By John Hays, Amy Baird, & Richard Howell

On April 14, 2020, the Railroad Commission of Texas (RRC) will conduct an initial public conference to consider the joint application of Pioneer Natural Resources USA, Inc. and Parsley Energy, Inc. for market-demand prorationing of oil production in Texas as a response to current market conditions. This type of regulation – which has not happened in Texas since 1973 – could have a serious impact on oil and gas producers, working interest owners, royalty owners, and midstream companies.

In the alert below, we address:

1. the statutory basis for market-demand prorationing;
2. the RRC’s historical use of market-demand prorationing and why it ended;
3. the application filed by Pioneer Natural Resources and Parsley Energy requesting that the RRC conduct a hearing and implement market-demand prorationing;
4. the RRC’s upcoming conference on April 14, 2020, and potential next steps; and
5. the potential impacts of market-demand prorationing.

We are actively monitoring this issue. If you have any questions, please contact John R. Hays, Jr., Amy Baird, and Richard A. Howell.

Statutory Basis for Market-Demand Prorationing

The Texas Constitution treats oil and gas as important natural resources and grants the Texas Legislature the power to prevent waste.^[1] More than a century ago, the Legislature enacted the first law to prohibit wasteful practices, and it directed the RRC to enforce those prohibitions in order to preserve the state’s long-term goals. Despite its name, the Railroad Commission is the state agency with broad jurisdiction over all oil and gas wells in Texas, including drilling and operations, and all intrastate oil and gas pipelines.^[2]

Texas Natural Resources Code § 85.046 defines “waste” to include specified operating practices such as unnecessary gas flaring^[3] as well as the “production of oil in excess of… reasonable market demand,” and allows the RRC to determine when “excess production exists or is imminent and ascertain the reasonable market demand.”^[4]

Market-demand prorationing is a subset of prorationing in general; it is a tool to limit production of crude oil based on anticipated demand. It may be thought of as operating on top of the system of allowables, such as yardstick allowables, top allowables, discovery allowables, and exempt marginal wells that has long been in place. It cannot be imposed without a hearing under Section 85.049 and a determination that the action is necessary to prevent waste.^[5] In the hearing, in addition to determining if waste is occurring or imminent, the RRC may also adopt a rule, order, or action if needed to correct, prevent, or lessen that waste.^[6] If the RRC adopted a remedy, all affected persons must comply.^[7] In the event of market-demand prorationing, all oil and gas operators may be affected, although to different extents based on their mix of production and allowables.

Historical Use of Market-Demand Prorationing

The Texas Legislature passed the Market Demand Act in a special session in 1932, and it was upheld in 1934 following an initial challenge.^[8] Over the next 40 years, the RRC periodically imposed market-demand prorationing, typically after the discovery of a new field or after the resolution of international supply disruptions.^[9] However, the use of market-demand prorationing statutes in Texas and elsewhere came under fire by influential financial publications because of their disruption of the free market and operation as a “legal cartel” controlled by the RRC and other state agencies.^[10] Since the 1973 Arab Oil Embargo, the RRC has not imposed market-demand prorationing.

Pioneer Natural Resources and Parsley Energy’s Request for Prorationing

On Monday, March 30, 2020, Pioneer Natural Resources and Parsley Energy filed a joint motion requesting that the RRC impose a market-demand order effective for May 2020 production. Citing the oversupply of the worldwide oil and gas market, recent actions by Saudi Arabia and Russia to increase oversupply, and the demand shock caused by the COVID-19 pandemic, Pioneer and Parley claim that world and Texas oil production are in excess of reasonable market demand, resulting in waste. To address the alleged oversupply, Pioneer and Parsley request that the RRC conduct a hearing, determine market demand, and issue rules or orders necessary to impose market-demand prorationing beginning in May 2020.

RRC’s April 14, 2020 Conference

On Friday, April 3, 2020, the RRC posted a Notice of Meeting for a public “virtual conference” of the RRC on April 14, 2020, beginning at 9:30 a.m. Notably, the Notice of Meeting states that the conference is “not a meeting to conduct a hearing.” Natural Resources Code § 85.051 requires a formal hearing before the RRC can determine if market-based prorationing is needed, so the April 14 meeting cannot be used to impose prorationing. However, the RRC could consider that issue in a future hearing.

View the open meeting live at 9:30 a.m. on April 14, 2020 »

Potential Impacts of Market-Demand Prorationing of Oil Production

Market-demand prorationing of oil has not been imposed at this time, and it is unclear how such prorationing would be imposed if it is approved. The RRC’s current rules do not appear to address that type of prorationing. None of the three elected commissioners have suggested how the RRC would impose market-demand prorationing or what limitations should apply. Pioneer Natural Resources and Parley Energy also did not suggest a prorationing plan, other than asking to “bring fairness and uniformity to any curtailment of production” and to cut immediately production deeply enough to stabilize prices and avoid “widespread destruction [to] producers and their suppliers.” In the event that the RRC decides to impose market-demand prorationing, the RRC could return to the prorationing system it last applied 50 years ago or it could impose a new prorationing system within its broad discretion based on the statutory factors or to account for operators’ other waste.

If the RRC were to impose market-demand prorationing, it would likely have immediate and serious impacts across the state. Oil and gas operators would likely have to immediately limit production of certain existing wells and change drilling plans for future wells. Royalty owners may be affected to varying degrees, depending on their lease terms, including terms related to production requirements or continuous drilling. Gas, NGL, and crude oil pipelines, as well as other midstream and downstream producers, may also see impacts based on the reduced production, again depending on their contract terms.

Questions?

Market-demand prorationing and its potential impacts are complex issues. If you have questions, please contact the attorneys listed below.

^[1] Texas Constitution, Art. 16, Sec. 59.
^[2] Tex. Nat. Res. Code § 81.051(a) (Jurisdiction of Commission).
^[3] See 16 Tex. Admin. Code § 3.32; Railroad Commission v. Flour Bluff Oil Corp., 219 S.W.2d 506 (Tex. Civ. App.—Austin 1949, writ refused) (affirming Railroad Commission order prohibiting flaring and holding and that a producer cannot justify flaring on economic grounds).
^[4] Tex. Nat. Res. Code § 85.046(a)(10).
^[5] See Tex. Nat. Res. Code § 85.053(a).  The RRC may also act – with regard to dense drilling in a pooled unit – to adjust the correlative rights of each owner in a common reservoir.  See 16 Tex. Admin. Code §§ 3.39 and 3.40 (RRC rules related to prorationing among pooled units).
^[6] Tex. Nat. Res. Code §§ 85.049 & 85.051.
^[7] Tex. Nat. Res. Code § 85.052.
^[8] See Railroad Commission Chairman Ernest O. Thompson, The Texas Market Demand Statute on Oil and Gas and Its Application, 39 Tex. L. Rev. 139, 142 (1960) (citing Amazon v. Railroad Commission, 5 F.Supp. 633 (E.D. Tex. 1934)).
^[9] J.A. O’Connor, Jr., The Role of Market Demand in the Domestic Oil Industry, 12 Ark. L. Rev. 342, 342 (1958).
^[10] Id. (quoting the Wall Street Journal’s editorial in 1958, which said domestic oil and gas companies “are in effect [part of] legalized cartels operated by state governmental agencies to curtail production in an attempt to keep prices high…. In the most important oil producing state, the Texas Railroad Commission this month and next is permitting oil wells to fulfill their function only eight days out of each month.”).

Meet Amy

Amy L. Baird represents clients in the energy industry.  She does complex commercial litigation for those clients, along with project development, commercial contracts, and regulatory work. Amy’s experience includes the representation of natural gas gatherers, oil and gas producers, interstate and intrastate natural gas pipelines, natural gas liquids and crude oil pipelines, natural gas processors, gas marketers, storage and terminalling operators, merchant power plants, local distribution companies, municipally-owned gas and power distributors, industrial gas and power end users,  cogeneration facilities, and utility regulators.

Meet Richard

Richard A. Howell represents commercial clients in complex disputes that require a skilled and creative presence in the courtroom. Richard has served as the lead trial attorney for oil & gas industry clients, national and regional banks, and other businesses in many trials, as well as many cases that were resolved before trial. Richard has also represented many clients—including two pipeline operators, a national bank, a private equity company, a chemical plant, and a food distributor—in “emergency” actions to enjoin or avoid injunctions of business activities and actions to obtain receiverships over property.

The opinions expressed are those of the authors and do not necessarily reflect the views of the Firm, its clients, or any of its or their respective affiliates. This article is for informational purposes only and does not constitute legal advice.