Texas Railroad Commission Will Consider An Oil Production Cut That Is Too Late To Matter

With news this morning that Chesapeake Energy is preparing to file for bankruptcy, The Texas Railroad Commission (RRC) will once again take up the concept of invoking prorationing on oil production at its conference on May 5.

This time, the RRC will have an actual, detailed proposal to consider, one that many believe amounts to a ‘too little, too late’ approach. The draft resolution, brought forth by Commissioner Ryan Sitton, was posted on the RRC website on Wednesday.

In brief, the proposed order would establish every operator’s October, 2019 Texas production volumes as a baseline, and limit their production moving forward to 80% of that amount each month. Operators whose overall volumes were less than 1,000 barrels of oil per day in January, 2020 would be exempt from the requirements, violations of which would be punishable by a fine of $1,000 per well.

The effective date of the order would be left up to the Commission to determine. Commissioner Ryan Sitton, who brought the proposed order to the table, was quoted by the Houston Chronicle as saying that “the earliest that the order could take effect would be June or July.” In an op/ed published Wednesday in the Houston Chronicle, fellow Commissioner Wayne Christian, the RRC’s current chairman, stated on Wednesday that he will not support the plan. Assuming Commissioner Sitton supports his own proposal the hearing, that will leave Commissioner Christi Craddick with the deciding vote.

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Industry Reaction

I reached out to all of the statewide Texas oil and gas trade associations for comment on Wednesday. All of the groups who responded had testified in opposition to prorationing as a concept at the RRC’s first hearing on the matter on April 14. Not surprisingly, they’re all pretty much opposed to this draft order as well.

Karr Ingham, a petroleum economist and current Executive Vice President of the Texas Alliance of Energy Producers, told me that he believes that the production cuts proposed in this draft order have likely already been implemented by Texas producers. “We certainly know the market has already acted,” he said, “and has done so swiftly, well in advance of any action by any agency of government, which is virtually always the case. It's much to early to tell, of course, but it is plausible that a 20% production decline in Texas may be achieved by the end of the month of May.” Indeed, the anecdotal evidence I’ve been able to collect indicates that such a decline in production may already have taken place.

Todd Staples, President of the Texas Oil and Gas Association, echoed Ingham’s comments, stating that “Texas producers are doing their part to curtail production. These circumstances are catastrophic and government trying to manage daily production will make matters worse, not better.” He added that his members believe that “Proration is a bad idea no matter how you package it.”

Ed Longanecker, the President of the Texas Independent Producers and Royalty Owners Association, expressed similar thoughts, saying that “Based on the significant reduction in capital expenditures and decline in domestic production this year without a mandatory curtailment, it’s evident that the market will continue to work faster and more efficiently than any government entity.”

Obviously, there is a growing consensus in the Texas oil and gas industry that this proposed 20% reduction, and likely significantly more than that, is already baked into the cake.

Kenny Stein, the Director of Policy for the Institute for Energy Research, said that that market-oriented energy think tank also remains skeptical of prorationing as a timely and effective policy solution. “The oil market situation we see today cannot be solved by government cuts,” he said, adding that “the only government solution is letting the economy restart. RRC intervention now will have virtually no effect on prices, but sets a terrible precedent and will lead to calls for more government cuts every time prices dip.”

Finally, I reached out to Scott Anderson, Senior Policy Director for the Environmental Defense Fund’s (EDF) Energy Program, since I thought that the comments he had filed in advance of the April 7 hearing had been very much on point. Anderson reiterated EDF’s position that if the RRC wants to address real “waste” in the Texas oil and gas business, it should use prorationing to target oil wells that are flaring natural gas. “Flaring, of course, is the very definition of waste. Protecting wells that don’t flare from any cutbacks required by proration would create added incentive for producers to operate more efficiently and with less pollution and provide fair reward to those that already do.” There is certainly merit to such an approach but the question at this point becomes whether the market conditions at play have already dictated a less orderly downward spiral in production.

So, here we are, several weeks down the road from the initial hearing, and it is apparent that no one’s minds have been changed on the subject. While it is also likely that the producers who testified in favor of the concept on April 14 will also weigh in to support this proposal, between them, the trade associations quoted above represent the great preponderance of the Texas oil and gas business.

On the other hand, the RRC is the regulator of the industry in Texas and not a rubber stamp for it. While the commissioners certainly will take the industry’s positions under advisement, they have much more to consider. They must weigh the industry’s concerns against what in their judgment are the best interests of the state of Texas, and the interests of conserving the natural resources that lie beneath its lands.

What About a Longer-term View?

Personally, I had hoped that the commissioners would adopt a more long-term view of the situation, and work in concert with regulators in other large oil producing states to try to take the U.S. shale industry out of its competition with the OPEC+ countries for global market share. The U.S. industry is doomed to a repeat of what has happened since early March in just a few years so long as it operates on a business model that is reliant on other nations to be willing to cut their own production and income levels so that U.S. businesses can drill more wells and take more market share.

This very issue was why the OPEC+ agreement was blown up by Russia and Saudi Arabia in early March, and it is why the new and improved OPEC++ deal will blow up again at some point in the not-too-distant future. This is not speculation: This is an inevitable outcome that will be repeated over and over again without the application of some form of production discipline on the upstream sector of the business. In the U.S., that kind of discipline can only be applied by these state regulators.

It’s obvious that most operators in the Texas oil industry are willing to keep operating and trying to survive within this vicious boom and bust cycle. But fair warning: Chesapeake is just the canary in the coal mine here, and many more will be following it into the bankruptcy courts in the coming weeks. Every time the industry goes through this cycle, its reputation is severely damaged, its employee base is decimated, and millions of young people who are trying to decide what to do with their lives vow to never even consider a career in the oil business.

The plan to be considered by the RRC on May 5 is a short-term plan only. As such, it is most likely that the market has already passed its stated goal by, and that few operators would even be impacted by its provisions. The most likely outcome here is that the RRC will take no action on May 5, and no action by Texas - which produces more than a third of all U.S. oil - renders any action taken in North Dakota, Oklahoma or any other state currently considering similar proposals largely irrelevant.

Thus, the industry itself, having succeeded in maintaining the status quo, will lurch on to its next cycle of boom and inevitable bust.