On April 14, 2020, the Railroad Commission of Texas (the “RRC”) held an online open meeting (the “Proceeding”) in response to a motion by Pioneer Resources USA Inc. (“Pioneer”) and Parsley Energy Inc. (“Parsley”). The motion, filed on March 30, 2020, requested a RRC hearing to determine the reasonable market demand for oil in the State of Texas, whether wasteful production is occurring or imminent and, if so, the appropriate proration orders to prevent such waste. The April 14th Proceeding was held to allow some of the parties who submitted written comments to also provide live testimony via webcast and, in some cases, to answer questions from the Commissioners. Beginning at 9:30 am, the RRC took live comments from approximately 50 speakers then closed the Proceeding shortly after 7:30 pm without further discussion. A summary of those speaking for and against prorationing (and those remaining neutral) can be seen here.

Pioneer and Parsley’s motion is now on the agenda for the April 21, 2020 RRC open meeting. Items placed on the agenda may be, but are not required to be, taken up and discussed. The filed comments and live testimony provide some insight into the issues that may be on the table at the April 21st open meeting. While many topics were covered, most of the ten-and-a-half hour meeting focused on one or more of the following eight categories, which we believe are the key issues to listen for should the Commissioners decide to take up the subject on April 21st. 

 

Waste. A key topic was how to define and quantify waste and whether waste is actually occurring in Texas.  Speakers in favor of prorationing argued that because production in Texas vastly exceeds demand, waste is occurring. Parties opposed to prorationing argued that if the term “waste” is interpreted to mean supply in excess of demand, then there would be many situations where there would be waste, because there are routinely market fluctuations in supply and demand.  The speakers were divided on whether waste includes only physical waste or can also include economic waste resulting from low prices. The phrase “economic waste” is often used to describe the type of waste defined in Tex. Nat. Res. Code § 85.046(10) and was used frequently throughout the Proceeding. That phrase, however, does not actually appear in § 85.046(10), which refers simply to “production of oil in excess of transportation or market facilities or reasonable market demand.” Several supporters of prorationing stated that smaller producers do not have the volume of production necessary to negotiate long-term contracts or firm transportation rights.  They alleged that without a proration order small producers will be forced to shut in their production, which may create waste if wells cannot be restored to full production.  They argued that by cutting all production ratably, the RRC will create additional demand for smaller producers’ production, thereby providing smaller producers with greater access to the market and the ability to keep their wells in production, even if significantly choked back. 

 

Impact of Prorationing. Speakers in favor of prorationing focused primarily on the negative impacts to small oil and gas producers if the RRC does not prorate production, and some stated that Texas can achieve its objective of curbing oil production even if it provides exemptions for smaller producers.  Speakers against prorationing argued that the RRC should not be in the business of deciding winners and losers in the oil and gas market at the expense of a free-market system. A few speakers noted the attempt by Alberta, Canada, to limit heavy oil production. They argued that Alberta’s actions had produced unintended consequences, that Alberta is finding it difficult to end the program, and that prices in the province are lower than before curtailment began. Several speakers advocated that the Governor of Texas should issue an order declaring a force majeure or an emergency situation, thereby allowing producers to claim force majeure and take advantage of the protections provided by existing contract and lease provisions. There was discussion of the potential disparate impact of a proration order on producers that have already begun cutting production compared to producers who have been increasing their production.  Most of the speakers who addressed the issue advocated calculating allowables based on reported production in the fourth quarter of 2019, because that was the last period before some producers started making heavy production cuts. 

 

Storage Capacity. Many speakers asserted that oil storage capacity will likely be full by the middle of May, but the speakers differed on the significance of the lack of available storage capacity.  Several speakers argued that if storage capacity fills up, it will actually serve to eliminate waste because producers will stop producing or send their barrels to other markets. Other speakers argued that absence of available storage capacity is a clear indication that waste is occurring because production is exceeding demand.

 

Flaring. There was considerable discussion of whether reducing the amount of natural gas flaring permitted by the RRC would decrease oil production and help balance supply and demand.  Many of the speakers on both sides supported (or did not oppose) a reduction in the amount of permitted flaring, but some of them also argued that flaring was an operational and safety issue that should not be conflated with prorationing.  

 

Prorationing Contingencies. A number of speakers suggested that prorationing should be contingent upon other states or countries agreeing to also cut production. One speaker suggested that Texas prorationing orders should not take effect until one month after cuts by other states or countries. Many of the speakers in favor of prorationing argued that Texas should be the leader of this effort and that Texas leadership would encourage other states to follow suit. 

 

RRC Process. Several speakers argued that the RRC does not have the man-power and resources to enforce such an order.  One speaker expressed concern that funding a prorationing effort would require severe budget cuts to other important RRC programs, because the RRC’s budget is fixed at least until the next legislative session, which does not begin until January 2021.  

 

Other Tools Available to the RRC. In response to Commissioner questions about alternatives to prorationing, several speakers answered that they had not done sufficient research to support an answer.  Other speakers, however, suggested options. As discussed above, one of these proposals was a reduction in flaring permits.  Some speakers argued that the federal government should impose a tariff on refiners that import oil over some threshold to be set by the RRC.  Other speakers argued that the RRC could institute waivers for certain regulatory requirements (plugging deadlines, e.g.) that would decrease the financial impact on small producers in particular. 

 

Free Market vs. Regulation. Many speakers framed their remarks in terms of a choice between the free market versus regulatory intervention.  Most of the proponents of an oil proration order argued that the free-market system must give way under the extraordinary current circumstances. Speakers opposed to a proration order argued that the nature of a free market is that there are some winners and some losers, and that the RRC should not decide who wins and who loses. Opponents of prorationing also argued that the market rewards the most efficient, best-prepared companies and that regulation would punish the more efficient companies and reward the least efficient. Opponents also argued that the market is working on its own as production is already decreasing. Several speakers argued that each operator is best positioned to determine how market conditions affect its operations and to tailor its response accordingly. They maintained a proration order would force a single solution upon all producers in Texas without regard to differences in the scope or economics of their businesses. 

 

The RRC ended the Proceeding without addressing next steps or whether they would rule on the motion. At the end of the proceeding, none of the Commissioners expressed any views on the positions discussed. However, as noted above, Pioneer and Parsley’s motion is now on the agenda for the April 21, 2020 RRC open meeting. A live webcast of the April 21st open meeting can be accessed here: http://www.adminmonitor.com/tx/rrc/open_meeting/.  

 

ABOUT BAKER BOTTS L.L.P.
Baker Botts is an international law firm whose lawyers practice throughout a network of offices around the globe. Based on our experience and knowledge of our clients' industries, we are recognized as a leading firm in the energy, technology and life sciences sectors. Since 1840, we have provided creative and effective legal solutions for our clients while demonstrating an unrelenting commitment to excellence. For more information, please visit bakerbotts.com.