California's Drought Puts These Companies' Plans On the Brink of Failure

The drought effecting the West Coast has highlighted problems with utilities switching to natural gas, but there's also concerns about the amount of water used in the drilling process, too.

Mar 1, 2014 at 1:30PM

Hydraulic fracturing is a key factor in the United States' energy resurgence. However, as the name implies, the process uses water—that's an increasingly scarce resource on the West Coast right now. Basically, drought is just one more reason to be concerned about natural gas is this country.

Sunny California
The drought that's hitting the western portion of the country has caused a number of problems. For example, California has been forced to limit water supplies to farmers and warned about power problems if consumers don't conserve. While the impact of a drought on farms is pretty straightforward, why would it impact electricity markets?

Craquelure

California is home to about 14% of the country's hydroelectric power, so less water means less power. That, in turn, means other power sources have to make up the balance. Unfortunately, the state has been shifting more and more toward gas and away from base-load power sources like nuclear and coal. There are legitimate concerns that there aren't enough pipelines to supply all the natural gas needed to power California.

Water and drilling
But that's not the only problem with natural gas when it comes to water. The dramatic increase in the fuel in this country has been driven by a technique called hydraulic fracturing. Essentially, water and other materials, like sand and chemicals, are forced underground to free up natural gas so it can be brought to the surface.

Erdoelbohrung

According to a recent report from Ceres, although California gas drilling makes relatively light use of water resources, "Nearly all hydraulic fracturing water use in California is in regions of extremely high water stress..." and, " Most of the industry's activity is centered in Kern County, which has a large agricultural water demand..."

That, essentially, pits natural gas drillers like ExxonMobil's (NYSE:XOM) XTO Energy and Occidental Petroleum (NYSE:OXY) against food and electricity interests with regard to water. That's probably not a fight that either wants, particularly Exxon, which has already admitted that it paid too much when it bought natural gas specialist XTO at the turn of the decade. Occidental, meanwhile, counts California as one of its four key focus areas. Not only is Occidental the largest landowner in the state, but it spent about a quarter of its capital budget there in 2013.

Not the only place with problems
California, however, is just an example. According to Ceres, "More than 55% all U.S. wells are in areas experiencing drought." In other words, natural gas drillers could increasingly have to deal with local concerns about water. Chesapeake Energy (NYSE:CHK) is practically the poster child for the issue, since it, "was the biggest user of water for hydraulic fracturing at 12 billion gallons..."

Now that activist investor Carl Icahn has ousted Chesapeake's CEO and replaced him with a drilling focused leader, water shortages are probably the last thing management wants to deal with. Paying off a heavy debt load with land sales is complex enough, with some industry watchers suggesting it's selling assets at fire-sale prices.

Anadarko Petroleum (NYSE:APC), meanwhile, was found to have, "the highest water risk exposure... with more than 70% of its wells in high or extremely high water risk regions..." The thing is, Anadarko has been selling foreign businesses, including a recent divestiture of Chinese assets, to help fund its U.S. drilling program. So the company is basically doubling down on its water risks.

Not now, but maybe soon
The water issue as it relates to hydraulic fracturing hasn't grabbed the public's attention yet. However, if you own Anadarko, Chesapeake, Exxon, or Occidental you should keep an eye on the news. If drought conditions don't improve, these drillers, and many more, could quickly find themselves the unwanted center of attention. Although that may not be such a big deal for a massive company like Exxon, smaller players might find the fight distracting. They may also lack the political and financial strength to keep the water flowing into their wells, which would be particularly bad for business. And even if the current drought doesn't bring the fight to the fore, this issue isn't going to away.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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