The Railroad Commission of Texas (RRC) will hold a hearing tomorrow morning to discuss the possibility of prorationing Texas oil production after receiving a petition from Pioneer and Parsley. The hearing comes as the COVID-19 pandemic has reduced national and global oil demand and significantly lowered crude prices.
While the RRC undoubtedly has the authority to regulate production, it does not have the resources. Proration requires up-to-date production data, a large number of employees with technical knowledge, a large budget, and the will to enforce the policy aggressively. The RRC does not have any of these requirements.
What does history tell us?
History shows us that regulation without the ability to monitor or enforce creates chaos and wastes taxpayer money. The discovery of the East Texas oilfield in Rusk County, Texas, in 1927 led to continuous production increases until oil prices collapsed to 10 cents a barrel. In an effort to raise prices, the RRC issued its first proration order for the East Texas field on April 4, 1931, effective May 1.
However, the order created unrest and violence in the area. Producers refused to comply and continued to increase production. In response, the Texas legislature passed the Oil Conservation Act in a special session called by the governor. However, proration was challenged in federal courts and a three-judge panel sided with oil producers against the Commission.
On August 17, 1931, Governor Sterling, claiming insurrection, declared martial law in the East Texas Oilfield, and asked General Jacob Wolters to lead a force of Texas National Guard and Texas Rangers to shut-in all wells to preserve order and enforce the RRC rules. Once production was under control, Sterling called a special session in 1932 to approve the Market Demand Act, which gave the RRC more powers.
However, all 19 proration orders in1932 were successfully challenged in court. Such stories are not limited to Texas. Oklahoma also resorted to use of the National Guard to remove oil producers from private oilfields and shut down wells in order to enforce state regulatory orders.
Absent the technology and wherewithal to sensibly enforce proration in a modern and efficient manner, Governor Abbot might be forced to take the unlikely step of calling the National Guard back in to monitor producers.
What does the data tell us?
For the RRC to impose production prorationing, it needs to know the production of each producer in recent months. For various technical and legal reasons, the RRC gets only partial production information in the short run. It takes months to get full production data.
Lack of complete and timely data will deem any proration efforts useless. Producers who want to ignore RRC orders will find many loopholes and avoid cutting production.
The U.S. Energy Information Administration (EIA), the independent statistical arm of the U.S. Department of Energy (DOE), realized the data limitation of the RRC. It then hired consultants to build mathematical models to estimate the true oil production in Texas.
The chart below shows the difference between the RRC estimates of Texas oil production and the EIA’s estimates in 2019. These estimates merge as more data became available to the RRC.
The chart illustrates the wide discrepancy in accounting. Without agreeance on crude production in numbers, efforts to prorate oil in Texas will be difficult at best, and, at worse an impossible bureaucratic nightmare. (For more info on EIA production calculation, see page 5: https://www.eia.gov/petroleum/production/pdf/eia914methodology.pdf)
Other Issues
In addition to enforcement and monitoring issues, the following issues should also be considered before implementing proration policies.
– The “Market Demand” Issues: Current times are different from the past. Producers are NOT refusing to shut in production as East Texas Oil Field producers did. Instead, they are shutting in production voluntarily. Therefore, the issue of “market demand” is not there, as the law requires. Ironically, if we reach tank stops around Houston, many oil producers in West Texas have to shut in wells anyway, without any intervention from the RRC.
The petition to the RRC states: “…bring fairness and uniformity to any curtailment of production.” That means companies that asked the RRC to apply a statewide production cut are doing so out of self-interest: they want others to share their pain. This sounds like socialism at its best!
– The “Waste” Issue: It was the intention of Texas Legislature over 90 years ago to prohibit wasteful practices. The definition of “waste” is essential to reject proration or adopt it. Limiting the definition of “waste” to “oversupply” violates the basic principles of investment. However, the issue of “waste” does not apply since producers are shutting in production voluntarily.
– Crude Quality Issues: In the past, once a field is under control, it was easy to prorate assays that are close to each other quality-wise where the demand is the same for all of them. Now, with shale, we have a large variation in qualities with different demand patterns. The quality issues will make it extremely hard for the RRC to apply a blanket cut on every producer in the state of Texas. In fact, a blanket cut using the market demand argument is certain to see a large number of court challenges. It might even violate its own rules related to proration and market demand.
– Refinery Issues: It is unfortunate to see that the U.S. President, Senators and oil producers focus on the cut by Saudi Arabia, Russia, and the Texas Railroad Commission, including talks of tariffs on oil imports or halting oil imports from certain countries, without any regards to refiners. Proration would end up harming U.S. refiners who depend on Texas oil, while others who depend on oil from other sources, including Saudi Arabia and Russia, will not be affected, which seems to limit fairness and uniformity to Permian oil producers per the statement in the petition: “bring fairness and uniformity to any curtailment of production.”
Without reliable data on Texas production and without state monitoring and enforcement capabilities, proration policies are farfetched and unreasonable.
Shale producers have long prided themselves as independents who brought in one of the largest energy revolutions in history. The petition to the RRC brought forth by Pioneer and Parsley would set a dangerous precedent making Texas producers dependent on the whims of a state regulator.
Let free markets do their work.
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