Climate Change and Scenario Analysis

SWN is committed to – and recognized for – the responsible development of needed energy resources, and we recognize the concerns of our stakeholders about climate change. We also understand that regulations and practices aimed at protecting the environment, and specifically reducing greenhouse gas (GHG) emissions, can affect our business. We consider these issues as part of our risk management process.

In addition to efforts to limit emissions in our own activities, we consider the long-term consequences of new regulations and industry-leading practices aimed at limiting climate impact. We closely follow developments in policy and stakeholder sentiment, including through frequent engagement with local community members, government officials and investors. We also consider future price and demand projections, such as those from the Annual Energy Outlook published by the U.S. Energy Information Administration (EIA) and from the World Energy Outlook published annually by the International Energy Agency (IEA). We are particularly interested in price and demand projections regarding low-carbon natural gas, which along with natural gas liquids (NGLs), comprises essentially all of our production.

Demand for Natural Gas Is Likely to Increase

Demand for natural gas and associated NGLs in the U.S. and around the world will grow through 2050 under a wide range of scenarios, according to the EIA.1  The IEA, in its 2017 publication Perspectives for the Energy Transition, similarly concludes that new gas resources must be developed, even under the organization’s stringent 66% 2°C Scenario (i.e., a 66 percent probability of limiting global temperature increases to 2°C).2  The report states that even under this aggressive scenario “natural gas plays an important role in the transition across several sectors.”3  Under the IEA’s New Policies Scenario (in which countries adhere to the policy commitments they made in the 2015 Paris climate agreements), natural gas demand is likely to increase by 70 percent from 2014 to 2050, primarily due to increased demand for electricity generated by lower-carbon sources.4

“Expansion [of U.S. shale gas production] on this scale is having wide-ranging impacts within North America, fueling major investments in petrochemicals and other energy-intensive industries.”IEA, World Energy Outlook 2017, Executive Summary, p. 4

With substantial low-cost reserves, SWN is well positioned to produce and deliver natural gas and NGLs needed to meet this growing demand.

SWN’s Proved Reserves Are Likely to Be Produced Under Stricter Policies

SWN reported 14.8 trillion cubic feet of gas equivalent (Tcfe) of proved reserves as of year-end 2017. Reserves are a direct and commonly used measure of how much gas or oil a company will be able to produce profitably. We believe that substantially all of SWN’s proved reserves as of year-end 2017 are likely to be produced even with heightened climate-change policies and practices.

The U.S. Securities and Exchange Commission (SEC) requires that energy companies report their reserves according to specified methodologies. Under these requirements:

"Proved oil and gas reserves are those quantities of oil and gas, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible – from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations – prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. The project to extract the hydrocarbons must have commenced or the operator must be reasonably certain that it will commence the project within a reasonable time."5

Thus, under the SEC’s rules, proved reserves must be economically producing or be certain of starting production within a few years. Importantly, any changes to regulations to combat climate change that impact production levels, methods, costs and/or demand for the commodities we produce would be reflected in the periodic reporting of reserves. If and when these measures arise, the transparency of reserve reporting assures that investors will quickly see their impact.

The following factors point toward SWN’s ability to develop substantially all of our current proved reserves, even with stricter climate-related regulation and practices:

  • Like most energy companies, the vast majority of SWN’s existing proved reserves are likely to be produced within 10–15 years.6
  • As noted above, the IEA has concluded that gas demand will increase under its New Policies Scenario, and that new gas resources must be developed even under its strict 66% 2°C Scenario. Which reserves will be produced depends on supply and demand.
  • Regulations or practices focused on mitigating climate change can affect demand by limiting the amount of natural gas that can be consumed or encouraging consumption as a substitute for higher-carbon fuels. As a simple matter of economics, should demand fall, the reserves with the lowest marginal cost of production are the most likely to continue producing.
  • Currently producing reserves – reserves with wells in place and connected to pipelines, which comprise more than 50 percent of the reserves shown in SWN’s year-end 2017 SEC filings – are likely to continue producing, as the marginal cost of producing from existing wells is small.
  • SWN’s core nonproducing reserves are in the Appalachian Basin, which as the figure below shows has some of the lowest breakeven production costs in the United States, the only market where SWN operates.7

Thus even if prices fall due to higher production or lower demand, SWN’s core assets are among the most likely to continue producing and to be developed.

Rystad Energy, a leading global source of energy data and a consultant on energy matters, has projected energy commodity demand at various prices under various climate-change scenarios, including:

  • The IEA’s 450 Scenario
  • The IEA’s New Policies Scenario
  • The IEA’s 66% 2°C Scenario
  • The IEA’s 66% 2°C Scenario adjusted for lower methane emission levels due to changed processes in producing, transporting and consuming natural gas

Rystad Energy also tracks information on producers such as SWN, computing costs and comparing them to its projection of demand and the impact of the scenarios above. As the following chart shows, the weighted average cost of producing SWN’s reserves – which Rystad defines substantially the same as the SEC except for future price and cost assumptions and including the reserves from all our producing areas – is well within even the IEA’s stringent 66% 2°C carbon budget and thus are likely to be produced.

Scenario analysis can be a valuable risk management tool to assess potential future risks and opportunities under specific sets of assumptions. But there are numerous pathways to achieve the 2°C goals, and the oil and gas industry has shown continued ability to adapt and implement new technologies to unlock new resources while minimizing its carbon footprint. Hence, these scenario analyses are not predictions of what will happen but merely a mathematical projection of potential outcomes of the current portfolio under specified assumptions. As with any projection of future outcomes, what actually happens may differ, and perhaps dramatically.  

SWN Weighted Average Cost of Supply vs. U.S. Supply Curve in Various Scenarios

SWN Weighted Average Cost of Supply vs U.S. Supply Curve in Various Scenarios

Of the scenarios described, only the 66% 2°C adjusted for low methane takes into account changes in production, transportation and combustion designed to limit emissions. As the figure above shows, these steps can unlock significant additional demand for natural gas. As the IEA recently reported, “Implementing these measures in the New Policies Scenario would have the same impact on reducing the average global surface temperature rise in 2100 as shutting all existing coal-fired power plants in China.”8  SWN has been an early adopter and innovator in reducing emissions from our operations and encourages downstream sectors to do the same.

SWN Is Not Likely to Spend Capital on Assets That Will Be “Stranded”

When making an investment in new wells or reserves, an oil and gas company such as SWN must consider whether it will be able to recover the capital it deploys, in light of a host of factors, including new regulations and policies such as those designed to limit climate change. Capital conceivably could become “stranded” if policies shift after a company has made large capital investments that must be recovered over decades – e.g., transportation and processing infrastructure or massive-scale projects requiring long lead times, such as large non-U.S. or offshore projects.

But as the IEA points out:

"[T]here is no reason why other upstream oil and gas assets should become stranded in the transition [to a lower-carbon economy], provided the process is one in which a consistent and credible course towards decarbonisation is pursued. . . . [I]f the path towards the 66% 2°C Scenario is clear and visible to investors, there would be little reason for oil and gas companies to develop new resources in the expectation of a much higher trajectory for demand and prices."9

In accordance with SWN’s Formula, we wisely invest within the cash flow that is generated by our underlying assets. In deciding on new projects, we are committed to choosing only those that are projected to generate at least $1.30 for each $1 invested on a discounted basis. Should policies and practices aimed at mitigating climate change alter demand for our commodities, costs of production or both, our planning practices take those modifications into account.

SWN practices capital discipline. After a dramatic fall in natural gas prices that began in late 2014, SWN ceased drilling entirely in January 2016. We resumed drilling as prices stabilized later that year, but reduced our capital investments to $1.3 billion in 2017, with a similar level budgeted for 2018.

As regulations and norms change, SWN’s business practice shows that we can adjust our capital expenditures to levels projected to generate an attractive return.

Some organizations have published studies purporting to show probabilities of “stranded assets” by projecting the cost of developing individual companies’ resources – including resources not yet found – and estimating how much of those additional capital expenditures might not be recovered if changes in policy and practices to achieve the 2°C limit curb demand or production. These studies, however, assume that oil and gas companies in fact will spend capital developing the resources, even when recovering their costs is unlikely. As the IEA points out, that defies common sense.

A better focus is on the probability that reserves will be produced, not what it takes to produce all reserves when that is not rational.

Conclusion

SWN’s low-cost resources are well positioned under multiple 2°C scenarios. Our leadership in reducing GHG emissions further enhances our ability to comply with new policies and practices. Our capital discipline constrains us from investing in assets that are unlikely to recover their capital costs. Any impacts that do affect the ability to produce reserves would be reflected under SEC regulations governing the reporting of reserves.

  1. EIA, Annual Energy Outlook 2018 (AEO 2018), p. 61, https://www.eia.gov/outlooks/aeo/pdf/AEO2018.pdf.
  2. IEA & International Renewable Energy Agency (IRENA), Perspectives for the Energy Transition, p. 108, http://www.irena.org/DocumentDownloads/Publications/Perspectives_for_the_Energy_Transition_2017.pdf. The 66% 2°C Scenario and its companion, the IEA 450 Scenario, are pathways designed to achieve the “carbon budget” limiting concentration of GHGs in the atmosphere to 450 parts per million of carbon dioxide, the level at which global temperatures should rise no more than 2°C. Although this report was published jointly by IEA and IRENA, certain chapters reflect the views of only the EIA or only IRENA. The passages cited are from an IEA-only section.
  3. Ibid., p. 9. In the 66% 2°C Scenario, global gas demand grows until the mid-2020s and then falls to 16 percent below current levels by the middle of the century.
  4. Ibid., p. 61.
  5. 17 CFR § 210.4-10(a)(22) (emphasis added). Undrilled locations must have a development plan with drilling scheduled within five years. 17 CFR § 210.4-10(a)(31)(ii).
  6. IHS Markit, Do Investments in Oil and Gas Constitute Systemic Risk?, https://ihsmarkit.com/research-analysis/do-investments-in-oil-and-gas-constitute-systemic-risk.html.
  7. Gas associated with low-cost oil production, such as in the Permian Basin, also has a low breakeven cost. SWN currently is pursuing strategic alternatives for our Fayetteville Shale assets, which according to the chart that follows has the highest breakeven cost of our principal assets. SWN without Fayetteville is concentrated almost entirely in the low-breakeven Marcellus and other Appalachia areas.
  8. IEA, World Energy Outlook 2017, Executive Summary, p. 8. http://www.iea.org/Textbase/npsum/weo2017SUM.pdf.
  9. IEA, Perspectives for the Energy Transition, p. 108.