Texas Rail Road Commission Takes Center Stage

Updated: Apr 17, 2020


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April 15, 2020

In Texas, an economic powerhouse, the outbreak and oil shock have created huge risks for the states' historically strong energy economy, but nothing the state hasn't managed before.

"Established by the Texas Legislature in 1891, the Texas Railroad Commission is the state's oldest regulatory agency and began as part of the Efficiency Movement of the Progressive Era. From the 1930s to the 1960s it largely set world oil prices, but was displaced by OPEC (Organization of Petroleum Exporting Countries) after 1973. In 1984, the federal government took over transportation regulation for railroads, trucking and buses, but the Railroad Commission kept its name" according to Wikipedia. The three-member commission was initially appointed by the governor, but an amendment to the state's constitution in 1894 established the commissioners as elected officials who serve overlapping six-year terms, like the sequence in the U.S. Senate, elected statewide. No specific seat is designated as chairman; the commissioners choose the chairman from among themselves. Normally the commissioner who faces reelection is the chairman for the preceding two years. The current commissioners (from left to right in photo below) are Christi Craddick since December 17, 2012, Chairman Wayne Christian since January 9, 2017, and Ryan Sitton since January 5, 2015.

When the Railroad Commission was given oversight of the energy industry in March 1919, Texas was awash in wildcatters, speculators and roughnecks drilling oil and gas wells under virtually no regulation. The Commissioners and staff set to work literally writing the book on safe, responsible energy production. Today, our rules reflect a century of regulatory expertise and experience, from well spacing and groundwater protection requirements to seismicity rules to water recycling guidelines.

It has been fifty years since The Texas Railroad Commission has considered market intervention...typically in the form of "pro-rationing."

But yesterday, in a historic meeting the state took center stage as the three RRC commissioners took testimony from 58 different parties, ranging from oil companies, mineral owners, economists, university professors, industry groups, think tanks, and investors.

It was a day-long-affair. You can imagine how many different viewpoints were expressed.

I was amazed at how much debate there was around statewide pro-rationing; highlighting various dynamics facing the more than 9,000 independent producers of America.


Key questions being weighed:

  1. Is waste occurring?

  2. If so, is that waste due to production in excess of market demand?

  3. If so, can that waste be effectively reduced by the RRC systematically prorating Texas production?


Commissioner Ryan Sitton Statement

“This weekend, OPEC and additional countries reached a historic agreement to pull 9.7 million barrels of oil out of the market. When you add the 1.5 million barrels that the US, Canada, and Brazil have already cut, the world’s supplies will have dropped over 11 million barrels from a week ago.

The question remains, should the Texas Railroad Commission do anything?

Much has been made of the Texas Railroad Commission’s consideration of proration of oil.

"As Coronavirus has presented some of the most extraordinary challenges in our history, we are not only faced with trying to stave off a global pandemic, but now likely facing down the next great depression."

I have not advocated for Texas to prorate. I have advocated that we consider it. I felt that we should be open to evaluating any path that helps to bring the international oil community together in a global deal. While I have been public about my thoughts that Texas should take a lead role in this conversation, I still have many reservations, and I will be examining heavily if and how proration could be done.

As I consider the testimony, I will be working to find the answers to these three questions. If the answer to any of these is “no”, then I will vote against proration. If the answers are all “yes”, then I may vote for it.

"I believe that any argument that the Railroad Commission should not even consider proration is simply misinformed. The fact is we are CHARGED with this duty in Texas’ state laws."

Texas Natural Resources Code

“Some say that this duty doesn’t make sense, that the Railroad Commission should never do this, and just let the market play out. That is a point worth considering, but not in this meeting. If someone believes that this statutory framework is wrong, then they should take that up with the Texas legislature, and amend our state laws. “

"For now, we have a duty to follow the law and consider the request in front of us (remember, the Commission didn’t call this hearing on its own motion)" said Sitton.

It is uniquely interesting to hear the different perspectives offered by small versus large producers - threatening layoffs or force majeure (unforeseeable circumstances that prevent someone from fulfilling a contract) - juxtaposed against lobbyists reminding us of the impact of state oil production for severance taxes, royalties, and other mineral benefits according to one former State Comptroller (not to mention the impact on employment, property taxes, and education). Others called out the cascading effect of the economy since oil & gas produces so many great jobs in our state.

Did you know that oil production from University Lands in the Permian and other Texas basins goes directly towards endowments at The University of Texas and to Texas A&M University? Jon Olson, Department Chair, Hildebrand Department of Petroleum and Geosystems Engineering, displayed a chart of the impact of oil price swings on petroleum engineering enrollment in Texas.

There are so many different viewpoints, agendas, and motivations behind each testimony. I've spent the last 24 hours capturing and synthesizing the comments so you don't have to...

(but you can find the meeting archive here for the next 6 months.)


The Case For Mandatory Cuts


Scott Sheffield - President & CEO of Pioneer Natural Resources

"Thank you for having a hearing for the first time since 1973. Texas was the OPEC from 1930 to 1973 in prorating and setting the price of oil, set between $2-3/bbl. As an ex-reservoir engineer, I’d rather have stable prices with [the RRC] that is prorated than what I’ve lived with in my entire career in the last 35 years as CEO. Just look at the price swings, our industry has created so much economic waste. Nobody wants to buy our stocks due to the volatility. The energy sector has gone from 15% of the S&P 500 to 2.5%. We were at 28% in the 1980’s. Exxon has gone from a market capitalization of $500B to $130B over the last few years. Nobody wants to give us capital, because we have all destroyed capital and created economic waste. Only the majors and EOG have raised capital in the last five weeks, $50B of debt issuance. The equity and debt markets are closed to everybody else" says Sheffield. "I love the IEEFA Think Tank Paper written by Tom Sanzillo which I circulated to our board. [Here are some of the highlights]: 1) The RRC is compelled to act when production is in excess of reasonable market demand

2) If RRC does not regulate long term, we will disappear like the coal industry. The market capitalization of the entire coal industry is equal to Pioneer's. "We have been dependent on OPEC+ since 2016. We have stolen market share from OPEC+. We have invested billions, and most of those wells ROCE (return-on-capital-employed) average 5-6% with only two operators exceeding 10%, Pioneer and EOG. This is not efficient and is economic waste. All other industries have averaged 10%+" exclaims Sheffield. "OPEC announced record cuts last weekend, but oil prices are down 8% to $21 today. Last week saw discounts of $3 for Delaware and $10 per barrel for Midland basin crude." "Texas can lead the way by getting a G20 cut of 5 MBPD. Oklahoma is moving forward on hearings. North Dakota is reducing flaring. We will be full in Cushing in the next 4-5 weeks. No one disputes this. Producers without a mechanism to transport oil will be disadvantaged" according to Sheffield. "If you read the WSJ article from TexLand, they will be curtailed 75-100%. Storage does not have to be totally full in the world. Waste is occurring today and expected to continue and the RRC is obligated by law to act to prevent or lessen the waste. Witnesses today have strongly different views on whether proration is a remedy, and that is the issue, but no one disputed the facts that waste is occurring."

"If anyone thinks we really have a free market, you’ve got to be joking. After 35 years of CEO, I’ve never seen a free market."

- Scott Sheffield, CEO of Pioneer Natural Resources

"Companies speaking after me are asking for government debt bailouts, tariffs, carbon tax credits..is that free market? [A free market means] survival of the fittest, and efficient operators…Those companies could care less about small-medium producers. Most of the companies saying this have the worst track record and ROCE, thus they are not efficient in preventing economic waste." "This downturn will probably be worse than 1986. Demand is not going to come roaring back. We recommend the RRC reduce 1 MBPD for the month of May and maybe reduce again." "As a leader to reduce flaring in Texas, I love the idea from Rystad to shut-in all that is above 2% emission. You can cut oil, and you can also reduce CO2 emissions."

"One of our challenges is to quantify the waste."

-Commissioner Sitton.

Mark Berg - Executive Vice President of Pioneer Natural Resources

"Our understanding of the definition of economic waste is “production in excess of market demand. Market demand is defined as what is needed for consumption plus storage. Some have argued there is sufficient storage in this market. Many of those are trade associations with certain objectives. If you seek out market intelligence firms [like Clark Energy Consulting], they agree market demand loss estimates from COVID-19 are 20-30 MBPD."

"At this rate, the world storage will fill up between May or July. The RRC can’t wait until all storage is full, because that would make proration futile. The law is clear that the RRC must prorate, if you look at legislative history. Earnest Thompson testified in the early 1900’s that it should be permissive that RRC could elect to prorate. And the legislature decided otherwise. They thought it was important to preserve critical resources of this state, and not allow them to be wasted for political reasons" says Berg. Berg reiterates "Look at the behavior of all of our companies. CEO’s met with Trump to seek a cut from OPEC, and we all applauded. So why did we do that? We did that because it is constructive for prices - it reduces waste."

Harold Hamm - Executive Chairman of Continental Resources

"We’re here because the industry has been hit with a double-whammy of epic proportion. COVID-19 has cut demand by 20-23%. The Saudi's have dumped oil into our markets." "Over coming weeks, thanks to Trump, we persuaded Saudi Arabia and Russia to reduce by 10 MBPD. It’s a good first step, but we will get real relief when America goes back to work. Additionally OPEC++ is expecting 3-4 MBPD reduced in US." "We’ve created millions of jobs. It certainly was a miracle, energy independence, etc. It created a trillion dollar swing, and billions in state and local government taxes. We can get back to that place, but we need to get there soon" says Hamm. "As America's largest producer, Texas is four times the production of North Dakota and ten times that of Oklahoma." Hamm says, "In Oklahoma, as a predominant gas state, we recently introduced proration for gas curtailing, and Continental has led the way in this effort." Continental has cut production already across the board. "We’re going to average about 30% for both April and May," says Hamm. "We’re down about 20% right now, and next month probably 40%." Chairman Christian asked Hamm his thoughts...

"How do you feel about prorating specifically in Texas, versus working with North Dakota and Oklahoma to prorate together? Should Texas go it alone on this thing, or first get together with other states to join us?" Hamm responds "First of all, Texas leadership is very good, as the biggest US producer, TRRC certainly should be the leader. The NDIC is also great body, we’ll see. North Dakota is a long ways from market, so we already have a big differential. The state will see a lot of oil shut in the market, you can expect that," says Hamm.

Don Sparks - Discovery Operating

"I entered the oil & gas industry in 1962, prior to 1970’s OPEC price control. With amount of oil in Texas today, we should be involved to prevent waste of valuable Texas resources. As storage fills, smaller producers will be squeezed. Proration is a way to prevent reservoir damage" says Sparks.

"The RRC should encourage the governor to declare Texas Oil and Gas in a force majeure to prevent lease obligation issues as a result from long shut-ins we may be facing.” “I believe every reservoir can be damaged by being shut-in, and I still believe the best way to protect our reservoirs is to produce by curtailment, or pinching back."

"When I came into industry you could produce 8 days a month and that is how it was done. In my opinion, that was not the best way to do it, because shutting in and trying to produce 8 days a month could damage the formation and lead to unintended consequences. Choking back and prorating on a field basis is the way to cut. Most leases have force majeure as part of the contract with the mineral owner that makes lease allowances in case of such hardship. You could go to the court room and win that during COVID-19, but why should each company have to go to the court room, when it can be declared industry wide?" asks Sparks.

Even Commissioner Christi Craddick was confused on how to tackle the problem.

“If we go to proration, we don’t know how to do it, we haven’t done it in a long time at the commission. Where do we start? What kind of process should we employ? I don’t think we know the right answer to this. Some producers have already curtailed production, when do we start the mandatory date of curtailment so you don’t get double hit?” asks Craddick.


The Case Against Mandatory Cuts


Dean Foreman, Chief Economist at the American Petroleum Institute

"You the producer [should] make a decision on how your margin makes economic since. [The answer may vary depending on] if you’re competing for capital, [and/or] have an advanced infrastructure. If you move unilaterally, you are costing Texas as a result of jobs coming in and growth sending out” says Dr. Foreman. Current crude oil production is 12.9 mb/d. "The Eagle Ford and Midland Basins will be disproportionately harmed, [and] Texas proration appears unlikely to improve market conditions" according to Dr. Foreman. "[For example] Alberta has increased curtailments and seen it’s oil sold at lower prices (an example of what not to do). We will see how demand rebounds when COVID-19 subsides, and this [will be] a self calibrating exercise."

"[The previous] 40% Brent premium to WTI has narrowed, and some days WTI is at a premium to Brent as OPEC has slashed prices across the globe. Proration will yield unintended consequences. The US needs Texas to be prepared to ramp back quickly and prorationing would sell Texas short." "API says that US crude oil storage of 100 Million barrels typically fills between February and March. How long could it take? 3 months, or 5-7 months? EIA now projects storage could tip over in May [and the forecast] has been advanced by a couple months with the large drop in rigs. There are more degrees to freedom syncing up to market that provide resiliency to happen. Avoid [looking at] small sample sets, [try to] look at the whole of data dynamically over time." The more efficiently we can resolve market the better" says Dr. Foreman. Commissioner Sitton argues that “waste is defined as production in excess of reasonable demand and..."

  • Waste is not limited to Texas.

  • Infrastructure nuances complicate a fair resolution.

  • Texas shouldn’t be concerned with waste because it more materially has to do with global supply & demand and the RRC can’t operate separately of that larger force.

  • Small companies would be at a disadvantage due to small volume: if you force the small producer to cut, you would disadvantage them even more.

  • Large companies are already advantaged by benefits of scale, transport infrastructure, and vertical integration.

James Mann - Texas Pipeline Association

"If you start cutting oil production, you must think about natural gas and liquids that are required in the whole energy chain" says Mann.

"I worked at the RRC after market demand went to 100%, I wasn’t there when proration below 100%, but all the people that knew how to do the arithmetic back then are now dead.”

“The producers [used to] estimate how much they could produce or sell the following month. The RRC proration system assigned every well in the state a slice of the pie. Your well got shut-in until you made it up. The whole purpose of proration was not to tell them how much they should produce or balance the market, but hear from the producers how much they could produce and could sell, divided by every well in the state - which is not what we are talking about today" says Mann.

“Today we are talking about the RRC telling how much producers should be able to sell under the statutes you must roll down to every field. It requires extensive information on which wells can be statutory exempt, which wells will be damaged if they cut back, how the field rules apply in each field, which needs to be allowable based on depth to be fair. That data may still be at the RRC, I don’t think the staff or process is available to slice every well as a piece of the pie, but would have to be based on a completely different process.”

"I don’t believe the type of waste we are talking about today is the type of statutory waste [as it was originally intended]. [Statutory waste was a result of wildcatters] producing as much as possible despite infrastructure to prevent from depletion. [Back then, the name of the game was] who could drain who the fastest. The proration was to keep production down to what could be sold, what could be marketed, and allow each producer a chance to produce a part of that. What is being discussed today is not what the statute was originally created for. I don’t know how that would look in court, but I believe the litigation time would exceed the length of time of the downturn itself" according to Mann.

Ken Medlock, Sr. Director, Energy Studies at Rice Baker Institute of Public Policy

"[This is an] incredibly important issue and worth the time spent. Listening to testimonies, [opinions are] all over the place." "There has been discussion about free market (as if we aren’t or if we are) in [a free market]. In reality it’s a distraction in this context, because what we are really seeing is every non-OPEC and non-government [investing and operating] along a competitive margin" says Dr. Medlock. "What does competition do for markets? It rewards innovation & efficiency, [and] why we’ve seen the shale revolution in the US: largely from competition that governs investments in upstream that has driven this US miracle." "Other places in the world have shale, [and/or] promising rock, but they haven’t seen the kind of growth in the oil market, they don’t have the economic and governing policies that we have" says Dr. Medlock. "Another point, [is the] idea that returns to capital haven’t been sufficient, and that is well documented as true, but should dictate a flight away from the sector, still representing competition in capital markets [as a whole]. [We need] competitive capital markets, [rather than asking] government to effectively regulate capital in US that will by construction negate the benefits of rewarding competition and efficiency." One Comment about “Economic Waste:"

"When we talk about policy intervention, there are often justifiable opportunities for intervention to impact economics. Typically we talk about addressing flaring, etc. [and argue] for intervention on policy. Here we see an over condition that is priced in the market. [The market] is doing exactly what it is going to do, [regarding storage etc.] but I don’t know a single forecast that has ever been right. The one thing that is always right is price. [We need price] to act in markets to incentivize entry or exit. We don’t need to interfere with price signals with something like pro rationing" according to Dr. Medlock.

"What is the appropriate role of government? If the Saudi's flood the market, should we just sit back? Some say yes."

-Commissioner Sitton.

"Open competition means you can’t have [a single] goliath player with unlimited funds to [control markets]. Currently, we have foreign monopolies in control that have more power." Says Dr. Medlock.

"Do you think we should encourage other states to move forward? The hardest thing for me to do, and it’s hard, is to do nothing. Are you suggesting we don’t prorate, our best place in this free market is to do nothing?"

-Chairman Christian

"I don’t know if that is the right answer." says Dr. Medlock. "This discussion is on prorationing. If we look at what the RRC can do, it’s important to look at the impact on all producers, operators, firms, universally (not limited to O&G), because this pain is across the board."

"The Texas Workforce Commission is directly impacted by the action or inaction that the RRC can take. That said, as we [discuss] how prorationing might actually be implemented. If you were to auction the quota on proration instead of a uniform cut, you would get the same outcome. Low cost producers would outbid the right to produce versus the small producers."

"If you prorate how do you prorate equally? By setting a proration level. Could we allow producers to sell their portioned barrels? If everyone cuts 20% but your 20% is [larger in volume, it would still advantage larger producers.]" "[In this scenario, we would still see a] market-based re-allocation towards the low-cost producers. But if that is going to happen by design, what is the point of the proration in the first place?" says Dr. Medlock.

Kenneth B. Medlock III, Ph.D., is the James A. Baker, III, and Susan G. Baker Fellow in Energy and Resource Economics at the Baker Institute and the senior director of the Center for Energy Studies at Rice University in Houston, TX.


US Rig Count


According to Enverus "Since early March, US upstream operators have been announcing immediate or upcoming cuts to their rig counts. The number of rigs being released has materialized in a significant way, with the US count down more than 200 rigs in the last month, or 26%, as of April 8. In the last year, the active rig count has fallen by 42%. WTI front-month prices settled at $25.09/bbl on April 8, up 24% in the last week, but down 25% in the last month and down 59% YOY. On April 9, OPEC+ agreed to cut 10 MMbo/d in production in May and June, a move aimed at raising prices amid the coronavirus pandemic. Saudi Arabia will reduce its current 12 MMbo/d output by 3.3 MMbo/d, and Russia will trim 2 MMbo/d off its 10.4 MMbo/d production. Beyond June, the consortium will keep 6 MMbo/d off the market until April 2022."

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