- The EIA's revised estimate of Monterey shale, while dramatic, has very little impact on the energy industry.
- Occidental shareholders may be punished but the damage may not extend far beyond it as much of the industry has been skeptical about Monterey shale.
- The energy industry is on a long-term march to convert to renewables such as solar and wind and the change in Monterey shale estimates has no meaningful long-term impact.
The US Energy Information Administration's view of recoverable shale resources took a big turn yesterday when the news media reported that the EIA is about to officially cut its estimate of Monterey shale recoverable resources. This is not good news for Occidental Petroleum (NYSE:OXY) but Monterey shale had its doubters for a while now and some of the downside has already been priced into the stock. However, the magnitude of the revision, a 96% cut, is likely to be a surprise to investors and Occidental shareholders may not like what lies ahead.
For Occidental investors and others chasing Monterey shale, this was always a highly speculative play. Setting aside concerns from California environmentalists and their strong opposition to fracking, many in the industry have expressed significant doubts about the size of Monterey shale resources. Had the industry found this formation to be more competitive, we would have seen substantially more industry and regulatory action in California by now. For some examples of past industry skepticism, see here and here. Occidental's intent to split California operations last year was also an indicator that Occidental itself had questions about the value of the deposits or doubted its ability to convince the markets about the deposits.
But does this downgrade really change the long-term energy story in California or rest of the world?
For us, this new story is just a blip on a long-term story of energy. We see shale as an excellent short-term stop gap as the energy industry transforms from fossil fuels to renewables - in particular solar and wind.
Wind energy, in many instances, has already achieved a Levelized Cost of Energy (LCoE) well below that of natural gas. And, Solar energy is now rapidly approaching the stage where it will be cost competitive with natural gas on an LCoE basis in many situations. To be sure, Wind is nowhere near ready to take on the role of replacing Natural gas due to technology limitations. And, solar needs to ride further down the cost curve before it can become a meaningful energy source to the world.
The key difference between solar and natural gas is that, while natural gas prices are likely rise over the long term due to resource extraction limitations, solar prices will fall due to technology advancements. The limitations of the solar energy plants, such as their intermittent production profile, are expected to be substantially solved with cost effective storage technology in about a decade. Given that these two energy technologies have opposing cost curves, the end result is a foregone conclusion. It is only a matter of "when" and not "if."
In the new world, the companies energy investors should be looking at are not just the Oil & Gas companies, but renewable technology companies such as First Solar (NASDAQ:FSLR) (see thesis here), SunPower (NASDAQ:SPWR) (thesis here), SunEdison (NYSE:SUNE) (thesis here), JinkoSolar (NYSE:JKS) (thesis here), GE (NYSE:GE), and NRG Energy (NYSE:NRG).
In summary, we believe the announcement about Monterey shale to be a side show in the energy transformation that has been underway in the US and around the world. The negative views on Monterey may have impact on players like Occidental but does not really change the industry prognosis.
Our Sentiment on OXY: Avoid