By John Hays, Amy Baird, & Richard Howell
On April 14, 2020, the Railroad Commission of Texas (RRC) conducted a conference on the application of Pioneer Natural Resources USA, Inc. and Parsley Energy, Inc. for market-demand proration of oil production in Texas. The conference considered the urgent circumstances facing many Texas oil and gas producers, whether market-demand proration is an appropriate response, legal and practical challenges to any RRC proration, coordinating a response with other states, and other potential actions such as enforcing existing limits on unnecessary flaring. Each of these topics is discussed below.
Background on the Law and the April 14, 2020, Conference
Texas law charges the RRC with a duty to prevent waste in oil and gas production. Texas Natural Resources Code § 85.046 defines “waste” to include specified operating practices such as unnecessary gas flaring[1] as well as the “production of oil in excess of… reasonable market demand.” Texas law allows the RRC to impose market-demand proration of oil after a formal hearing when it determines that “excess production exists or is imminent and ascertain the reasonable market demand.”[2] Market-demand prorationing is a subset of prorationing in general.[3] For more detailed information on the statutory basis and historical implementation of market-demand prorationing, please see our earlier article here.
The RRC called the April 14, 2020, conference to consider Pioneer’s and Parsley’s request to that the RRC impose a market-demand proration order effective for May 2020 production based on the oversupply of the worldwide oil and gas market and the demand shock caused by the COVID-19 pandemic. Intentionally, the conference did not meet the formal statutory hearing requirements, but it did provide an opportunity for the commissioners to discuss whether market-demand proration or another solution is needed.
Strong Public Response to Pioneer’s Motion for Market-Demand Proration
Prior to the April 14 conference, the RRC received more than 140 letters, presentations, and briefs from the public concerning the request to impose market-demand proration. Due to the importance of this issue, the RRC received submissions from large international producers, independent producers, royalty owners, current and former government officials, environmental groups, industry associations, environmental groups, and concerned citizens.
The RRC conducted a webcast of its April 14 conference and heard from more than 50 witnesses representing a cross-section of the individuals and companies who filed public comments.
Texas Producers Face Unprecedented Supply and Demand Challenges
Almost all speakers during the conference – both for and against the proposed proration – agreed that the oil and gas industry in Texas faces unprecedented challenges based on the global oversupply of oil and the demand shock caused by the COVID-19 crisis and government stay-at-home orders.
Pioneer’s CEO Scott Sheffield stated that oil prices are lower than production costs, which he said destroys capital and has caused a shocking decrease in funding for almost all producers. Marathon Oil Company’s Lee Tillman – the first speaker to oppose proration – agreed, saying that the interconnected global oil market is oversupplied. Bob McNally – an international oil markets expert – who leads Rapidan Energy Group did not speak for or against proration, but he detailed the oversupply situation and the factors that are likely to lead to continued low oil prices for the year and beyond.
Many independent producers also provided comments regarding the loss of midstream transportation and markets for their oil. Harry Pefanis of Plains All American Pipeline noted that Plains now requires producers to show proof of a market for their product before a shipper can nominate a volume, saying, “We’re only taking crude into the pipe that has a home at the other end.”
Is Market-Demand Proration An Appropriate Response?
Although most witnesses agreed that production is likely to exceed demand for the foreseeable future, the witnesses disputed whether and how the RRC should respond.
Pioneer requested that the RRC find waste – based on the market-demand definition – and act by imposing proration to cut oil production beginning in May 2020 based on prior production levels. Pioneer also explained why it believes RRC action is urgent, saying there is no truly free market for oil and gas due to a long history of government actions and warning that without RRC action, dozens of producers and service companies will fail and tens of thousands of Texans will lose their jobs.
Speakers from Parsley Energy, Continental Resources, Latigo Petroleum, Elevation Resources, Texland Petroleum, Discovery Operating, and Quantum Energy Partners, all amplified the concerns Pioneer raised and urged RRC action to prorate oil production to match market demand.
Other speakers disagreed. Marathon Oil Corporation argued that the RRC should avoid any action. Marathon CEO Lee Tillman asserted that RRC action will act only to “protect weaker companies from true competition.” Ovintiv’s CEO Doug Suttles concurred, saying that the only fair outcome is allowing unprepared businesses to fail, while allowing companies that built their businesses to withstand downturns to avoid the hindrance of proration. Mr. Suttles – as well as Todd Staples of the Texas Oil and Gas Association – addressed the potential regulatory uncertainty that would be created by any RRC action, suggesting that market-demand proration would drive capital to other countries or states that do not include this regulatory risk. Notably, although he opposes the proposed proration, Mr. Suttles said that RRC enforcement of flaring restrictions is critical to preventing waste, and he suggested that the RRC turn its attention to that issue.
Jim Teague, co-CEO of Enterprise Products, also spoke against any RRC action. Mr. Teague argued that the solution to low oil prices is low oil prices; that is, basic economic principles will force companies and foreign nations to bring supply and demand into alignment. He suggested that government action is undesirable and that real waste exists when “inefficient producers continu[e] to produce at a time like this.” He also addressed concerns raised by Pioneer and others about storage becoming full, saying that storage will not fill and oil prices will continue to drop until they “move to a point where someone will poke their head up to take barrels.” Karr Ingham of the Texas Alliance of Energy Producers echoed these comments, saying that Texas companies are already responding to limit economic waste, and so RRC intervention is not needed.
Other speakers spoke on the issue of market-demand proration, rather than for or against it. One of the leading speakers in this category was Mark Hauser, CEO of University Lands, which uses revenues from its mineral interests to fund state university endowments. Mr. Hauser said that his organization believes that if oil prices remain below $30 for the remainder of the year, it may lead to 100 bankruptcies filed by oil and gas producers and service companies and have a long-lasting impact on the State of Texas and the energy industry as a whole. While Mr. Hauser indicated that University Lands does not take a position on whether market-demand proration is needed, he noted that the lack of flaring enforcement is contributing to oversupply and said enforcing existing statutes and rules to prevent unnecessary flaring should act as a production control.
Legal and Practical Challenges to Imposing Market-Demand Proration
The RRC conference also addressed concerns about when and how market-demand proration could be imposed. Between 1932 and 1973, the RRC imposed market-demand prorationing periodically, but it does not have any recent history of imposing proration.
John Tintera, who served as the Executive Director of the Railroad Commission for some years until 2012, addressed practical enforcement issues. He noted that Statewide Rule 52 – Oil Well Allowable Production – could be used for RRC action, but Mr. Tintera said that the RRC likely lacks the staff and procedures to implement any action immediately or in the near term.
James Mann of the Texas Pipeline Association raised concerns and suggested that the RRC currently lacks an adequate rule to enforce proration, lacks adequate data from producers to avoid making a double cut (forced proration cuts on top of cuts that producers have already made voluntarily), and lacks staff to set proration values each month. Mr. Mann also warned that litigation may arise from any action the RRC takes.
The Commissioners and many speakers discussed concerns about how any market-demand proration could be enforced and how to monitor and penalize violators. Other speakers addressed long-term damage to reservoirs that could be caused by slowing or shutting down production. Multiple commissioners noted that one of the key issues they would need to look into is how the RRC could act – if they decide to act – and the efforts and resources needed to make their actions effective.
RRC Interest in Coordinating a Response with Other States
In its opening presentation, Pioneer suggested that the RRC should coordinate action on market-demand proration with other states and perhaps even condition its action on other states taking similar action.
Texas and many other states have similar market-demand proration powers, and Texas coordinates with many other oil and gas producing states through the Interstate Oil and Gas Compact Commission, which was formed in 1935 to conserve oil and gas resources. If Texas and other states limit the allowable oil production, federal law makes it illegal to transport oil in interstate commerce in excess of state limits.[4]
After Pioneer suggested coordinating with other states, RRC Chairman Wayne Christian asked multiple speakers for input about possibly coordinating or conditioning RRC action. Continental Resources Executive Chairman Harold Hamm described his efforts to work with Oklahoma regulators, and suggested that Texas should immediately extend its efforts to work with Oklahoma and North Dakota regulators on these issues.
Next Steps in the RRC
The April 14 conference ended without any action by the commissioners. The RRC is set to meet on April 21, 2020, and its agenda for that conference includes further discussion and debate on market-demand proration.
Market-demand prorationing and its potential impacts are complex issues. If you have questions, please contact John R. Hays, Jr., Amy Baird, and Richard A. Howell.
[1] 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 left flaring on economic grounds).
[2] Tex. Nat. Res. Code § 85.046(a)(10).
[3] Market-demand proration 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.
[4] See 15 U.S.C. § 715 et seq.
Meet John
John R. Hays has an extensive background in the private practice of law, government, and academia. His government experience began when he served as an Examiner (Administrative Law Judge) with the Railroad Commission of Texas, followed by many years of private practice, writing, and speaking on energy topics at conferences for industry representatives and the legal profession, together with teaching Energy Law and Policy at the University of Texas School of Law.
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.
