News & Insights

Client Alert

May 1, 2020

Railroad Commission of Texas (“TRRC”) to Rule on Proposed Proration on May 5, 2020


Over a hearing that lasted over 10 hours on April 14, 2020[i], the TRRC listened as oil and gas industry participants and stakeholders provided their input on a motion by Pioneer Resources USA Inc. and Parsley Energy Inc. requesting that the TRRC limit oil production in Texas.  Following the hearing, the TRRC formed the Blue Ribbon Task Force for Oil Economic Recovery to review potential actions that may be taken to assist upstream operators in Texas, including proration.[ii]  Further, WTI crude oil contract traded at a negative price for the first time in history[iii], and the Oklahoma Corporation Commission (the “OCC”), the corollary agency to the TRRC in Oklahoma, issued an order allowing producer in that state to curtail or completely shut-in production if they determine such action is necessary and warranted to prevent economic waste, effective for 90 days starting April 17, 2020.[iv]  Now, the TRRC has issued a draft proration order for consideration at its upcoming May 5th meeting.[v]  This article provides a summary of the hearing discussions and draft proration order.

TRRC Proration Hearing

Advocates for prorationing at the hearing generally cited to the following benefits to support their position:  prorationing will provide pricing support to protect the Texas oil and gas industry, prevent waste and reduce flaring; prorationing gives smaller, independent producers an opportunity to supply a portion of the reduced demand; reduced oil demand from COVID-19 and cheaper imported oil prices have disrupted free market dynamics and recently announced OPEC production cuts are not enough; and prorationing will help ease and mitigate the lack of downstream storage capacities.  Those opposed to prorationing generally point to the following reasons:  prorationing is unlikely to have much impact on oil prices, given the many dynamics that go into oil prices; prorationing will create a disadvantage for Texas producers as compared to those in other states; free market dynamics can better limit production levels than regulators; and the knock-on adverse effects of prorationing on oilfield services industry and tax revenues for the state.  Below is a summary of the participants at the hearing and their stated position on proration[vi]:

 

For Proration

Against Proration

Neutral

1.   Pioneer Natural Resources

2.   Parsley Energy

3.   Latigo Petroleum

4.   Texland Petroleum LP

5.   Discovery Operating Inc.

6.   Elevation Resources

7.   Institute for Energy Economics  & Financial Analysis

8.   Quantum Energy Partners

9.   Honorable Kent Hance

10. UT Engineering School

11. Texas Campaign for the Environment

12. Environment Texas

13. Public Citizen org

14. Alex Cranberg

15. Fort Apache Energy

16. Continental Resources

17. Mark Stanger

18. Incline Energy

1.    Marathon Oil

2.    Ovintiv

3.    Enterprise

4.    Texas O&G Assoc.

5.    Texas Alliance of Energy   Producers

6.    Tx. Independent Producers & Royalty Owners Assoc.

7.     Diamond Energy and Viper Energy Partners

8.     American Petroleum Institute

9.    Texas Pipeline Assoc.

10.  Mabee Ranch

11.  James LeBas

12.  Edward Hirs

13.  Baker Institute at Rice

14.  John Tintera

15.  Bradford Moody

16.  Canary LLC

17.  Institute for Energy Research

18.  R Street Institute

19.  Michael Collier

20.  Benjamin Zycher

21.  Edwards Energy Consultants

22.  Senator Bettencourt

23.  Rep Chris Paddie

24.  Rep Lyle Larson

25.  Rep Charlie Green

26.  Troy Eckard

1. Plains All American

2. University Lands

3. Texas Land and Mineral Owners Assoc.

4. HIS Markit

5. Rapidan Energy Group

6. Environmental Defense Fund

7. Sierra Club

8. Sinclair O&G

 

Aside from prorationing, speakers at the hearing advocated for other actions that the TRRC may undertake to support the Texas E&P industry.  These alternative actions include limiting the grant of flaring permits and a declaration of force majeure to prevent lease expiration from lack of production activity.

Draft Proration Order

The draft proration order is marked as an agenda item under Commissioner Sitton.  This is unsurprising as so far Mr. Sitton has been the sole Commissioner to consistently champion the idea of a statewide proration order to address the issue of oversupply caused by COVID-19 and former OPEC wrangling.[vii]  The draft order takes official notice of various facts around the oversupply of crude oil in the State of Texas due to the crisis (mentioning Russia, Saudi Arabia and COVID-19 by name) and concludes based on these facts that “waste” of crude oil is occurring or is reasonably imminent in Texas.[viii]  The actual proration order contained in the draft order follows, and is issued based on, this finding of waste, under the TRRC’s authority to prevent waste.[ix] 

The draft order is materially different from the OCC shut-in order and has a number of interesting features, including the fact that proration is only triggered once all other U.S. state and foreign country jurisdictions (i.e., other than Texas) agree to curtail production by 4 million bbl/day, in addition to the prior OPEC cut.  When triggered, proration under the draft order applies to 80% of production (subject to adjustment by the TRRC), with production being determined on an operator basis, aggregated across all of an operator’s wells, based on a certain prior period benchmark (e.g., proration is not determined on a well or field basis). 

Relevant provisions of the draft order are set out in more detail in the table below, but since the order’s actual content enacting proration is contained in a single paragraph (with most action taking place in the definition of terms), the operative provision is quoted in full here:

Commencing with the Initial Proration Month and ending on the last day of the Last Proration Month, each Applicable Operator shall restrict the aggregate volume of Oil produced by such Applicable Operator from Oil Wells during each Proration Month so that the aggregate total volume of Oil produced from all Oil Wells Operated by such Applicable Operator during each Proration Month, in the aggregate, does not exceed the Proration Volume applicable to such Applicable Operator for the applicable Proration Month (such restriction requirements referred to in this paragraph shall be referred to as the “Prorationing Requirements”)[x]

 

Material Terms of Draft Proration Order

Proration Trigger

(Initial Proration Month)

Proration starts on the Initial Proration Month, which is triggered upon the enactment of “Complementary Proration Measures” (being the calendar month following their enactment, if enacted before the 7th day of a month; or the second calendar month following their enactment, if enacted on or after the 7th day of a calendar month)

Complementary Proration Measures apply when the governments of all states in the U.S. other than Texas and/or all foreign countries other than the U.S. have enacted laws to curtail production of crude oil by, in the aggregate across all such state and foreign country governments, at least 4 million bbls per day, in addition to the 9.7 million bbl/day reduction already announced by OPEC+

Proration Term and Termination

(Final Proration Month)

Proration ends at the completion of the Last Proration Month, which is the earlier of (i) the first calendar month following the month during which the applicable Complementary Proration Measures, or (ii) the month during which the Commission finds that global demand for crude oil exceeds 85 million bbls per day

Applicable Operator + Active Well Basis

Proration is determined on an operator-basis, and on an aggregate basis across all active wells operated by an applicable operator (not on a well by well basis), subject to exclusion for certain operators

Proration Volume

The volume subject to proration is equivalent to an operator’s Benchmark Oil Production Volume multiplied by the Market Demand Factor (multiplied by the number of days in the applicable month), where:

Operator’s Benchmark Oil Production Volume is the operator’s highest daily average aggregate production volume (across all of its operated, active wells) during either October, November or December of 2019 (i.e., take the month with the highest daily average production volume and use that); and

The Market Demand Factor starts at 80% under the draft order, and is subject to adjustment by the Commission from time to time if necessary to prevent waste

Excluded Operators

Proration does not apply to operators with active wells that, in the aggregate, produce less than 1,000 bbls / day

Exempt Wells

Wells exempted from the TRRC’s proration authority under Texas law generally are exempted from proration and are not counted for purposes of determining an operator’s benchmark oil production

 

It is worth noting that the TRRC Chairman has already openly announced that he intends to vote against the draft order, describing proration as “an antiquated policy” and pointed to the Blue Ribbon Task Force as a means to develop ideas to save E&P jobs with industry input.[xi] 

Takeaway

At the time of this article, WTI price has rebounded from negative territory but remains in the teens.  On Tuesday, the upstream industry will likely watch closely the TRRC vote on the draft proration order.  Given that two of the three Commissioners have openly expressed their reviews on the order, it appears that Commissioner Christi Craddick has the deciding vote.  Irrespective of the outcome, additional proposed measures to support the Texas oil and gas industry may follow from the Blue Ribbon Task Force.

 

[i] See meeting recording available at http://www.adminmonitor.com/tx/rrc/open_meeting/20200414/.

[ii] See https://www.rrc.state.tx.us/all-news/042120a-christian-discusses-proration-task-force/.

[iii] Cameron Wallace, WTI Crude Price Goes Negative for the First Time in History, WorldOil.com (Apr. 20, 2020).

[iv] See Oklahoma Corporation Commission Issued Order on Prevention of Economic Waste, available at kslaw.com for further discussions on this order.

[v] May 4th meeting agenda is available at https://rrc.texas.gov/media/57506/final-conference-agenda-for-may-5-2020.pdf.

[vi] Compiled from TRRC hearing minutes, available at https://rrc.texas.gov/media/57365/rrc-open-meeting-minutes-april-14-2020.pdf.

[vii] Asher Price, Texas Railroad Commission Holds Off Putting Cap on Oil and Gas Production, The Dallas Morning News (Apr. 21, 2020).

[viii] “Waste” is defined at Texas Natural Resources Code § 85.046.

[ix] Texas Natural Resources Code § 85.051

[x] TRRC Open Meeting Notice for Tuesday, May 5, 2020, Appendix A, Order at para. 1.

[xi] Wayne Christian, Opinion: Texas Capping Oil Production? Chairman Wayne Christian Picks a Side, Houston Chronicle (Apr. 29, 2020).

Related
Houston Energy