California oil companies were the third largest producers of petroleum in 2016, but the state is often overlooked by investors and competitors.
While Texas and North Dakota lead the U.S. in production, California finds itself in a unique position because it imports 70% of its crude oil. The state also saw a decline in production in 2017 to 3.53 MMbbl in February, according to data from the Energy Information Administration (EIA), the independent statistical arm of the Department of Energy based in Washington, D.C.
In the 1980s, California produced on average over 30 MMbbl a month, but production has steadily declined since then because most of the major fields in the state were discovered before 1920 and are under secondary and tertiary recovery, mostly from enhanced thermal techniques, said Patrick Morris, CEO of New York-based HAGIN Investment Management. California’s extensive shale reserves and diatomite formations have yet to be fully exploited by independents and remain largely untapped. California has not permitted a new offshore well since 1969.
While investors often mistakenly believe that California is a difficult state to work in because of its tighter regulatory framework, the state ranks third in oil refining capacity as of January 2017 with 18 refineries, according to the EIA.
“The perception is that it’s too risky because of the regulations, but California is an overlooked opportunity for producers despite the hurdles,” he said.
As demand in California continues to rise, production has dipped, giving California’s main producers an opportunity to benefit from higher oil prices with some companies receiving a premium to WTI and Brent prices for their crude oil. The cost to transport oil into California is high due to a shortage of transportation infrastructure including rail.
While California used to import more oil from Alaska, that state is also producing less oil. California is importing its oil from Canada, Saudi Arabia and other countries from the Middle East and South America.
”Alaskan oil production has dropped dramatically due to low crude oil prices, high drilling and operating costs and the recent changes in the state’s tax rebate policies,” Morris said.
One advantage of drilling in California is that many of the fields have more sand thickness in their composition and less rock, making drilling 10,000-ft wells less costly at an average of $1.2 million to $2 million per well, said Rod Eson, CEO of Foothill Energy, which owns and operates oil and gas properties in Texas and California and produces 200 barrels of oil per day (bbl/d) within 3 sq. mi. in California.
Eson says states like Colorado and Louisiana also have their barriers to entry because their state regulations can be strict while Texas has its drawbacks because it is highly competitive.
“The environmental guidelines are tougher than other places, but reasonable and companies just need to work with the counties and cities,” he said. “It’s easy to drill in California—it’s a give and take, and we have learned how to work with the regulators.”
Since the refiners in California need light oil to blend, producers are reaping the rewards of higher oil prices.
“There are opportunities in California—the newer technology in the rigs has reduced costs,” Eson said. “We can live with oil being $50 to $60 a barrel because we can still make a profit.”
Despite the perception that working in California is more challenging, oil companies can thrive in the state as long as they budget for more time to obtain permits and other regulatory approvals, said Trem Smith, CEO of Berry Petroleum, a Bakersfield, Calif., exploration and production company which emerged from the Linn Energy bankruptcy in March 2017 with new management and board members. Berry’s oil and natural gas reserves are located in the San Joaquin Basin in Kern County, Calif., the Uinta Basin in Utah, the Piceance Basin in Colorado and the East Texas Basin in Texas.
The company is focused on California since 70% of its total fourth quarter 27,000 boe/d production is derived from the state.
“It is certainly manageable, but do not pretend your company can do it faster than the law allows you to,” he said. “Having prior overseas experience myself, I find it refreshing to have rules. If you don’t like it, then there are probably better places for you to be.”
California is not unique its regulatory and environmental requirements, says Smith.
“California is not exempt,” he said. “Texas, Utah, Colorado and Pennsylvania have their own regulatory issues. There is always pressure and politicians trying to change things.”
The state is a growth opportunity for Berry since the San Joaquin Basin still has a tremendous amount of untapped oil to be recovered since it is known as a “Super Basin.” Midway-Sunset, Kern River, South Belridge and the Elk Hills fields have produced approximately 8.5 Bbbl or oil.
While most industries fear more competition, Smith says the addition of more producers than the existing ones would be good for the industry. California has historically had few operators and the current landscape is dominated by Chevron, CRC, Aera Energy, a joint venture of Shell Oil and ExxonMobil, and Sentinel Peak.
“Some of the producers in California are producing from existing oil fields and are not actively looking to grow,” he said. “We view that as an opportunity and it would be nice to have more operators in the basin.”
Berry has been focused on increasing their production and reported a 3% fourth quarter increase compared to third quarter in 2017.
“We turned around a significant inherited production decline of 20% in 2017,” Smith said. “Production is moving up and our wells have a low natural decline.”
While California is not a “walk in the park,” once investors see the data, they tend to change their mind, he said. Since the basins have conventional, shallow wells, drilling can be completed for $300,000 to $500,000 within seven days and is typically cheaper than hydraulic fracturing.
The decline in production in the state needs to be reversed.
“We have lots of opportunities to expand in the Belridge, Midway Sunset and McKittrick oil fields,” Smith said.
The chronic energy deficit in California needs to be changed, said Todd Stevens, CEO of California Resources Corp. (NYSE: CRC), a Los Angeles-based oil and natural gas exploration and production company which produces 126,000 bbl and is the largest operator in the state.
“California is misunderstood and like an island since transporting oil by rail is too costly,” he said. “However, our crude oil has less impurities and is better for refiners.”
Production in the state remains high—Kern County, which includes Bakersfield, produces more crude oil than the state of Oklahoma.
As oil prices have rebounded, investors have shifted their attention to CRC’s inventory and how the company will add value.
“Investors now realize the opportunities are there and California is not dramatically different from Colorado or Pennsylvania,” said Stevens. “It would help to have competition.”
Any opinions expressed by Hart Energy contributors are their own.