Before the. 130 th General Assembly House Ways and Means Committee The Honorable Peter A. Beck Chair. Proponent Testimony on: House Bill 375

Transcription

1 Before the 130 th General Assembly House Ways and Means Committee The Honorable Peter A. Beck Chair Proponent Testimony on: House Bill 375 Presented By: Thomas E. Stewart Executive Vice President Ohio Oil & Gas Association January 8, 2014

2 Chairman Beck, Ranking Member Letson and members of the House Ways and Means Committee, thank you for the opportunity to offer Proponent testimony regarding House Bill 375. I am Tom Stewart and I serve as the Executive Vice President of the Ohio Oil & Gas Association (OOGA). The OOGA is a statewide trade association representing 3,172 members who explore for, develop and produce Ohio s crude oil and natural gas resources. The membership consists of people who professionally represent all phases of the exploration and production (E&P) process and all sizes of producers, from small independents to major oil companies. The membership comes from Ohio and 36 other states. Every producer that is currently active in drilling and developing Ohio s Utica Shale is a member of the Association. Additionally, long-established, Ohio-based OOGA members are now engaged or are preparing to engage in Utica development in this state. The OOGA has represented the Ohio E&P industry since Today s hearing focuses on House Bill 375, a proposal to reform Ohio s severance tax in light of recent activity to develop Ohio s resource shale play primarily in the Ordovician Utica Shale/Point Pleasant formation, deploying highly advanced horizontal drilling and formation stimulation technologies. Ohio Oil & Gas Taxation: Ohio s oil and gas industry and landowners pay many taxes. The majority of Ohio landowners with royalty interest must pay their proportionate share of taxes on oil and gas produced off of their land. The severance tax is just one of the taxes paid. In addition, the industry pays income taxes, commercial activity tax (CAT), sales taxes, ad-valorem taxes, fuel use taxes, employment taxes and all of the other taxes that any other traditional manufacturer pays. Landowners pay income taxes, CAT, ad-valorem and severance taxes. The oil and gas severance and ad-valorem are taxes that oil and gas companies and landowners pay. The severance tax predates other means of taxation such as an income tax. Its earliest mention is approximately 75 years ago. Some states enacted a severance tax to capture the value of their minerals before those products left the state. In terms of a low-population western state, this argument may make some sense. The mineral that is extracted finds its way to manufacturing centers in other states to be turned into useful products by workers in other states and consumed by citizens from other states. Therefore, the substantial value that was created from producing that mineral was captured in another place. In addition, when one looks at modern oil and gas exploration, deposits are being produced today that were previously unknown to exist or were un-commercial to recover. For instance, the production of the Utica in Ohio over the last several years has added billions of dollars to Ohio s economy, under the current tax structure. The economic impact of the production of these deposits has increased the value of the state, not decreased it. Ohio s historical manufacturing base was developed along with the oil and gas industry. Ohio is one of the largest consuming states of oil and gas in the nation, and has a large integrated economy. Unlike less populated states, we use the oil and gas that we produce in Ohio. In addition, it lowers the costs of oil and gas for all Ohioans, saving residents billions of dollars on their energy bills. 1 The Association s mission concentrates on oil and gas producers. OOGA s membership also includes industries and individuals who are allied to the exploration and production process including providers of all kinds of relevant professional services; suppliers of oilfield tubulars, equipment and material; pressure pumping, cementing and well stimulation services; geophysical and wireline formation evaluation services; providers of contract drilling and workover services; oilfield trucking and construction; produced water injection and transportation; the crude oil refining industry; the mid-stream natural gas gathering and processing industry; and the interstate natural gas transmission industry. Page 1

3 Ohio has a vested interest in promoting the production of oil and gas. This is probably why in its 150- year oil and gas history Ohio has never imposed a bigger severance tax. Ohio stands to gain more by the production of oil and gas; and doing anything to suppress production would cause a reduction in supply to consumers and a price increase. The state is better served from the economic activity generated from the availability and affordability of energy than a bigger severance tax. Locally produced oil and natural gas stays, for the most part, in Ohio and provides secure energy resources, reduces volatility and provides Ohio industries and consumers many millions of dollars in savings from avoided natural gas long-haul transportation costs. The dramatic ramp-up of natural gas supplies is confirmed by the marketplace s long-term outlook for natural gas prices. This saves Ohio consumers literally billions of dollars in avoided costs. Ohio is poised to be a leader in this industry. The existing Ohio severance tax is based on volumes produced and is dedicated by law to support the Ohio oil and gas regulatory program, whose distinctive expertise is required to oversee a complex and diverse industry. Using severance tax revenues specifically paid by the industry for oversight of the industry is in the public interest and the wisest use of those funds to ensure a robust regulatory program. Under this system every producer, from the smallest to the largest, contributes to the regulatory program based on the company s size, measured by output. The state s current severance tax was significantly modified in 2010 to create an effective rate, when combined with a regulatory fee, of three cents per MCF of natural gas and 20 cents a barrel of oil. The natural gas severance tax equates to nearly 1% of value. Therefore, it is 4 times higher than the CAT charged to all other manufacturers in Ohio; and, in addition to the severance tax, oil and gas producers and landowners must pay the CAT. The severance tax on oil is nearly equal to the CAT and again oil and gas producers and landowners are subject to the CAT. In addition, for many Ohio producers a significant portion of the income generated by an oil and gas well will be subject to Ohio income taxes. The legislature in 2005 exempted C corporations from income taxes. The 2005 law did not exempt businesses or landowners that file their business income on their personal tax returns. In addition to the severance tax that is paid to the state, an ad valorem tax goes to county governments. The ad valorem tax is a real property tax based on oil and gas deposits in the ground once a well is in production. In 2005 the General Assembly amended the ad valorem formula to account for the fact that Ohio eliminated tangible personal property taxes on businesses. To account for this change, the present value of the oil and gas deposits are calculated after deducting the costs of the drilling, completing and operating the well and landowner royalties. Generally, the ad valorem tax averages about 1% of gross income. Therefore, another tax nearly 4 times the size of the CAT is already in place for local government. State of the Utica Play: To date, success in the shale play has occurred primarily in seven eastern Ohio counties. (Please refer to the attached map 1). It is in this fairway or sweet spot that the best wells have been established. Fairway wells exhibit prolific initial natural gas production that has an elevated heat content higher Btu. Exploration work is also testing the reservoir in counties to the north of Carroll and west of Noble. Good production has been found in Monroe County, but it is mostly dry natural gas (largely methane at 1050 Btu) a situation that currently presents economic challenges when capital competes against areas more disposed to produce higher Btu natural gas. Utica producers are reporting oil production. In Ohio, liquids collected on the well location are sold as oil. However, in most cases these liquids are free condensates and natural gas liquids (NGLs) that have dropped out of gaseous phase at the wellhead due to pressure and temperature drop Page 2

4 as production flows through on-site separation equipment. Condensate is very light high gravity, sometimes clear, volatile oil that sells for less value than normal gravity (black) crude. Condensate is considered a natural gas liquid. (More on NGLs later.) The Utica Shale formation extends into mid-ohio, an area where the thermal maturity of the reservoir makes itself known as the oil window. It is located west of the fairway. Wells drilled in the oil window have been at best mediocre and for the most part failures. This is due to the realities of geology and the state of technological developments. The conclusion is that, to date, initial production results demonstrate that Ohio s Utica Shale play is a natural gas play with associated liquids. It is the higher Btu natural gas production produced in the fairway that makes the Utica an attractive play. Previous Tax Legislation: Previously introduced severance tax proposals imposed on shale wells a 1 percent gross receipts tax on natural gas production; a 1.5 percent gross receipts on crude oil production during the first year of production, escalating to 4 percent on oil after the first year; and a BTU-tiered tax scheme applied against average spot prices for refined products generated on the outlet side of a processing plant in an effort to capture the value of natural gas liquids processed from natural gas in the gaseous phase. In a manifest demonstration of the dangers associated with gross receipts taxes, during the final stages of House Bill 59 the proposal was (unsuccessfully) mutated to inflate the 4 percent tax to 4.5 percent. Remember a gross receipts tax imposes the tax burden regardless if the taxpayer is making a profit or not. The OOGA opposed the H.B. 59 tax proposal for many reasons. But specifically we opposed the 4 percent crude oil tax because it imposed the heaviest part of the tax on an area of the state that most needed risk-taking and investment. It closed the exploration window. Public policy picked winners and losers, limiting opportunity for Ohio s existing producers and Ohio landowners. According to the Administration s worksheets and budget data, the 4 percent proposal relied on Ohio generating within two years 300,000 barrels of oil per day. Ohio would move from 19th of all oil producing states to 5 th, overtaking Oklahoma. This would mean that within two years, it would be necessary that several eastern Ohio counties would have to produce nearly 5%, of all U.S. oil production considering the oil producing area of the United States stretches from the North Slope of Alaska to hundreds of miles out in the Gulf of Mexico. This was not going to happen. Newly released production data shows this to be true. House Bill 375: House Bill 375 is a sensible modification to the state severance tax structured to capture for the state the total value of energy produced at the wellhead the point of severance from the earth produced from resource shale wells. This method captures the total value irrespective of the commodity price or whether the hydrocarbon produced is oil or natural gas. It is very simple to administrate. Simply put, the tax is levied on the value of the commodity the producer receives at the wellhead multiplied by the tax rate. The proposal is based on sound economics and realistic oil and production characteristics. Additionally, the tax-reform package would eliminate the threat of higher taxes for the state s thousands of royalty owner and landowners a significant point of contention with previous proposals. H.B. 375 would not eliminate the severance tax imposed on conventional producers (as was promoted by previous proposals). But, H.B. 375 does lower the severance tax volumetric rate on Ohio s conventional producers who have been under duress due to the economic ramifications of shale development. Furthermore, H.B. 375 designates base revenues to support the state oil and gas regulatory agency, a critical matter on behalf of the public interest. Even more so, the proposal directs revenues to enhance the Idle & Orphan Well Plugging Program. Page 3

5 1. Creates a Reasonable Horizontal Tax Method: H.B. 375 imposes a 1 percent tax on the value a producer receives from the energy produced at the wellhead during the initial five years of a well s life, effectively providing a level playing field for all wells across the play. State tax policy cannot be based on results from the best wells located in the sweet spot of the sweet spot. That same tax policy must also encourage risk taking in areas of the play now considered marginal and thus encourage expansion of the exploration window and economic opportunity. The five-year cost recovery period is half of the maximum cost recovery period Texas provides tor high-cost shale development and is equal to that provided by Oklahoma. After five years the tax doubles to a 2 percent tax on the value a producer receives from the energy produced at the wellhead. The rate returns to 1 percent in the outer years of the well s decline curve at a time when the well is likely to be producing marginal volumes. This would encourage maximum recovery of the resource and avoid premature plugging. H.B. 375 imposes the tax on the value of the liquid uplift provided by the sale of NGL products, after consideration of the cost of third party processing which is a necessary cost to create that value. In effect, and in a very simple way, the value from the sale of these liquids will be considered as a value added on to the normal market price of natural gas. Generic analysis demonstrates that under current conditions shale gas averaging 1258 Btu will provide an additional value of $1.09/MMBtu, after processing, onto the price that the producer would have otherwise received had the producer simply sold that natural gas directly into the pipeline system without processing. Shale Well Revenue Pathway: There are three things a producer will find in the pore spaces of a reservoir rock: oil, natural gas and water. Water is a waste stream and an operating cost. Natural gas may have different values depending on the heat content of the gas. Therefore there are three potential taxable revenue streams that exist. But only two of those revenue streams can exist for any one particular well depending on the heat content of the well s natural gas production. (Please refer to the attached flow chart 2) Value 1: Crude oil, free condensate and NGLs captured on site are simply the amount of barrels produced multiplied by the NYMEX market price adjusted for basis differential. Value 2 - Dry Gas: If the well produces dry natural gas that generally has a Btu value of less than 1,100, then that producer will sell the well s natural gas directly into the marketplace and receive a value for that volume of natural gas multiplied by the NYMEX price per MMBtu adjusted for basis differential. OR Value 2 - Wet Gas: If the well produces wet natural gas that has a higher heat content value or Btu than dry gas, then that producer will 1) sell the tail/residue gas (natural gas that has been stripped down to pipeline quality gas) directly into the marketplace and receive a value for that volume of natural gas multiplied by NYMEX price per MMBtu adjusted for basis differential; and also 2) the producer will receive the value from the sale of NGL products sold at the outlet of the processor plant which would equate to gallons of products sold multiplied by the market price less fees paid to the processor to provide the service necessary to create that value. Page 4

6 To further explain midstream processing: Natural gas liquids (NGLs) are hydrocarbon components of natural gas that can be separated from the gaseous phase in the form of liquids using various processes, afterwards leaving mostly methane (CH4) in the gaseous phase. NGLs include low molecular weight hydrocarbon compounds such as ethane (C2H6), propane (C3H8), butane (C4H10), and natural gasoline. For the most part, these products have value. However, the Appalachian oil and gas fields are experiencing what is known as ethane rejection a supply and demand imbalance market condition whereby over-production of NGLs (usually ethane) coupled with lack of sufficient takeaway capacity results in significant amounts of recoverable ethane being left in the natural gas stream because it s more economic to do so. This situation is expected to continue for some time. Sample'1258'Btu'"wet'gas"' Sample'1100'Btu'"dry'gas"' Methane' Ethane' Propane' Iso'Butane' n1butane' Iso'Pentane' n1pentane' n1hexane'+' Methane' Ethane' Propane' Iso'Butane' n1butane' Iso'Pentane' n1pentane' n1hexane'+' CO2'and'other' Nitrogen' Nitrogen' CO2'and'other' Downstream of the well sites, processing plants are midstream facilities that perform a complex industrial process designed to remove the liquid hydrocarbons from the raw natural gas by separating the liquid hydrocarbons to produce what is known as pipeline quality dry natural gas (tail gas) that can be used as fuel by residential, commercial and industrial burner-tip consumers. Because the processor strips out several components from the natural gas, the volume of the tail gas is less than the volume that entered the plant. 2. Provides Tax Fairness to Ohio Taxpayers: Previous tax proposals stumbled when they were encountered with the fact that most Ohio landowners pay their share of taxes on oil and gas produced from their property, including severance taxes. The result would be an additional and unintended layer of taxation on Ohioans who were already paying income taxes on their royalties. This became one of the more contentious aspects of previous tax proposals. H.B. 375 provides the Ohio taxpayer an offset credit against the income tax, making the Ohio taxpayer whole and thus protecting the Ohio taxpayer against double-taxation. This proposal takes the landowner issue off the table. It s only fair. The income tax offset also impacts pass through business entities that report business income on their personal income tax. Some Ohio-based producers are pass through entities. Nearly all of the large producers who have come to Ohio are C Corporations who pay no income tax. This proposal would provide those Ohio producers a level playing field should someday they are in a position to compete against C-Corp producers in the shale play. In addition to the severance tax, shale producers (and potentially landowners) also pay the commercial activity tax (CAT). The Ohio oil and gas industry has two industry specific taxes not applied to other Ohio commercial concerns. H.B. 375 recognizes that shale producers would Page 5

7 already be paying a gross receipts tax, such as the CAT, only at rates initially four times the CAT and eventually eight times the CAT. To provide tax fairness, H.B. 375 proposes to exempt shale producers from the CAT tax. 3. Provides tax relief to Ohio s conventional producers: The resource shale play has had a dramatic positive impact on Ohio s economy while providing to Ohio consumers significant natural gas supplies priced at a substantial discount when compared to historical pricing. Shale development is extraordinary intense economic activity, driven so far by fairly large producers. These producers are competitively driven to validate acreage and establish production on a large scale. It is the nature of shale development. The result has fundamentally changed energy markets by driving down commodity prices at the wellhead. It has also driven up demand and costs for oilfield services and goods, including the acreage necessary to replace reserves. This situation has placed singular distress on Ohio s conventional producers who have essentially stopped drilling will likely be the lowest drilling year for conventional wells in modern history. The current prices for natural gas coupled with the costs to drill and complete wells and the astounding acreage costs makes nearly all conventional prospects uneconomic. Regulatory scrutiny focused on shale development is layering additional expense on conventional producers with the additional impact of removing previously accepted standards for drilling shallow wells. These are the same producers who have traditionally paid severance taxes to support the state regulatory agency united in their support to double the tax in 2010 for that purpose under Senate Bill 165. At the same time these producers were united in their support to proactively upgrade Ohio s oil and gas laws to address contemporary issues. But events have overtaken them. Without the ability to replace reserves their production income is depleting. It s time to address that reality and provide these Ohioans relief. The OOGA has always advocated that all producers, no matter how small or large, should pay a severance tax to support the state s oil and gas regulatory program. Clearly though, H.B. 375 will generate sufficient revenues to guarantee funding for this public interest need. It s time to give tax relief to the producers who have always stepped up to the plate on this issue. H.B. 375 will adjust the existing volumetric severance tax on conventional production while eliminating the regulatory cost recovery fee, effectively reducing the tax burden by half. This will help extend the life on marginal stripper production. 4. Support for the Idle & Orphan Well Program: Ohio is part of the oldest commercially producing oil and gas basin in the world. Since 1860 there have been over 260,000 wells drilled in this state, the vast majority of wells being pre-regulatory, pre-world War II. Just before Spindletop (1901) in East Texas, the Lima Findley Trenton field was the largest producing oilfield in the United States. For nearly a decade at the birth of the 20 th Century 6,000 wells were being drilled a year in the Trenton Field (with wooden rigs!). Drilling and production practices were primitive, including plugging practices. Many wells were left abandoned by people who remain unidentified and who no longer are alive. Since that time Ohio oil and gas law has been established to ensure that well owners are held responsible for the wells throughout the entire life of the well, including proper plugging and restoration. In 1977, Ohio created the Idle & Orphan Well Plugging Program for the purpose of identifying and properly plugging improperly plugged oil and gas wells for which there can be found no responsible person. Ohio was the second state to create such a fund and has been recognized a leader in this area of oil and gas protections. The Plugging Program has always been funded from a portion of severance tax paid to the state by oil and gas producers. In 2010, Senate Bill 165 mandated that the Chief of the Division of Oil & Gas Resources shall spend 14 percent of funds Page 6

8 credited to the Oil & Gas Fund to plug abandoned wells or address issues of imminent threat to the environment. House Bill 375 proposes to provide to the Idle & Orphan Well Plugging Fund up to 50 percent of revenues from the adjusted severance tax, above that already delegated to the regulatory programmatic funding, in order to create a very robust program that could potentially eradicate abandoned wells in this state. The OOGA is very supportive of this concept. Revenues: A recent newspaper article described H.B 375 as a tax on shale drillers that is lower than what (Governor) Kasich proposed. That is not accurate. During the cost recovery period H.B. 375 taxes natural gas, the primary product from the Utica Shale, at exactly the same rate as the Administration s proposal for the life of the tax. During the post cost recovery period - the period of full taxation - H.B. 375 actually doubles the tax on natural gas when compared to the Administration s proposal. Finally, H.B. 375 places equal taxation on oil, avoiding the Administration s tax on a product that would not have been delivered in the volumes necessary to make the H.B. 59 proposal realistically work. The effect is that the H.B. 375 tax proposal generates similar severance revenues prior to providing tax fairness to Ohio taxpayers. It does so without imposing punitive tax rates, particularly on those areas of the state that most require risk capital and technological investments necessary to achieve future success. Dr. Ben Thomas from the Marietta College School of Petroleum Engineering and Geology will testify today on revenue projections using the H.B. 375 tax methodology. Dr. Thomas analysis is based on conservative assumptions using industry marketplace standards and applied to sound petroleumengineering principles that account for the impact of depletion on a shale well decline curve. Generally, this revenue model demonstrates that the H.B. 375 tax model could generate nearly $2.7 billion over a ten-year period, prior to providing tax offsets to Ohio taxpayers. $3,000$ Esmated)Ohio)Severance)Tax) (Annually)and)Cumulave)Ten)Year)Total)) 5)Year)CCR)Period) $2,500$ $2,000$ $)Millions) $ Cumulave)Severance)Tax) $)Millions) $1,854$ $2,255$ $2,689$ $1,500$ $1,000$ $876$ $1,161$ $1,489$ Annual)Severance)Tax) $)Millions) ) $500$ $0$ $637$ $424$ $241$ $96$ 2014$ 2015$ 2016$ 2017$ 2018$ 2019$ 2020$ 2021$ 2022$ 2023$ Page 7

9 Conclusion: H.B. 375 will provide much needed clarity for oil and gas producers who have already heavily invested capital in this state and plan to invest billions more to explore the state s Utica Shale reservoir. OOGA recognizes that the ongoing debate about increasing the severance tax has created an air of uncertainty within the industry. Resolving this issue in a fair and balanced way will allow oil and gas development to flourish in eastern Ohio, which in turn will expand economic opportunity and job growth throughout the state. Finally, House Bill 375 provides much needed tax fairness and protection to eastern Ohio landowners who, in many cases, have been waiting all too long for opportunity to come their way. The Ohio Oil & Gas Association urges the House Ways and Means Committee to favorably report H.B. 375 to the House floor. Respectfully submitted, Thomas E. Stewart Executive Vice President Ohio Oil & Gas Association 88 East Broad St., Suite 1400 Columbus, Ohio stewart@ooga.org Page 8

10 Tom Stewart serves as the executive vice president of the Ohio Oil and Gas Association (OOGA), having been elected to that position in September Stewart is the chief executive officer of the Association and its operations; editor of the Association s publications; an industry spokesman to media outlets and other forums; treasurer of the Association s political action committee; and serves as the public policy advocate in Columbus and Washington D.C. on behalf of OOGA s members interests. Stewart serves as the Ohio associate representative to the Interstate Oil and Natural Gas Compact Commission (IOGCC) ( having been appointed to that position by Governor George Voinovich in IOGCC is an organization of governors of the oil and natural gas producing states established to promote the conservation and efficient recovery of domestic oil and natural gas resources while protecting health, safety and the environment. Stewart is an active participant with the Independent Petroleum Association of America (IPAA)( ) and serves on the IPAA Environment and Safety Committee, the Communications Steering Committee, the Gas Pipeline Safety Sub-Committee, Stewart is a founding member of the management team organizing the national BRIEF Project (Bringing Real Information on Energy Forward) that has evolved into the Energy in Depth Program (EID). ( Stewart serves as the executive director of EID - The Ohio Project. In December 2001, Stewart was elected to the Board of the State Review of Oil and Natural Gas Environmental Regulations, Inc. (STRONGER) as one of three representatives for the U.S. oil and gas exploration and production industry. On August 31, 2012, Stewart was selected to serve as chairman of the STRONGER Board, marking his second rotation through the organization s officer seats. From August 2002 to November 2005, Stewart served as the secretary treasurer of the Liaison Committee of Cooperating Oil and Gas Associations. The Liaison is a national network organization of state and regional trade associations that represent the independent oil and gas exploration and production industry in the United States. Stewart was responsible for coordinating the organization s efforts. Prior to joining OOGA, Mr. Stewart has fifteen years of formal experience in the oil and gas industry as an oil and gas producer and provider of contract drilling services. He is the third generation of his family to engage in exploration, development and production of crude oil and natural gas. The family heritage extends back to the original oil regions of western Pennsylvania and southeastern Ohio. Thomas E. Stewart Executive Vice President Ohio Oil & Gas Association stewart@ooga.org Page 9

11 LORAIN TRUMBULL ME RCE R 1292 ME DINA PRODUCING DRILLED, DRILLING OR INACTIVE PERMITTED OR NOT DRILLED SU MMIT PORTAGE UTICA HORIZONTAL WELL STATUS THROUGH 11/30/2013 REPORTED INITIAL PRODUCTION GEAUGA CUYAHOGA ATTACHMENT 1: MAHONING LAW RENCE 560 WAYNE ST ARK MORG AN 977 BELMONT MARSHALL GREENE 772 OHIO NOBL E WASHINGTON MUSKINGUM BROOKE Miles MONROE 2000 GUERNSEY PERRY HARRISON LIC KING JEFFE RSON 668 Ü COSHOCT ON IP VALUES AS REPORTED TO THE STATE ON COMPLETION REPORTS. BARRELS OF OIL EQUIVALENT (BOE/D) CALCULATED AS 6 MCF NATURAL GAS PER DAY EQUALS 1 BOE/D. IP VALUES GREATER THAN 500 BOE/D ARE POSTED (SOME VALUES ARE NOT SHOWN FOR CLARITY) KNOX 1046 PRODUCED AS GAS BEAVER HOLMES PRODUCED AS OIL ,000 TUSC AR AWAS BBLS OIL EQUIVALENT PER DAY COLUMBIANA ASHLAND INITIAL PRODUCTION AS REPORTED WETZEL (614) MARION P a g e 1 0

12 ATTACHMENT 2: Flowchart of the Revenue Pathway for a Typical Utica Shale Oil & Gas Well Producer (Severer) Well Owner, Operator and Permit Holder Revenue Sale of crude oil or free condensates (barrels x NYMEX (+/-) basis differential) Producer s Accounting/ Distribution Payments Utica Shale Oil & Gas Well On Site (The Pad) Oil & Gas separation, crude oil storage, natural gas production lines Lease Contract Jt. Interest / Working Interest Partners & Overriding Royalty Interest Mineral Owner Royalty Interest (Lessor) Fractionator Separates Liquids into Pure Products Revenue Sale of Natural Gas Liquids ((Gallons x Market Price) - Processing & Midstream Gathering Fees) = Net Value back to Wellhead fee for service via contract Propane Iso-Butane Butane Natural Gasoline Interstate Transmission Line High-Pressure, High Volume Delivery to Utilities and Consumers Gas Measurement Custody Chromatograph Meter Cryogenic Processing Separates Liquids from the Gas Stream Inlet Compression Assume Ethane Rejection with Ethane Tail (Residue) Natural Gas = 1050 Btu Approx. 85% of original gaseous volume Refiner buys Crude Oil / Free Condensate: Truck pickup and delivery to refinery Midstream Gathering Lines & Relay Compression Outlet Compression IF Wet Wet High Btu Natural Gas at > 1100 Btu Dry Dry Natural Gas at < 1100 Btu (Methane) Relay Compression Pipeline Quality Gas Sold to End-User (Burner-tip) Market Revenue Sale of Dry or Tail Gas (Dth x NYMEX (+/-) Basis Differential) - 3rd Party gathering fees Key: The Producer: Exploration & Production Crude Buyer/Refiner: Purchases Crude Oil and/or Condensate Midstream Industry Sector Midstream Natural Gas Gathering Pipelines and Compression Midstream Natural Gas Gathering Pipeline Pathway Midstream Natural Gas Processing Plant - Stripping NGLs from Gaseous Phase Revenue Source: Back to the Producer Revenue Pathway to the Producer Page 11