Editor's note: Originally published on Wednesday, May 21, 2014
The U.S. shale oil "miracle" has about as much believability left as Jimmy Swaggart. Just today, we learned that the EIA has placed a hefty downward revision on its estimate of the amount of recoverable oil in the #1 shale reserve in the U.S., the Monterey in California.
As recently as yesterday, the much-publicized Monterey formation accounted for nearly two-thirds of all technically-recoverable U.S. shale oil resources.
But by this morning? The EIA now estimates these reserves to be 96% lower than it previously claimed. Yes, you read that right: 96% lower. As in only 4% of the original estimate is now thought to be technically-recoverable at today's prices:
EIA Cuts Monterey Shale Estimates on Extraction Challenges
May 21, 2014
The Energy Information Administration slashed its estimate of recoverable reserves from California’s Monterey Shale by 96 percent, saying oil from the largest U.S. formation will be harder to extract than previously anticipated.
“Not all reserves are created equal,” EIA Administrator Adam Sieminski told reporters at the Financial Times and Energy Intelligence Oil & Gas Summit in New York today. “It just turned out it’s harder to frack that reserve and get it out of the ground.”
The Monterey Shale is now estimated to hold 600 million barrels of recoverable oil, down from a 2012 projection of 13.7 billion barrels, John Staub, a liquid fuels analyst for the EIA, said in a phone interview. A 2013 study by the University of Southern California’s Global Energy Network, funded in part by industry group Western States Petroleum Association, found that developing the state’s oil resources may add as many as 2.8 million jobs and as much as $24.6 billion in tax revenues.
From 13.7 billion barrels down to 600 million. Using a little math, that means the hope for 2.8 million jobs become 112k and the $24.6 billion in tax revenues shrink to $984 million.
The reasons why are no surprise to my readers, as over the years we've covered the reasons why the Monterey was likely to be a bust compared to other formations. Those reasons are mainly centered on the fact that underground geology is complex, that each shale formation has its own sets of surprises, and that the geologically-molested (from millennia of tectonic folding and grinding) Monterey formation was very unlikely to yield its treasures as willingly as, say, the Bakken or Eagle Ford.
But even I was surprised by the extent of the downgrade. This takes the Monterey from one of the world's largest potential fields to a play that, if all 600 million barrels thought to be there were brought to the surface all at once, would supply the U.S. oil needs for a mere 33 days.
Yep. 33 days. And along with that oil come tremendous water demands, environmental, infrastructure and air pollution damages.
So if you do go for it California, the rest of the country will be your best buddy for a little more than 4 weeks. But don't keep calling us afterwards, as we'll be off to the next oil party (if there are any other ones to be had). But know that, sure, we still respect you.
Of course I'm being sarcastic here. But if I lived over or near a shale formation, I would be putting up a hell of a fight to prevent the many long-term damages and airborne pollutants that inevitably accompany such short-lived fracking operations.
At this point, you might be wondering just how the EIA got its estimate so badly wrong. The answer is that the EIA relied on a private firm, one now scraping corporate relations and PR egg off its face:
U.S. officials cut estimate of recoverable Monterey Shale oil by 96%
May 20, 2014
Federal energy authorities have slashed by 96% the estimated amount of recoverable oil buried in California's vast Monterey Shale deposits, deflating its potential as a national "black gold mine" of petroleum.
Just 600 million barrels of oil can be extracted with existing technology, far below the 13.7 billion barrels once thought recoverable from the jumbled layers of subterranean rock spread across much of Central California, the U.S. Energy Information Administration said.
The new estimate, expected to be released publicly next month, is a blow to the nation's oil future and to projections that an oil boom would bring as many as 2.8 million new jobs to California and boost tax revenue by $24.6 billion annually.
The 2011 estimate was done by the Virginia engineering firm Intek Inc.
Christopher Dean, senior associate at Intek, said Tuesday that the firm's work "was very broad, giving the federal government its first shot at an estimate of recoverable oil in the Monterey Shale. They got more data over time and refined the estimate."
Wait a minute. The 2011 California shale oil estimate that launched a flotilla of excited "shale miracle" headlines, led the EIA to publish an estimate of the Monterey at 13.7 billion recoverable barrels, and helped to form a national narrative around potential U.S. "energy independence" was done by a Virginia engineering firm?
Okay, well who are they exactly? Looking at their website, clearly put together using cheesy stock photos, early Internet font formats, and touting the fact that they've been a business "since 1998" doesn't quite project the hoped-for aura of gravitas and seasoned competency:
Seriously? A clock in an arch? Typing fingers? A woman gesturing in a meeting and a guy on a phone? I mean, does anyone other than me have a "no lame stock photos" requirement of the businesses they use to generate the data used to justify a major geopolitical energy realignment? It's the closest thing I have to a hard rule.
Okay, just kidding again....sort of.
At any rate, the bottom line here is that the EIA relied on this firm's back-of-the-envelope calculations which turned out to be -- surprise! -- unreliable. And now, Occidental Petroleum (NYSE:OXY) is scrambling to get its assets out of the Monterey and deployed somewhere more promising. The lesson to be learned here is: don't believe every headline you read. Consider the source, and more importantly -- stock photos or not -- always question the data.
Price, It's Always About Price
However, I cannot completely write off the entire 96% as 'gone' because the media has left off the most important part, as they always do: the role of price. Without having access (yet) to the latest well data to know exactly what sort of potential disaster we're dealing with, the correct way to write-down an oil resource is to say: at today's oil prices, this asset can yield (or is worth) $X.
At higher prices, it is certainly true that more of the resource will be 'worth' going after. But as you and I know, the price mechanism is just a means of obscuring the most important variable: the net energy that will be returned from a given play. Generally speaking, the higher the price (which is often a function of the energy required to extract), then the less net energy will come from that play.
So anytime we hear that a given play is being 'written down', as the Monterey is in rather spectacular fashion, what's really being said is that the net energy from the play is a lot less than prior and/or existing plays, and will not be useful to us until higher oil prices come along.
In the case of the Monterey, much higher prices. Whether we have an intact, functioning and highly complex economy of the sort necessary to develop and deliver the technology required to prosecute such low-yielding plays is another matter entirely. My best guess as of today is, 'probably not.'
Today's write down of the Monterey shale asset is a huge blow to Occidental Petroleum specifically, to California's energy and employment dreams more broadly, and to the U.S.'s energy dreams at a national level.
This is not surprising at all to anybody following the shale story with a critical eye. We always knew that the best plays were being prosecuted first for obvious reasons; it's human nature to go after the easy stuff first. And this is especially true for the folks in the oil patch.
The best plays were tapped first, not by some accident of technology or lucky holes plunged into the ground, but because they were cheapest to prosecute. The remaining shale deposits are less rich, more costly to explore, and the profitable pockets much harder to find.
Your main take-away is this: the U.S. has a lot less shale reserves on the books today than it did yesterday. Look for future downward revisions as the other remnant shale plays are poked and prodded and found to be wanting.
Investors need to be wary here too. The hype about shale prospects are wedded to a Wall Street cheap capital machine that is showing clear signs of over-heating:
Shale Drillers Feast on Junk Debt to Stay on Treadmill
Apr 30, 2014
Rice Energy Inc. (NYSE:RICE), a natural gas producer with risky credit, raised $900 million in three days this month, $150 million more than it originally sought.
Not bad for the Canonsburg, Pennsylvania-based company’s first bond issue after going public in January. Especially since it has lost money three years in a row, has drilled fewer than 50 wells -- most named after superheroes and monster trucks -- and said it will spend $4.09 for every $1 it earns in 2014.
The U.S. drive for energy independence is backed by a surge in junk-rated borrowing that’s been as vital as the technological breakthroughs that enabled the drilling spree. While the high-yield debt market has doubled in size since the end of 2004, the amount issued by exploration and production companies has grown nine-fold, according to Barclays Plc. That’s what keeps the shale revolution going even as companies spend money faster than they make it.
“There’s a lot of Kool-Aid that’s being drunk now by investors,” Tim Gramatovich, who helps manage more than $800 million as chief investment officer of Santa Barbara, California-based Peritus Asset Management LLC. “People lose their discipline. They stop doing the math. They stop doing the accounting. They’re just dreaming the dream, and that’s what’s happening with the shale boom.”
I guess there's a little less dreaming going on in the Monterey shale patch this morning. Not to pick on RICE here, because they are more typical than not, but when you are spending $4 to earn $1, somebody ought to be asking some hard questions. Especially the investors.
More broadly, I have been clearly concerned by the recent reports indicating that the shale operators have been spending far more in CAPEX than they’ve been generating in operating earnings.
That's a larger subject that I've covered in more detail in recent reports, but the summary is this: over the past four years, free cash flow (FCF) has been negative for most of the major shale players.
Which leads us to the really big question: When will all these shale drilling efforts actually generate positive FCF?
In the case of the Monterey, and at today's prices, the answer looks to be 'Never.'
Disclosure: No positions