Texas Oil Regulators Unsure Drilling Cuts Will Aid Industry

By Keith Goldberg and Jack Queen
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Law360 (April 14, 2020, 11:00 PM EDT) -- Texas oil regulators on Tuesday questioned whether the state's drillers are in dire enough straits due to coronavirus-depressed demand and a growing supply glut for them to order a statewide curtailment of oil production for the first time in nearly five decades.

Texas shale giants Pioneer Natural Resources USA Inc. and Parsley Energy Inc. want the Texas Railroad Commission to start a statewide proration of oil production as early as next month, in which Lone Star state drillers would have to reduce a percentage of their total production in order to align it with market demand. The agency hasn't ordered proration since 1973.

At a closely watched virtual public meeting on the companies' request, RRC commissioners grappled with three questions: whether the current supply-demand imbalance fueled by the COVID-19 pandemic constitutes a "waste" of oil that necessitates prorationing, whether smaller oil producers would be disproportionately hurt by prorationing and whether cracking down on excessive gas flaring from wells could accomplish sufficient production cuts without resorting to prorationing.

"How would that prevent waste?" RRC Commissioner Ryan Sitton said of statewide proration. "That's the crux of our discussions."

Pioneer CEO Scott Sheffield said that a statewide curtailment of 1 million barrels of oil per day — 20% of Texas' total oil production — starting in May and potentially a 10% production cut in June is necessary to prevent the state's industry from further drilling its way into financial oblivion.

"Our industry has created so much economic waste that nobody will buy our stocks or own our stocks," Sheffield told the RRC on Tuesday.

Meanwhile, Parsley CEO Matt Gallagher said at the current rate of production, U.S. storage capacity will be exhausted by mid-May, which would send oil prices crashing even lower.

"I don't think we should wait," Gallagher told the RRC. "I think we should take pragmatic action on a temporary basis."

But Sitton, who had previously floated the idea of proration, questioned whether such a cut would make a difference when global demand is down by 20 million to 30 million barrels per day. Meanwhile, RRC Chairman Wayne Christian noted that the crash in oil prices is already pushing many drillers to cut production and mentioned Sunday's deal by the Organization of the Petroleum Exporting Countries and its allies to cut 9.7 million barrels per day of global production in May and June.

"Why is it necessary we have additional regulations if the market itself is already limiting production?" Christian said Tuesday.

Producers and trade groups opposed to any proration order echoed that sentiment.

"If we're going to ascribe waste to all of those fluctuations where we have a deviation between supply and demand, the RRC is going to be very busy," Marathon Oil Corp. CEO Lee Tillman told the commission. "The bottom line is production is coming down."

Diamondback Energy Chief Financial Officer Kaes Van't Hof said his company would cease all activity immediately if the RRC elected to prorate, wiping out more than 3,000 jobs.

"We are in the greatest economic contraction in recorded history," he said. "Why should oil prices rise?"

And Jim Teague, co-CEO of pipeline giant Enterprise Products Partners, questioned whether proponents of proration are looking to get out of contractual obligations.

"I don't see the rationale of those pushing for this," Teague told the commissioners. "Do you really think a cut by Texas can fill a 25 million-barrel demand hole?"

RRC commissioners also questioned whether a proration order would disadvantage Texas if other oil producing states didn't take similar steps.

"Other [companies] may just move across the border to New Mexico, or up to North Dakota," RRC Commissioner Christi Craddick said Tuesday.

Wil VanLoh, CEO of Quantum Energy Partners, called the OPEC cuts a "Band-Aid on a gunshot wound" and said the cooperation of other states is necessary to stem the bleeding.

Christian returned to the idea of a coordinated response several times throughout the afternoon, asking what the proper role of the RRC should be on the national level.

"The hardest thing in my mind is to sit back and do nothing," he said. "And that is sometimes what we need to do, but it's hard for me to do."

The price of inaction, VanLoh said, would be the wholesale destruction of smaller market producers, an undesirable outcome even for big players like Quantum. He described the arguments against production curbs by other heavyweights as self-serving.

"Right now we have a thunderstorm, not a hurricane," he said. "We've got a little bit of time now to board up the windows."

Commissioners also suggested that cracking down on flaring from wells could result in enough production cuts that prorationing might not be necessary.

"What do you think about the idea about us getting more strict about flaring and restricting flaring permits and flaring volumes?" Sitton asked Gallagher.

Gallagher said that such a move "dovetails" with efforts to prevent waste, but he and others said that isn't a substitute for prorationing, especially as U.S. storage capacity fills up.

Environmental groups told commissioners that sharply reducing flaring would prevent the needless release of trillions of cubic feet of emissions contributing to climate change. Doing so would serve the public health at a time of heightened urgency, they said.

"Reducing this pollution now is critical because the pandemic makes people with respiratory problems specifically more likely to have health problems and even to die," said Robin Schneider of the Texas Campaign for the Environment.

Harry Pefanis, president of oil pipeline giant Plains All American Pipeline, said his company doesn't have a position on prorationing. But Pefanis said Plains has notified all its shippers that it won't accept any new transportation of crude oil unless they can show proof of a destination.

"We can't act as a storage facility for everybody that doesn't have a market," Pefanis told the RRC. "We're only taking crude into the pipe that has a home at the other end."

Oil producers are about to hit a wall, need to be proactive and think about ways to curtail production in order to cushion the blow, Pefanis said.

The RRC did not vote Tuesday and set its next meeting for April 21.

--Editing by Michael Watanabe.

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