California Needs a Crude Awakening: Drill, Baby, Drill!

After the Deepwater Horizon oil rig exploded in the Gulf of Mexico in April 2010, the Obama administration slapped a moratorium on deepwater drilling in the Gulf and backed away from plans to expand drilling along the eastern United States. Louisiana’s governor, Bobby Jindal, saw thousands of jobs at stake and demanded that the moratorium be lifted. But the governor of California, Arnold Schwarzenegger, responded differently: he withdrew his support for Tranquillon Ridge, an offshore drilling project that would have delivered up to $100 million in yearly revenue to the financially struggling state government.

Schwarzenegger’s reaction was a prime example of California’s animus toward oil drilling. Tranquillon Ridge wouldn’t have required a new drilling platform; it would have used an existing one. That platform stands in a safe 242 feet of water—Deepwater Horizon was drilling in about 5,000 feet—and is far from any coastal towns. Environmental activists had even cut a deal with the driller to retire the platform after 14 years. It was a deal with low risks and no losers. But news coverage from the Gulf blinded Schwarzenegger. “I see on TV the birds drenched in oil, the fishermen out of work, the massive oil spill, and the oil slick destroying our precious ecosystem,” he declared at a May 2010 news conference. “That will not happen here in California.”

California pays a high price for its aversion to oil. By refusing to tap much of the oil wealth off its shoreline, the state is forgoing a resource that could go far to revive its economy and bring state and local governments back to fiscal health. On dry land, too, California is missing an opportunity: its vast onshore oil reserves are underused, thanks to a green-energy agenda that raises the cost of oil production and refining. Policymakers have to realize that their quixotic quest to outgrow fossil fuels isn’t helping the state.

You wouldn’t know it from recent history, but the Golden State’s gold has been as much black as yellow. A century ago, California’s cities and future suburbs bristled with oil towers, especially in and around Los Angeles. At one point, in the mid-1920s, the state produced about a quarter of the world’s oil; today, this would be a bigger share than that of the largest two producers—Saudi Arabia and Russia—combined. With all this oil came plenty of money. In the words of author Eric Schlosser: “In many ways Southern California was the Kuwait of the Jazz Age.” Oil was part of the California dream.

But California’s attitude toward oil began to shift in January 1969, when a well six miles off the Santa Barbara coast blew out just after workers had finished drilling it. The spill—the largest in American waters at the time, now ranked third, behind the Deepwater Horizon and Exxon Valdez spills—received saturation press coverage, united Santa Barbara residents in outrage, and caught the oil industry flat-footed. “I am amazed at the publicity for the loss of a few birds,” said Fred Hartley, president of the Union Oil Company. His words simply raised the outrage level higher.

The impact of the Santa Barbara spill extended far beyond California; more than any other single event, it brought the various strands of environmentalism and conservation together into a national movement. Among other things, it inspired Gaylord Nelson, then a U.S. senator from Wisconsin, to promote the first Earth Day, and it spurred the creation of the Environmental Protection Agency. But the spill’s most immediate result was that California stopped leasing tidelands—the zone within three nautical miles of shore, whose resources the state owns—to oil companies. Not a single acre of this oil-rich seabed has been auctioned since, though drilling continues in areas leased before 1969.

Natural resources more than three miles offshore belong to the federal government, which continued to lease tracts off California through 1984. But then Congress cut off funding for further leases. Consequently, California’s onshore and offshore production hit its all-time peak in 1985—424 million barrels, 13 percent of the U.S. total—and then began declining. Falling oil prices in the 1980s also took their toll on production, both onshore and off. In 1990, President George H. W. Bush issued a moratorium on new leasing in most of the waters under federal jurisdiction, including all zones off California. Plans to open up the California areas briefly revived under George W. Bush in 2008, but the Obama administration has put them back on hold.

Onshore, the situation is less dire: new wells are continually being drilled, mostly on private or federal land. But the state no longer goes out of its way to attract oil investment, and environmental and land-use laws give local opponents tools to stymie drilling plans. Outside of regions like the southern San Joaquin Valley—where drilling has been an important part of the economy and landscape for a century or so—Californians don’t like drilling rigs and can block projects at the local government level. This past March, to take one example, the planning commission in San Luis Obispo County rejected a plan to drill a dozen new wells, with one commissioner arguing that “the isolated and pastoral Huasna Valley” was “not a suitable place for oil production,” as the local Tribune put it.

Another problem for onshore oil producers is California’s ambitious climate-change law, AB 32, passed in 2006 but only now starting to take hold in the form of specific regulations. When fully in effect, it will slam drillers with a double whammy. First, as users of fossil-fuel energy for such extraction techniques as steam injection, they will be placed under a cap-and-trade system that amounts to a carbon tax. If they can’t reduce their greenhouse-gas output to the required levels, they and other affected businesses will have to pay $500 million a year or more to buy carbon credits.

Second, AB 32’s Low Carbon Fuel Standard (LCFS) requires that the “carbon intensity” of all transportation fuels sold in California—a measure of how much greenhouse gas they emit in their entire life cycle, from production and transportation to combustion—fall by 10 percent by 2020. The problem is that at least half of California’s crude oil must be extracted from the ground by means of energy-intensive steam injection, according to a 2011 analysis from the state’s energy commission. That crude, therefore, will have a high carbon intensity, and under the LCFS, it will be at a competitive disadvantage with imported crude oil, which tends to have a lower carbon intensity. So despite having ample in-state refining capacity, California producers may have to send much of their oil overseas to find a market for it. (Worsening America’s dependence on oil imports is another probable effect of the LCFS.)

Despite its evident distaste for oil, California is still the country’s fourth-largest producer—behind Texas, Alaska, and North Dakota—and yields more than 15 million barrels per month, about 9 percent of the U.S. total. That doesn’t count the output from offshore federal tracts, which is much smaller than that of the Gulf of Mexico but still a respectable 22 million barrels per year.

And the state’s roughly 50,000 wells, both onshore and offshore, still have plenty of oil available for pumping. According to 2011 estimates from the U.S. Department of the Interior, federal tracts off the shore of Southern California alone probably hold 5.32 billion barrels of recoverable oil. Onshore, rising prices have breathed new life into old fields, and drillers are using methods such as steam injection to coax oil out of wells that would be dry by now with conventional pumping. “What has been produced in California is only 25 percent of what is in the ground,” says Iraj Ershaghi, a professor of petroleum engineering at the University of Southern California. “Lots of small producers are going after small fields that have been abandoned.”

The biggest onshore story is the potential of the Monterey Formation (also known as the Monterey Shale), a zone of petroleum-rich rock that extends much of the state’s length. The Monterey holds an enormous amount of oil, estimated at up to 500 billion barrels. Though it has long been difficult to extract oil directly from it, advancing technology, along with rising oil prices, has put much more of its oil within reach. If even a small fraction of its reserves proves accessible, the Monterey would be the biggest shale oil play in the nation. In July 2011, the federal Energy Information Administration (EIA) estimated that the Monterey had 15.4 billion barrels of recoverable crude—four times what’s estimated to lie within the Bakken shale formation, which is fueling North Dakota’s current oil boom. Those 15.4 billion barrels would be worth about $1.5 trillion at today’s crude prices.

The potential impact of 15.4 billion barrels of oil is enormous. Even if California managed to tap just half of that quantity over the next 35 years, the state would be adding an average of 220 million barrels a year—doubling its current output and matching its peak year of 1985. It would also be pumping $22 billion each year into its economy if crude prices stayed near their current levels (in light of global demand, it’s more likely that prices will rise). If the EIA estimate is reasonably close to the mark, the Monterey Formation would be in a class with oil fields in Saudi Arabia. “Having a field like this on American soil would be a game changer for American dependence on foreign imports,” says Chris Faulkner, CEO of the Dallas-based exploration company Breitling Oil and Gas.

The state could certainly use an oil boom right now. Its jobless rate is stubbornly running nearly 3 percentage points above the national average, and most new drilling in the Monterey Formation would be taking place in the San Joaquin Valley, where unemployment is chronically high. (In the four counties most likely to be sites for drilling—Kern, Fresno, Tulare, and Kings—the March 2012 jobless rate averaged 17.5 percent, compared with 11.5 percent for the state as a whole.)

Simply looking for oil provides an economic boost. Operating one drilling rig creates 100 jobs, says Rock Zierman, head of the California Independent Petroleum Association. The oil-field service firm Baker Hughes reports that 46 rigs are currently active in California. If drilling were to return to early-1980s levels, tripling that count to more than 130 rigs, the 100-to-one ratio means that more than 8,400 new jobs would be the result. And oil-field jobs are well paid. According to the Bureau of Labor Statistics, the average pay in the Kern County oil fields in 2010 was $66,700 a year for a rotary-drill operator, $46,580 for a derrick operator, and nearly $36,000 for a roustabout (an oil-field maintenance worker)—not counting overtime, which can be generous in oil and gas work. None of these jobs requires more than a high school education.

Oil drilling also produces plenty of revenue for the government. For starters, there are the sales, income, and property taxes that oil producers pay—and it’s worth noting that the state’s property assessments take the value of proved reserves and extracted oil into account, meaning that the more oil is discovered, the higher the assessment and the higher the tax revenue. Then there’s the 16.67 percent royalty that California takes from oil pumped from state-owned land and waters. In just the first decade of the 2000s, state leases inside the three-nautical-mile limit pumped $2.4 billion in royalties into the state treasury. The state also gets half of the royalties on oil pumped from federal land in California, as well as 27 percent of royalties from oil produced in federal waters up to six nautical miles offshore. In a 2011 study, University of Wyoming energy economists Timothy Considine and Edward Manderson estimated that fully developing the oil and gas reserves in the state and federal waters in the Santa Barbara Channel would generate nearly $33 billion (in 2010 dollars) in tax and royalty revenues for state and local governments over 20 years.

It’s too early to tell how much of a boost the state would gain from tapping the Monterey, but the impact could be huge—“potentially at a much larger scale” than the development of the offshore resources, Considine and Manderson say. The state government would reap these rewards without having to spend much initially, since the oil industry provides its own infrastructure of pipelines, tanks, pumps, drilling rigs, and refineries. All the drillers need is a green light.

Well before the state flashes that light, revenue-starved local governments may create an oil boom of their own. The city of Whittier, just east of Los Angeles, has agreed to let the Santa Barbara–based Matrix Oil Corporation drill on 22 acres of city-owned land, now part of a 1,290-acre open-space preserve. The project is tied up in lawsuits (three, at last count), but if it can run that gauntlet, it could net the city as much as $115 million a year, according to an economic study done as part of its environmental-impact report.

Oil is appealing not only because it brings in a substantial sum of money through royalties but also because it can be extracted from small surface footprints. Slant-drilling equipment taking up just a few acres can reach oil five miles away or farther. In the same way, onshore rigs can easily reach oil under state-leased seabed up to three miles offshore. The risks of such land-to-sea drilling are almost nil, since any spills at the drilling site would be on land and easily manageable. In fact, the risks of drilling in water are low as well, to judge from the record. Estimates of the 1969 Santa Barbara spill run from 80,000 to 100,000 barrels. But in the more than four decades since, according to federal data, all oil spills off California’s coasttotaled less than 900 barrels. The Coal Oil Point seep, a natural feature just off the Santa Barbara coast, releases that much oil in a typical week.

Despite California’s history of discouraging drilling with environmental laws and land-use regulations, the state’s track record with the oil industry has not been completely bleak. Governor Jerry Brown sent a positive signal last fall when he fired two officials who had sharply slowed down the process for issuing new drilling permits. He followed that with the year-end appointment of Tim Kustic—“a geologist who knows the industry,” says Zierman—as the chief drilling regulator. Occidental Petroleum CEO Steve Chazen gave Brown a nod at the company’s fourth-quarter conference call in January: “We are pretty encouraged by the way things are going now. . . . The governor is very pro-jobs.”

But the larger balance of political forces hasn’t changed. The state shows no signs of abandoning its quest for freedom from fossil fuels. Until California surrenders to realism, its oil drillers will be fighting political and regulatory headwinds. If they can look anywhere for hope, it’s not to the political elites but to the broader public. Ordinary Californians are not anti-oil ideologues, and a fair number favor drilling off the state’s coast. In a July 2011 poll by the Public Policy Institute of California, the drilling question produced a nearly even split, with 46 percent in favor and 49 percent opposed. As might be expected, support was lower in coastal regions but still significant, at 40 percent. Nearly half of Californians, then, understand the connection between their automobile-based lifestyle and those platforms dotting the channel off Santa Barbara.

And pro-drillers aren’t always a minority in these polls. In the summer of 2009, a low point for the U.S. and California economies, 51 percent of the PPIC respondents said yes to offshore drilling. The following year, just after the Deepwater Horizon blowout, opinion lurched to the negative, with only 36 percent in favor of offshore drilling and 59 percent opposed. The lesson is that Californians’ views on oil aren’t set in stone. They can change dramatically, depending on what they see on the news or feel in their pocketbooks.

The pocketbook issue that matters most, says political scientist Eric R. A. N. Smith, is the price of gasoline. Smith, a professor at the University of California at Santa Barbara, has been studying public opinion on oil drilling since the mid-1990s. He says that the main objection to offshore drilling is its risk, followed by aesthetics; people prefer not to see oil platforms when they look out at the blue Pacific. Green ideology—such as the argument that drilling will make California more dependent on fossil fuels—is less important. That may explain why Californians consistently back the goals of AB 32, at least in PPIC polls, while blowing hot and cold on offshore drilling. That is, despite their wish to cut down on greenhouse gases, they’ll take the oil if they think that the state needs it to keep the price of gasoline down. “If gasoline prices are stable, then probably opinions would stay the same as they are,” says Smith. But he thinks that global supply and demand will drive prices up—and then, he says, new drilling will finally commence off the coast.

If he’s correct, the prospects for the local economy would be bright. California was once a genuine petro-state, one of global importance. If it so chooses, it stands a good chance of becoming one again.

(Tom Gray, a former editorial-page editor at the Los Angeles Daily News and senior editor at Investor’s Business Daily, writes on California’s economy and politics. Originally posted on City Journal.)