Texas Energy Policy: Back to the Future with Prorationing?
Do we really want to go back to the future? Now, 1972 was a banner year, considering that is the year of my birth. Here are some other things that happened in 1972:
The Dallas Cowboys won their first Super Bowl
Nixon goes to China
The Watergate scandal begins
North Vietnamese negotiators walk out of the Paris Peace Talks
Top movie: The Godfather
Top song: American Pie
The last time prorationing was done in Texas
There are some good things on this list, and plenty of bad (I’m one of the good things, FYI). That bring us to this very interesting moment in energy policy history in Texas. On April 14, the Railroad Commission of Texas (RRC) will hold its first virtual hearing. Ironically, the hearing is about a policy that has not been implemented in almost half a century: Prorationing.
Will their decision be good or bad for the oil and gas industry in Texas? Here is what you need to know:
Prorationing in Texas is having the Railroad Commission determine the market demand, and then limiting the oil and gas companies to only produce that set amount. The Commission started this practice in the 1930s. At the time, Texas was by far the dominant force in global oil production. This was a tool used to stabilize the price of oil in a world with only a few big players. This model was so successful, OPEC adopted this policy. Fast forward to 2011, and oil production in shale happened and changed the world.
How we ended up here
The technique for horizontal drilling/hydraulic fracking for natural gas became economically viable in the early 2000s with the discovery of the Barnett Shale, and production escalated quickly. Around 2011, this technique was applied in oil-rich formations in the Permian Basin, South Texas (Eagleford), and other parts of the country. Oil production in the U.S., particularly in Texas, grew at an astonishing rate. So much so, that the U.S. Congress lifted the decades-old crude export ban, and the U.S. began selling its oil around the world.
In August 2019, the United States became the largest producer of oil and natural gas in the world. Texas is responsible for about 40% of this production. To put that in perspective, Texas was producing about 5 million barrels a day at that time.
The world is now in a position of oversupply for three reasons: 1) Russia and OPEC’s three-year production agreement ended, leading to the Saudi Arabia/Russia price war flooding the market with oil; 2) The Covid-19 virus has crippled the world economies, curtailing demand around the world; and 3) The U.S. has once again become and dominate player in global production.
A few week ago, the concept of reinstituting proration was being floated at the Railroad Commission. Around the same time, Commissioner Ryan Sitton addressed market demand in an interesting town hall meeting. You can watch it here. He has a lot of great data and walks through global demand. One intriguing question from a viewer was: “Would proration in Texas/the U.S. help stabilize price the price of oil without concurrent international cooperation?” Commissioner Sitton’s response was, “Texas doing something in a vacuum does nothing, but it shows we are bringing consideration and leadership to the table…”
On March 30, two independent oil and gas companies, Pioneer Resources USA and Parsley Energy, filed a motion with the RRC requesting a “Market Demand Hearing.” This is a highly controversially request, with the majority of the industry taking an opposing opinion. This hearing is going to take place on Tuesday, April 14, ‘virtually” at the Railroad Commission (you can watch here).
What you may see
The Railroad Commission has solicited comments from all interested parties on this hearing. Representatives from Pioneer Resources USA and Parsley Energy will lay out their case for the RRC to step in and regulate production. All of the oil and gas trade associations in Texas (and a national energy trade association) submitted written comments in opposition. Some will be asked to testify (it is invited testimony only). The Texas Association of Businesses and Texas Association of Manufacturers added their written opposition as well. Numerous questions need to be answered before any type of proration policy would be implemented:
Does the Commission have the staff and resources to implement such a policy?
How many barrels are operators being asked to reduce and from what base line total? (Many companies are already making cuts so this could disadvantage the early planners in this space)
How do you prevent other states from filling the reduced market share?
How do you provide an equitable result to producers already making cuts?
Is it a percentage statewide reduction? Is it a reduction by basin or field?
If a company produces oil in another state, what is to keep them from moving capital to other basins and producing more barrels in those states?
When and how does proration end? (The criteria, methodology, and process to change or otherwise wind down proration all need to be properly defined upfront.)
It is likely the market itself will naturally dictate production. The oil and gas industry is already responding by making deep cuts to their CAPEX with over $23.78 billion in cuts announced to date. If the average well cost was $10 million, it would mean that approximately 2,378 wells will not be drilled this year. The average onshore well cost is likely less than $10 million, so the number of wells is expected to be higher than 2,378.
Nevertheless, proration is a challenging policy to implement. But one thing I can guarantee, this Railroad Commission hearing will be one of the most watched hearings in the history of the RRC. Are we going to party like it’s 1972? Time will tell.
Chris Hosek is an Energy Consultant in Austin Texas