4 Reasons Fracking Isn't Dead in California

Why the Monterey might succeed in spite of itself.

Jul 19, 2014 at 9:54AM

One of the big questions about the American energy industry is whether or not California's Monterey formation, which in 2012 the EIA estimated to contain nearly two-thirds of the United States' technically recoverable tight oil reserves, will be developed on a large scale in the relatively near future. Today the Monterey produces only about 3% of American oil that is extracted from shale. The reasons it has not been developed so far are well known; these include California's environmentalism, high state taxes, expensive land, shortage of freshwater (which fracking uses intensively), geological discontinuities, and the possibility that, as a more recent EIA report claims, past estimates of California's shale potential were wildly overblown.  

Here, however, are some of the reasons the Monterey might soon be developed in spite of these factors:

If the US finally allows its oil to be exported, much of the demand for that energy will come from Asia as a result of South Asia's emerging economy and China's attempt to diversify away from coal . Given that it is expensive to pipe energy long distances across the US heartland and Rocky Mountains from states like Texas and North Dakota to the Pacific, or to ship it in a roundabout way through the Panama Canal (the canal's upcoming expansion notwithstanding), it may fall disproportionately to California, the only Pacific state other than Alaska that produces fossil fuels, to export oil to Asian markets if it can produce enough to do so. 

Indeed, Californian oil exports to Asia will not face too much competition from the rest of the Western Hemisphere either, as the vast majority of Latin America's energy production and reserves are located on the Atlantic side of the Panama Canal and Andes Mountains, and because Canada is likely to subsidize infrastructure that transports much of Alberta's oil to or through Ontario and Quebec rather than to Asia in order to keep the Canadian economy from fragmenting. This will give California a tremendous financial incentive to export oil to Asia. However, even if California were to dramatically decrease its own consumption of oil, it would still not have enough oil to start exporting unless it develops its shale deposits

Carbon emissions 
If the US government were to eventually impose a state limit (or cap-and-trade system) on per capita carbon emissions, as many Democratic voters would like it to, California would almost certainly come in well below any limit it assigns. In spite of producing the fourth largest amount of oil and ninth largest amount of energy in the United States, California's per capita carbon emissions are the lowest of any state aside from New York, barely more than half the national average and just 8%-35% as high as other leading fossil fuel producers like Texas, North Dakota, Louisiana, Alaska, and Wyoming. This could give California room to increase its emissions at a time when all of the other states involved most heavily in fracking will be forced to lower their own. 

Diminishing shale returns   
One of the biggest concerns some people have about fracking is that the incredible production gains it has yielded will be temporary; that each well will quickly deplete, forcing many thousands of wells to be drilled, which will be invasive, damaging to the local environment, cause earthquakes, etc. Some economists have also claimed that each basin will quickly deplete, the reason being that many of the most productive wells have presumably already been developed within each basin. If either of these things -- particularly the latter -- are true, it could lead to a situation where the US is replete with fracking expertise and equipment, yet has few areas left to frack. If this were ever to occur, energy companies might all come knocking at California's door. This is especially true because almost half of the recoverable oil reserves in shale deposits outside of the United States are predicted to be in Russia and China, where American energy firms might have a difficult time operating for political reasons.

Fracking, or more specifically the injection of water underground that accompanies fracking, seems to cause earthquakes in areas not otherwise prone to them -- states that include all of America's foremost frackers. Because shale wells run dry far quicker than conventional oil wells, requiring new wells to be drilled constantly, these earthquakes could be likely to increase in occurrence and magnitude over time. In states that are already prone to earthquakes, however, like California, some have argued that fracking may actually be likely to decrease the magnitude of earthquakes, since the lower-intensity earthquakes induced by fracking might release pressure on geological formations and so prevent more powerful earthquakes from occurring as often as they otherwise would. 

Crucially, California already has a lot of infrastructure that is designed to withstand all but the highest intensity earthquakes, whereas other states engaged in fracking mostly do not. As a result, it might be the case that earthquakes will lessen the economic viability of fracking in almost every state other than California, while not much affecting the economic viability of fracking within California. In fact, the likeliest solutions to fracking-related earthquakes are for energy companies to try to develop better ways to treat and recycle wastewater rather than dispose it underground, or else to use substances other than water, such as propane gel or compressed air, in the initial fracturing process. Either of these solutions could have the unintended consequence of helping California to overcome the water shortages that have so far limited its ability to frack. 

Foolish takeaway
All of this would seem to make hydraulic fracturing in California a high-risk, high-reward industry. If you're looking to make an investment of this sort, the most direct way to do so would be to invest in energy companies operating within California. This could include Occidental Petroleum (NYSE: OXY), the largest private energy producer in California -- though admittedly Occidental has said it may soon spin its Monterey holdings off onto a separate company. Venoco, which over the past few years has made major attempts to develop Monterey shale using fluids other than water in the fracturing process, could be a good bet as well if it becomes publicly traded again as it was prior to 2013.  

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Joseph Shupac 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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