To Prorate or Not to Prorate?

Originally published by John McFarland.

The Texas Railroad Commission heard comments yesterday in a virtual open meeting on the proposal from Pioneer and Parsley that the Commission re-institute proration of Texas oil wells in response to the drastic reduction of world oil demand. Unsurprisingly, those providing comments did not agree.

In general, the division was between majors and independents – though not totally.

Marathon, Ovintiv, and Diamondback opposed proration, as did TxOGA, Texas Alliance of Energy Producers, the American Petroleum Institute, Texas Pipeline Association, Plains All American Pipeline, and Enterprise Products Partners. Parsley and Pioneer testified in favor of proration, as did Latigo Petroleum, Discovery Operating, Elevation Resources, and former Railroad Commissioner and Congressman Kent Hance. Surprisingly, Quantum Energy, a major independent, testified in favor. In addition, the following provided written comments in favor of proration: Continental Resources, CrownQuest, Hibernia Resources, Texas American Resources, the Panhandle Producers and Royalty Owners Association, and Permian Basin Petroleum Association. Those submitting written comments opposing proration included Chevron, Cimarex, Concho, ConocoPhillips, EOG, Occidental, TXO, and former Commissioner Michael Williams. Written comments can be viewed on the Commission website, here.

Arguments against proration included:

• The free market should control and will solve the oversupply problem.
• Government should not pick winners and losers. Companies who are better positioned should not suffer to prop up those who are not.
• Reducing production in Texas will not materially affect market prices and will disadvantage Texas producers.
• Shutting in wells would harm the wells and result in lost reserves.
• Companies are better positioned than the Commission to match demand and supply.
• Proration would allow some producers to avoid their contractual obligations.
• Reducing oil production would also reduce natural gas and NGL production, reducing gas supplies to customers.
• Commission staff has no experience with proration.

Those in favor argued:

• There is no “free market” for oil. OPEC has set price by regulating supply.
• Proration stabilized prices before and can do so again.
• This is not just a supply imbalance but an unprecedented black swan event, requiring bold measures.
• Without a severe reduction in production worldwide, the industry will disappear as has the coal industry in the US.
• Independent producers, who account for 90% of Texas production growth, will disappear.
• Statutes require the Commission to prorate to reduce waste.
• Proration means all producers will share the pain.
• Texas should set the example for other states and countries.
• Capital markets have abandoned the industry because of price volatility.

I thought the testimony of Wil VanLoh, CEO of Quantum Energy Partners, was especially riveting. He said that, without proration, many companies will be liquidated in bankruptcy and the largest companies will swallow them up. He said the supply imbalance is now up to 30 mm bbls/day, 10 to 15 times higher than anything seen before. To balance the markets, another 10-20 mm bbls/day in cuts will be necessary over and above the OPEC-Russia reductions recently announced. He said without government intervention, the US industry will never again attain supremacy as the largest producing country. Only bold moves by the Commission to set an example will affect the supply and prices.

Kent Hance said that the Commission should cut production in concert with OPEC; it cuts, Commission responds with its cuts.

Most of those testifying, whether opposed or in favor of proration generally, agreed that the Commission should address flaring. All those in favor of proration agreed that stripper operators should be exempt.

Thomas Friedman posted an editorial today in the NY Times suggesting a different solution:

A farsighted leader, argued Andy Karsner, a former U.S. assistant energy secretary, “could have imposed a variable U.S. tariff or fee on imported oil, which would be easily absorbed while prices are now slumping.” Such an import fee “could dynamically and automatically kick in incrementally if prices fell below an agreed floor, say $40 to $50 a barrel — the price that U.S. producers need to stay in business and supply America. The fee would disappear if prices jump above the agreed level. Brent crude is now around $31.”

If we guaranteed U.S. oil producers a predictable price floor to enable the least indebted and most productive of them to survive, Karsner told me, it would pay multiple benefits: “It would raise money for us to invest in infrastructure; prevent job losses for skilled engineers and multibillion-dollar bailouts for U.S. oil companies; keep manageably low gasoline prices for U.S. consumers; and strengthen our energy security from predatory efforts by Russia and Saudi Arabia to wipe out our domestic oil industry.”

But, most important, it would accelerate our clean energy transition, by shielding our electric car industry from foreign-manipulated gasoline prices and our wind and solar industries from temporarily suppressed natural gas prices.

Food for thought.

Curated by Texas Bar Today. Follow us on Twitter @texasbartoday.

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