcellus play
2.5 3 3.5 4 4.5
-2.6 -2.3 -2.0 -1.8 -1.5 -1.3
-2.0 -1.5 -1.1 -0.7 -0.3 0.1
-1.3 -0.7 -0.2 ft A. HQ 1.4
-0.5 0.1 0.8 1.4 2.1 2.8
0.1 0.9 1.7 2.5 3.4 4.2
0.7 1.7 2.7 3.6 4.6 5.5
1.5 2.5 3.6 7.0

Haynesville play
8.5 9.5 10 10.5 11 11.5 12 12.5 13 13.5 14
-6.9 -6.8 -6.7 -6.6 -6.5 -6.4 -6.3 -6.2 -6.1 -6 -5.9 -5.8 -5.7
-6.0 -5.9 -5.7 -5.5 -5.3 -5.1 -4.9 -4.85 -4.8 -4.7 -4.5 -4.4 -4.2
-5.2 -5 -4.8 -4.6 -4.4 -4.2 -4 -3.8 -3.6 -3.44 -3.2 -3 -2.8
-4.4 -4.1 -3.9 -3.6 -3.3 -3 -2.7 -2.5 -2.4 -2.2 -1.9 -1.7 -1.5
-3.6 -3.3 -3 -2.7 -2.4 -2.1 -1.8 -1.5 -1.2 -0.9 -0.6 -0.3
-2.8 -2.4 -2.1 -1.7 -1.4 -1 -0.7 -0.3 1.4
-2.0 -1.6 -1.2 -0.7 -0.3 0.02 0.4 0.8 1.2 1.6 2 2.5 2.8

Montney play
3.5 4 4.5 5.5
-5.4 -5.1 -4.9 -4.6 -4.4 -4.1 -3.9
-4.6 -4.2 -3.8 -3.5 -3.1 -2.7 -2.3
-3.8 -3.3 -2.8 -2.3 -1.8 -1.3 -0.7
-3.0 -2.4 -1.8 -1.1 -0.4 0.1 0.8
-2.3 -1.5 -0.7 1 0.0 0.8 1.6 2.3
-1.5 -0.6 0.3 1.2 2.1 3.0 3.9
-0.7 0.3 1.3 2.3 3.4 4.4 5.5

78
 Utica play
2.5 3 3.5 4.5 5.5
-4.2 -3.8 -3.3 -2.9 -2.4 -2 -1.6 -1.1 -0.7
-3.4 -2.7 -2 -1.3 -0.7 -0.01 0.6 1.2 1.9
-2.4 -1.6 -0.7 0.2 1 2 2.8 3.7 4.5
-1.5 -0.4 0.6 1.7 2.8 3.9 5 6.1 7.2
-0.7 0.6 1.9 3.2 4.5 5.9 7.2 8.5 9.8
0.2 1.7 3.2 4.8 6.3 7.8 9.4 10.9 12.5
1 2.8 4.5 6.3 8.1 9.8 11.6 13.4 15.1

(Gas Price, IP rate ) IRR (NPV = 0, %) Sensitivity Analysis:

IP rate (Mmcf/d)
CD Barnett play
a 2.5 3 3.5 4.5
-21.8 -19.7 -17.7 -15.8 -14 -12.1 -10
-17.7 -14.8 -12 -9.2 -6.4 -3.4 -0.4
3
-13.9 -10.2 -6.3 -2.4 1.6 5.8 10
-10.0 -5.4 -0.4 4.70 10.0 15.4 21.9
-6.3 -0.4 5.8 12.2 18.7 25.4 32.2
-2.4 4.8 12.2 19.9 27.7 35.6 43 6
1.7 *i n 18.8 27.7 36.7 45.9 55.1

Marcellus play
2.5 3 3.5 4 4.5
-19.6 -17.6 -15.6 -13.6 -11.7 -9.7
-14.6 -11.6 -8.6 -5.6 -2.5 0.7
-9.6 -5.6 -1.4 2.9 7.4 12.0
:.■ ■ ■ ■ . .

-4.5 0.8 6.3 12.0 17.7 23.6

0.8 7.4 14.2 21.3 28.4 35.6
6.3 14.3 22.4 30.8 39.2 47.7
1 12.0 21.3 30.8 40.4 50.2 60.0

79
 Haynesville play
8.5 9.5 10 10.5 11 11.5 12 12.5 13 13.5 14
-24.0 -23.7 -23.2 -22.8 -22.4 -22.0 -21.6 -21.2 -20.8 -20.4 -20.0 -19.7 -19.3
-21.0 -20.2 -19.6 -19.1 -18.5 -18.0 -17.5 -17.0 -16.5 -16.0 -15.5 -15.0 -14.5
-18.0 -17.1 -16.4 -15.8 -15.1 -14.4 -13.7 -13.1 -12.4 -11.7 -11.1 -10.4 -9.7
-15.1 -14.2 -13.4 -12.5 -11.7 -10.9 -10.0 -9.2 -8.4 -7.5 -6.7 -5.8 -4.9
-12.4 -11.4 -10.4 -9.3 -8.3 -7.3 -6.3 -5.3 -4.2 -3.2 -2.1 -1.0 0.0
-9.7 -8.5 -7.3 -6.1 -4.9 -3.7 -2.4 -1.2 0.1 1.3 2.6 3.9 5.2
-6.9 -5.6 -4.2 -2.8 -1.4 0.1 1.5 3.0 4.5 6.0 7.5 9.0

Montney play
3.5 4 4.5 5.5
-23.1 -21.8 -20.6 -19.5 -18.4 -17.3 -16.2
-19.4 -17.8 -16.2 -14.6 -13 -11.4 -9.8
-16.1 -14 -12 -9.8 -7.7 -5.5 -3.3
-13.0 -10.3 -7.6 -5 -2.1 0.7 3.6
-9.8 -6.5 -3.2 0.1 3.6 7.1
-6.5 -2.7 1.3 5.4 9.5 13.8 18.1
-3.2 1.3 6 10.7 15.6 20.6 25.6

Utica play
2.S 3 3.5 4.5 5.5
-15 -13 -12 -10 -8.8 -7 -5.6 -4 -2.5
-12 -9.5 -7 -5 -2.5 -0.2 2.1 4.4 6.7
-8.7 -5.6 -2.5 0.6 3.6 6.7 10 13.1 16.3
-5.5 -1.7 2.0 6 10 14 18 22 26.2
-2.5 2.1 7 *"l s t -P**
16.3 21 26 31 36
0.6 6 11.5 17.1 23 29 35 40 47
3.7 10 16 23 30 36 43 50 58

(Gas Price, IP rate ) Payout period(years) Sensitivity Analysis:

80
 IP rate (Mmcf/d)
> Barnett play
2.5 3 3.5 4.5
NA NA NA NA NA NA NA
NA NA NA NA NA NA NA
3
NA NA NA NA g 5.5 4
NA NA NA 5.5 4 2.8 2
NA NA 5.5 3 2.5 2 1.5
NA ■*
3 2.2 2 1.5 1
10 4 2.5 2 1.5 1 <1

Marcellus play
2.5 3 3.5 4 4.5
NA NA NA NA NA
NA NA NA NA NA
NA NA NA 7 4.5 3
NA 10 5 3.1 2.5 2
10 4.5 3 2 1.9 1.5
5 3 2 1.8 1.2 1
3.0 2 1.5 1.2 1 <1

Haynesville play
8.5 9.5 10 10.5 11 11.5 12 12.5 13 13.5 14
NA NA NA NA NA NA NA NA NA NA NA NA NA
NA NA NA NA NA NA NA NA NA NA NA NA NA
NA NA NA NA NA NA NA NA NA NA NA NA NA
NA NA NA NA NA NA NA NA NA NA NA NA NA
NA NA NA NA NA NA NA NA NA NA NA NA
NA NA NA NA NA NA NA NA
NA NA NA NA NA >10 10 8.5 S 5.5 5

Montney play
3.5 4 4.5 5.5
NA NA NA NA NA NA NA
NA NA NA NA NA NA NA
NA NA NA NA NA NA NA
NA NA NA NA NA >10 6.5
NA NA NA 1 >10 7 4.5 3.5
NA NA 1U 5.5 4 3 2.5
:-■:■.■: .'Xy.Ùtt.,/.

NA *t f\
5 3.5 2.8 2 <2
iXi

81
 Utica play
2 2.5 3 3.5 4 4.5 5 5.5 6
2 NA NA NA NA NA NA NA NA NA
3 NA NA NA NA NA NA
4 NA NA NA b 5 4 3
5 NA NA >10 3 2.5 2
6 NA >10 6 4 >3 3 2 <2 1.5
7 6.5 4 3 <3 2 <2 1.5 1
8 9 5 3 2.5 2 <2 1.5 1 <1

The impact of FYGP on P50 NPV (Gas Price, CAP_EX) project economics

$m illion)
CAPJEX (Sm Barnett play
CD
Q 2.5 3 3.5 4 4.5
yry

5,, 0.80 0.35 -0.15 -0.60 -1.10

1.30 0.87 0.40 -0.12 -0.60
3" 1.80 1.39 0.89 0.39 -0.10
3= 2.40 1.90 1.40 0.90 0.40
2.90 2.42 1.90 1.40 0.90
3.43 2.93 2.43 1.93 1.40
3.95 3.45 2.90 2.45 1.90

Marcellus play
2.5 3 3.5 4 4.5 5.5
2 2.1 1.6 1.1 0.6 0.1 -0.4 -0.9
3 2.8 2.3 1.8 1.3 0.8 0.3 -0.2
4 3.5 2.9 2.5 1.9 1.5 0.9 0.5
5 4.1 3.7 3.1 2.6 2.1 1.6 1.1
6 4.8 4.3 3.9 3.3 2.8 2.3 1.9
7 5.5 5.1 4.5 4.0 3.5 3.0 2.6
8 6.2 5.7 5.2 4.8 4.2 3.7 3.2

82
 Haynesville play
6.5 7.5 8.5 9.5 10
0.4 -0.1 -0.6 -1.1 -1.6 -2.1 -2.6 -3.1 -3.5
1.3 0.8 0.3 -0.2 -0.7 -1.2 -1.7 -2.2 -2.7
2.1 1.7 1.2 0.7 -0.2 -0.8 -1.3 -1.7
3.1 2.7 2.2 1.7 1.1 0.6 0.2 [ -0.3 -0.8
4.1 3.5 3.0 2.6 2.0 1.6 1.0 0.6 0.0
5.0 4.5 4.0 3.4 3.0 2.5 2.0 1.6 1.0
6.0 5.4 4.9 4.5 4.0 3.4 2.9 2.4 2.0

Montney play
5 5.5 6 6.5 7.5 8.5
-0.1 -0.6 -1.1 -1.7 -2.1 -2.7 -3.1 -3.6 -4.1
0.6 0.1 -0.4 -0.9 -1.4 -1.8 -2.4 -2.9 -3.4
1.3 0.9 04 -0.1 -0.6 -1.1 -1.7 -2.1 -2.6
2.1 1.6 1.1 0.6 -0.4 -0.9 -1.3 -1.9
2.8 2.4 1.9 1.4 1.0 0.4 0.0 -0.6 -1.1
3.8 3.1 2.7 2.0 1.6 1.2 0.6 0.1 -0.3
4.4 3.9 3.4 2.8 3.4 1.8 1.5 1.0 _■_■_!
0.5

Utica play
5.5 6 6.5 7.5
1 -0.4 -0.9 -1.4 -2.0 -2.4 -2.9
0.3 -0.3 -0.7 -1.3 -1.7 -2.3
0.9 0.5 0.0 -0.6 -1.0 -1.6
1.6 1.1 0.6 0.1 1 -0.4 -0.9
2.3 1.9 1.3 0.8 0.4 -0.2
3.0 2.5 1.9 1.5 1.1 0.5
3.6 3.1 2.7 2.2 1.8 1.1

83
The impact of FYGP on P50 NPV (Gas Price, CAPJEX) project economics

CAPJEX (^million) Barnett play

2.5 3 3.5 4 4.5
-0.60 -1.10 -1.60 -2.10 -2.60
r«
-0.08 -0.50 -1.00 -1.50 -2.00
Zry

3" 0.40 -0.07 -0.60 -1.00 -1.50

0.94 0.40 -0.05 -0.50 -1.00
1.40 1.00 0.46 -0.03 -0.50
1.90 1.40 0.97 -0.02
1 2.49 1.99 1.50 1.00

Marcellus play
2.5 3 3.5 4 4.5 5 5.5
2 0 1 -0.4 -0.9 -1.4 -1.9 -2.4 -2.8
3 0.7 0.2 -0.2 -0.7 -1.2 -1.7 -2.2
4 1.4 0.9 0.5 -0.5 -1.0 -1.5
1.7 1.1 0.7 -0.3 -0.8
6 2.8 2.3 1.8 1.3 0.8 0.3 -0.1
7 3.5 3.0 2.6 2.1 1.5 1.0
8 4.2 3.7 3.2 2.8 2.2 1.7 ' 1-2

Haynesville play
6.5 7 7.5 8.5 9.5 10
-2.5 -2.9 -3.6 -4.0 -4.4 -5.0 -5.5 -6.0 -6.4
-1.5 -2.0 -2.6 -3.1 -3.5 -4.0 ^.5 -5.0 -5.5
-0.6 -1.1 -1.6 -2.1 -2.7 -3.1 -3.6 -4.0 -4.6
0.3 -0.1 -0.6 -1.2 -1.7 -2.1 -2.6 -3.2 -3.6
1.4 -0.2 -0.7 -1.3 -1.7 -2.1 -2.8
2.2 1.7 1.2 -0.3 -0.8 -1.3 -1.8
3.1 2.6 2.1 1.7 1.1 -0.5 -0.9

Montney play
5 5.5 6 6.5 7 7.5 8 8.5 9
2 -2.2 -2.7 -3.3 -3.6 -4.3 -4.7 -5.2 -5.8 -6.3
3 -1.5 -1.9 -2.5 -3.0 -3.5 -3.9 -4.5 -5.0 -5.6
4 -0.7 -1.3 -1.6 -2.2 -2.7 -3.2 -3.6 -4.3 -4.7
5 0.0 -0.5 -0.9 -1.5 -2.0 -2.4 -2.9 -3.5 -4.1
6 0.7 0.4 -0.2 -0.7 -1.2 -1.7 -2.2 -2.6 -3.2
7 1.5 1.0 0.6 0.0 -0.4 -1.0 -1.5 -1.9 -2.5
8 2.3 1.7 1.3 0.8 0.4 -0.2 -0.7 -1.3 -1.7

84
 Utica play
5.5 6 6.5 7.5
-2.3 -2.8 -3.5 -3.9 -4.4 -5
-1.8 -2.3 -2.6 -3.2 -3.8 -4.2
-1.0 -1.6 -2 -2.5 -3 -3.6
-0.4 -0.9 -1.4 -1.8 -2.3 -2.9
0.3 0.0 -0.8 -1.3 -1.7 -2.2
1 0.5 0 -0.5 -1 -1.6
1.7 1.1 0.7 02 -0.4 -0.9

85
A.4. Type Curves under 3 different production scenarios

(a), (b), (c), (d), and (e) represent cumulative production curves (EURs (bcf) on the y axis versus time (we
only consider the first 10 years of the total life span of wells) on the x axis) for Haynesville, Utica, Barnett,
Marcellus, and Montney P10, P50 and P90 wells, respectively.

(a) °

— PIO 7

— P50 6

— P90 5
4

i- 3

IO
(b)

«PIO - 7

P50 - 6
P90 --5

- 3

1- 1

10
(C)

86
 — PIO 7

— P50 6
— P90 5

- 4

- 3

- 1

(d)

(e) ° 10

87
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