(Bloomberg Opinion) -- It would be understandable if your first reaction to news that California’s governor has slapped restrictions on fracking was: They frack in California?
California actually ranks seventh in terms of state oil output, just behind Alaska.(1) Yet California is usually noted more for its thirst for the stuff, with its legions of drivers consuming more gasoline than in any other state. In terms of production, you’re more likely to associate California with barrels of Cabernet than crude.
Which goes a long way to explaining why Governor Gavin Newsom made his move.
Newsom hasn’t banned fracking in California — indeed, he says he isn’t empowered to do that unilaterally. Rather, in response to oil spills in Kern County, he has ordered regulators to assess the safety of a different technique for stimulating wells, called cyclic steam-flooding, use of which has surged in California. However, he has also taken the opportunity to order that new permits for fracking be subject to scientific review and that the whole permitting process undergo an audit by the state’s Department of Finance.
Phrases like “subject to review” and “undergo an audit” are most unwelcome in the planning departments of oil producers. Few things undercut the value of a project quite like time or uncertainty. So anything that delays drilling outright or puts enough doubt in the mind of the operator (or their financiers) about the viability of doing so effectively does one thing: raise the cost of capital. Exhibit A is what Newsom’s announcement on Tuesday did to the stock of California Resources Corp.:
California Resources rushed out a statement saying it doesn’t rely on cyclic steam-flooding and that less than a tenth of its wells used any sort of stimulation techniques in recent years. But that’s the thing about doubt and the sense that the governor of your titular state really just isn’t fond of oil and gas production: It persuades investors to shoot first and (maybe) dig into the details later. (It doesn’t help that California Resources sports leverage of 3.7 times Ebitda, but still.)
There’s a similar dynamic at play in Colorado. Last November, the state’s voters rejected a ballot measure that, again, wouldn’t have banned fracking outright but would have instituted minimum distances between buildings and wells that would have severely curtailed fracking anyway. Yet even though proposition 112 failed to pass, the state announced last month it would impose additional scrutiny on wells drilled within 2,000 feet of homes anyway, in response to a study finding heightened risk of benzene exposure within that distance. Hence, stocks of Colorado-exposed drillers remain under pressure:
California and Colorado are relative anomalies among America’s top oil-producing states. Both, unusually for such states, either tilt Democratic or lean outright. Moreover, and perhaps linked to that, their diversified economies mean they may be relatively big producers but aren’t what you would call resource states:
Citing that same data from his firm, Kevin Book of ClearView Energy Partners sums up Tuesday’s announcement in the context of its impact on California’s oil and gas production like this: “Newsom. Simply. Doesn’t. Care.” Curbing drilling in California should, all else equal, raise the cost of oil and, thereby, the state’s already famously high pump prices. Still, as I wrote here in the run-up to last year’s midterms, despite high prices and those clogged freeways, the burden of gasoline as measured against average income in California is relatively low. It’s also worth remembering that Kern County voted 59% for Newsom’s opponent and, above all, accounted for less than 2% of statewide ballots. Politically speaking, Newsom may be obeying the law of small numbers here.
California and Colorado may be relative oddities in the club of fossil-fuel states. But the tensions on display there between resource producers and their opponents intersect with wider forces acting on the energy industry.
One is the fragmentation of policies at more localized levels in the face of federal efforts to block or roll back measures to address climate change. California’s battle with President Donald Trump (and several large automakers) over fuel-economy standards is another prominent example of this.
Plus, in California and Colorado, we can see intimations of how America’s division between urban and rural voters affects energy and climate policy. Colorado’s disputes arise in part because fracking there is running into urban expansion in one of the fastest-growing populations in the country. This dynamic is worth watching in other states where the fracking boom has revived production relatively close to large population centers, such as Pennsylvania and Ohio.
Above all, Newsom’s decision can be viewed as another example of tactics aimed not at outright bans of fossil-fuel production, but the imposition of measures or delays that upend the economics of the business. Battles against key pipelines can be viewed through this prism, too.
One of the results of several decades of ignoring or obfuscating the costs of climate change is that the measures proposed to address it have become more interventionist in direct proportion to the increasing urgency of the issue. Calls for market-based solutions such as carbon taxes have increased in volume. But they now face real competition from demands for things like outright bans on fracking or phasing out internal combustion engines.
Disasters such as California’s wildfires show the costs of ignoring climate change will show up in disruptive ways. Similarly, having helped stymie a broader, coordinated approach to climate change, the energy business should brace for more disjointed disruption on the policy front.
(1) Based on trailing 12-month state oil production data through August 2019 (source: Energy Information Administration).
To contact the author of this story: Liam Denning at firstname.lastname@example.org
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Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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