World Oil analysis: Texas Railroad commissioners face difficult decision on prorationing

By Kurt Abraham, Editor-In-Chief on 4/16/2020

The special open meeting on potential prorationing, held by the Railroad Commission of Texas (RRC) on Tuesday, was an event for the ages—a truly historic moment. In its aftermath, the three Railroad commissioners are faced with what may be the major decision of their professional lives—whether to prorate or not. And, in tandem, the fate of many industry companies and individuals’ jobs could be hanging in the balance.

Commission Chairman Wayne Christian referred to the magnitude of the decision facing the commissioners, when he said at the end of Tuesday’s meeting, “It’s humbling to realize the position we find ourselves in. There’s hundreds of thousands of folks in this industry, and their families and their kids out there (in Texas), and my heart goes out to them. I will pray for myself and pray for my fellow commissioners.”

One has to give the commissioners—Christian, Christi Craddick and Ryan Sitton—immense credit for being willing to withstand 10 hours and 15 minutes of testimony, with just a few breaks and what seemed like an insufficient lunch period. Their stamina was impressive, as they sat listening to many speakers drone on for three to five minutes (and frequently longer) while citing various statistics and delving down into all sorts of aspects of procedural, contractual and legal minutiae. But the commissioners bent over backwards to be fair, and to ask intelligent questions of everyone.

The media’s herd view. If you read stories on the RRC meeting from most newswires or other media, they all have a rather homogenous flavor. Their stories play up the fact that the companies testifying against prorationing were concerned about protecting the free market. It’s as if these firms were acting as statesmen-like protectors of free-market economics, without any mention of potential ulterior motives (more on that, further down in the text). And, there was no mention of the fact that there is no true free market in oil, not when state actors like Saudi Arabia and Russia can impact the market so substantially through deliberate moves.

The general media make it sound like the vast majority of people testifying on Tuesday were against prorationing. That’s just not true. Out of 39 speakers that this editor listened to during all but 45 minutes of the hearing (total speakers testifying were probably near 50), 15 declared or leaned toward being “for” in their remarks, 18 declared or leaned toward being “against,” and six were truly neutral. This is certainly not a large majority. Now, it’s possible that when we get a final count from the RRC, the numbers will change some, but not enough to say that it was a slam dunk for the “against” crowd.

It’s real easy to lead with an inflammatory statement made by Diamondback Energy CFO Kaes Van’t Hof (as more than one outlet did), who said that the firm would cease all drilling if prorationing is instituted, and make it sound like this thought dominated the meeting. That’s not the case—there were far more angles discussed than this one. And, frankly, the Diamondback remarks could be construed as a bit of a threat to commissioners. 

Another egregious set of statements given heavy exposure by the general media referred to the accusation that some operators are supporting prorationing for selfish reasons, particularly as an opportunity to void contractual obligations, such as drilling. This may be true for a segment of operators, but certainly not for everybody. “Are they really trying to fix a problem?” said  Enterprise Products Partners Co-CEO Jim Teague in an accusatory tone. And earlier in the session, Marathon Oil Chairman Lee Tillman voiced that thought, as well.

To be sure, the anti-prorationing crowd came to the meeting, well-armed with voluminous statistics and prepared sentences that were all carefully crafted. API’s chief economist subjected the commissioners to a mind-numbing, roughly-10-minute set of remarks that was laced with rapid-fire statistics. But while many of the stats were regular and run-of-the-mill, if one was able to listen carefully to his comments and others’, it was possible to pick out the periodic slant in the numbers.  

What the media reports aren’t saying. The general media reports have left out much of the “feel” and “flavor” of the RRC meeting, which naturally leads toward an incomplete, slanted picture. So, here are a few observations and quotes that got little or no attention.

For one thing, the stand-out comments of the day were made by Quantum Energy Partners Founder and CEO Wil VanLoh, who acknowledged that he used to be a staunch prorationing opponent, but that he had swung around to the other direction in recent months, given the severity of the problem. In a passionate statement, VanLoh described in detail what he thinks the economic and physical carnage will be to Texas operators and vendors, as well as to their employees and all their families.  Judging by the looks on the commissioners’ faces, the vivid picture that he painted made an impression.

VanLoh called for immediate action by the RRC. He said that he favored a “conditional prorationing” set-up, whereby Texas would coordinate with other states, and the federal government, to structure a coordinated production cut.

Pioneer Resources CEO Scott Sheffield and Parsley Energy CEO Matt Gallagher were the executives that originally requested the RRC meeting on prorationing, and they both made strong statements in favor. Sheffield described the current market as an “unprecedented” period and maintained that the move for prorationing was centered on “fairness.” “My personal opinion is that this is going to go longer than anybody expected,” he added.  Gallagher reinforced his support for prorationing by referencing a Rystad Energy forecast and maintaining that hundreds of thousands of Texans would lose their jobs without any intervention, and that those jobs would not return.

One speaker barely cited in media reports was Continental Resources Executive Chairman Harold Hamm, despite his participation in the recent oil and gas executives’ meeting with President Donald Trump. Yet, he provided one of the more important knowledge nuggets of the day, telling the commissioners that the Oklahoma Corporation Commission is studying the oil price situation, and that he fully expects that body to adopt an oil production cut. For his part, Hamm said, “The industry has been hit with a double-whammy of historic proportions. We believe that you must act quickly to prorate a 25% cut.”

Marathon’s Tillman complained that Texas prorationing would be “unfair” to operators that also drill in other states, because it could force them to reduce production at fields that are more profitable than other properties. However, if other states coordinate an output cut in cooperation with Texas, as alluded to by Hamm and VanLoh, then this would be a moot point.

One of the more valuable inputs was the testimony of University Lands (UL) CEO Mark Houser, who stated that he was neutral, but whose remarks certainly made a case for prorationing. The UL manages the surface and mineral interests of 2.1 million acres of land across nineteen counties in West Texas for the benefit of the Permanent University Fund (PUF). In turn, the PUF benefits more than 20 educational and health institutions across both The University of Texas and Texas A&M University systems.

“We have about 9,000 producing wells on UL lands,” said Houser. “And we have a $25 to $60 break-even range (for those assets). So, to sell at these (current) prices is just not acceptable.” He went on to say that in 2019, an average 19 rigs were running on UL properties, but that this will decline to just five to seven rigs by the end of 2020, if nothing is done. He said that the data imply that “up to 100 companies operating on UL lands could go insolvent.”

The heads of the petroleum engineering departments at The University of Texas and Texas A&M University, Dr. John Olson and Dr. Jeff Spath, respectively, both favor prorationing. Speaking for himself and Spath, Olson said that “the market is out of balance and represents wasteful production. These conditions are unprecedented.” Agreeing with Pioneer and Parsley, Olson stated further, “we believe intervention by the Railroad Commission today will make the industry better able to respond tomorrow.”

Although they represent a significant factor in any prorationing argument, this editor did not hear any mention made of the thousands of stripper oil (and gas) wells throughout Texas, as well as the rest of the U.S. According to the National Stripper Well Association (NSWA), stripper oil wells average less than 15 bpd, and stripper gas wells produce less than 90 Mcfd.

The NSWA says that there were 396,000 marginally-producing oil wells and 381,000 marginally-producing gas wells that contributed to U.S. production during 2016. This equates to 10% of U.S. oil production and 11% of gas output. If nothing is done to intervene in the market, and prices remain extremely low, much, if not all, of this production may be lost. Are the companies opposed to proration, or any market intervention, willing to lose all of this production?    

One of the constants from Tuesday was a complaint from independent producers that the larger companies were painting them all with a broad brush as being “inefficient.” Some of these executives tried to explain that they had done nothing wrong, but were being forced out of rapidly shrinking pipeline and storage space availability, and thus would have to cease production. Another complaint voiced by several smaller independents was that the largest companies’ comments were self-serving, and that they were just waiting for the smaller firms to fail, and then scoop up assets (as in the Permian) for cents on the dollar.

One quick observation—there was essentially no difference between the presentations of Texas Oil & Gas Association (TXOGA), Texas Alliance of Energy Producers (TAEP) and Texas Independent Producers & Royalty Owners Association (TIPRO), which, like API, oppose prorationing. In contrast, the Permian Basin Petroleum Association (PBPA) took a mostly neutral position, leaning slightly toward some kind of RRC action.

Tuesday’s final speaker was one of the most personal pleadings in favor of prorationing. “I may be the smallest producer that you hear from today,” said Bill Graham, president of Midland, Texas-based Incline Energy. “We operate just 80 wells.” Graham said that his firm favors one of several ideas floated to commissioners, which is to mandate reductions in gas flaring as a means of reducing oil production. “If you eliminate flaring, you reduce oil output by 375,000 bpd,” said Graham.

So, given all of the back-and-forth testimony and voluminous data and facts, Chairman Christian and Commissioners Craddick and Sitton will have much to consider, as they deliberate a decision over the next seven to 14 days. We wish them well.

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