The L.A. Times spilled the beans last week that the Energy Information Administration is set to severely downgrade the Monterey Shale in California in an upcoming report. Once thought to hold 13.7 billion barrels of technically recoverable oil, the EIA now believes only about 600 million barrels are accessible. Slashing technically recoverable estimates by 96 percent could be enough to kill off the shale revolution in California before it really got started.
But why is the difference between the two estimates so staggering? Much of the hype surrounding the Monterey was based off a rudimentary 2011 assessment by Intek Inc., an engineering firm based in Virginia. The firm was so off on its projection of recoverable oil reserves because it used some shaky assumptions – and essentially concluded that the shale revolution going on elsewhere in the United States could easily be replicated in California despite there being key differences.
However, there have been warning signs before this report. According to an impressive report put together by geoscientist J. David Hughes late last year, the Monterey has very little in common with the Bakken or Eagle Ford, and he concluded that the Monterey formation would never live up to its billing.
For example, with less than a few hundred feet of thickness, the much older Bakken and the Eagle Ford formations are predictable and straightforward. The Monterey, on the other hand, is often over 2,000 feet thick. Also, it’s unlike the flat layered formations in the Bakken, which makes drilling relatively easy, the Monterey has a series of layers that are folded on top of each other. And the Monterey was established in a tectonically active area, making it highly unpredictable and geologically complex. This presents enormous engineering difficulties, and essentially seals off much of the oil located in the Monterey given today’s technology and prices.
But without its own survey, the EIA relied upon Intek’s inaccurate estimates back in 2011 and it has been the baseline from which everyone has been working.
Moreover the error-filled 2011 estimate of the Monterey was used in a 2013 economic analysis by the University of Southern California, which found that the state of California could reap as much as $24.6 billion per year in tax revenue, and create as much as 2.8 million jobs by the end of the decade by allowing shale development. Such heady estimates are too big to ignore for state policymakers, and Governor Jerry Brown has publicly supported hydraulic fracturing in a standoff with environmentalists.
That means that with the massive economic projections now deflated, the political tide could also turn against oil and gas companies in the state, further adding to their woes. The legislature is considering a statewide ban on fracking, a move that will no doubt pick up some momentum on the news that the Monterey actually will not deliver huge benefits to California. And with 100 percent of the state suffering from drought, using millions of gallons to frack a single well is drawing the ire of such disparate factions as farmers, ranchers, environmentalists, and average residents. A recent poll indicates that a majority of Californians now support a statewide moratorium on fracking.
“The cost-benefit analysis of fracking in California has just changed drastically,” State Senator Holly Mitchell, sponsor of anti-fracking legislation, recently told ABC News. “Why put so many at risk for so little? We now know that the projected economic benefits are only a small fraction of what the oil industry has been touting. There is no ocean of black gold that fracking is going to release tomorrow, leaving California awash in profits and jobs.”
Although it was merely one estimate, the erroneous 2011 projection fueled a land rush that may now come undone. It was published in an era when shale oil and gas was positively booming in other parts of the United States. If the industry had figured out how to get oil and gas out of shale in the Marcellus, the Bakken, and the Eagle Ford, then surely the same was in store for the Monterey. The industry jumped in.
But now with much of the Monterey’s oil out of reach for now, the bubble that inflated the value of many companies holding acreage in California could be set to burst.
The biggest loser from EIA’s downgrade is going to be Occidental Petroleum (NYSE: OXY), the largest acreage holder in the Monterey. The 1.2 million acres under Occidental’s control is spread up and down the Central Valley and also outside Los Angeles. The prospective revenues expected to flow from those holdings was thought to be huge.
Currently trading at around $96 per share, the company hit an all-time high in 2011 when it announced a big California discovery. Occidental was thought to be sitting on 10 billion barrels of oil, and some analysts speculated that the stock price could jump to nearly $200 per share. But drilling results and production have been disappointing since then.
Occidental has been trying to spin off its California operations into a standalone business, and the value of such a company was estimated to top $16 billion, according to a Deutsche Bank estimate last year. But if Occidental is only able to recover a very small fraction of what the market previously thought it could, its value could take a huge hit. And with a market cap of $76 billion, its theoretical $16 billion worth of California assets going up in smoke could do real damage.
Venoco Inc., a company that used to trade publicly under the ticker symbol VQ but was taken private in 2012, is an independent driller that has focused on the Monterey – with little to show for it. It owns 46,000 acres in the Monterey and drilled 29 wells between 2010 and 2012, but was not able to produce anything. It has since paired back capital expenditure due to the poor results. The latest EIA revision merely confirms the terrible experience Venoco has had in the Monterey.
Other companies are not as exposed to the Monterey as Occidental. Freeport McMoRan (NYSE: FCX) holds about 70,000 acres in the Monterey, but much of it is legacy oil and gas acreage for conventional production. The prospect of Freeport seeing much production from its shale acreage just took a bit of a hit, but the company hasn’t done much drilling and wasn’t putting much in the way of new capital expenditures into shale exploration anyway.
Bigger oil and gas companies have thus far been eyeing the Monterey without dropping huge outlays to get in. That leaves Occidental as the odd one out. The company thought it was getting in on the ground floor, but will have to face up to the fact that the Monterey formation – which was billed as holding two-thirds of the entire shale oil resources in the United States – will turn out to be a massive disappointment.