United States: COVID-19 - Impressions from the historic Texas Railroad Commission 14 April 2020 prorationing hearing

In brief

The Texas Railroad Commission (TRRC) held a hearing on Tuesday, 14 April 2020 to consider statewide oil production cuts at the request of Pioneer Natural Resources (Pioneer) and Parsley Energy Inc. (Parsley) under Section 85.049(a) of the Texas Natural Resources Code (Code). The TRRC’s marathon 10-hour hearing capped off a flurry of activity that began on 30 March 2020, when Pioneer and Parsley requested the TRRC take the extraordinary step to order the prorationing of oil production starting in May 2020 to combat the recent oil price shock due to oversupply and COVID-19 related demand reductions. The TRRC has authority to rule on these matters under several sections of the Code, including Sections 85.046, 85.051, 85.054, and 85.058. Under these sections, if the TRRC determines “waste” (production in excess of reasonable market demand) is occurring or is imminent, then the TRRC must take any action it considers reasonably required to correct, prevent, or lessen the “waste.”

More than 200 organizations made public comments, over 20,000 virtual participants attended all or a portion of the hearing, and over 50 organizations presented to Chairman Wayne Christian, Commissioner Christi Craddick, and Commissioner Ryan Sitton. The Commissioners’ ruling will have far-reaching consequences for global oil markets due to Texas’ role as the third largest oil producer in the world, representing approximately 5% of global oil production (41% of U.S. oil production), and could represent a historic event in the industry as the TRRC last curbed Texas oil production in 1972.

What Happened at the Hearing

Beginning promptly at 9:30 am, the TRRC allowed any interested party to speak for an initial three-minute period, followed by questions from the three Commissioners. Over 50 different industry stakeholders—spanning energy companies across the value chain, institutions, environmental groups, academics, and individuals—collectively presented evidence to the Commissioners. Each presenter was asked to state whether it is for, against, or neutral on the question of prorationing in the State of Texas.

After hearing all arguments for and against proration, as well as the comments of neutral parties, the TRRC adjourned the hearing, and is expected to issue its ruling on 21 April 2020. A distillation of the key positions for and against proration, questions posed by the Commissioners, as well as some of the legal issues raised by proration, are highlighted below. Baker McKenzie’s North American Energy Response team will continue to monitor developments closely, and is available to engage with you regarding any questions you may have. We will also be monitoring the prorationing hearing in Oklahoma that has been scheduled for May 2020.

Key Positions Expressed by those "For" Proration Key Positions Expressed by those "Against" Proration
  • Unprecedented times call for unprecedented action
  • Oil prices will continue to fall significantly without action by the TRRC
  • The TRRC is charged with the responsibility to prevent “waste”
  • Texas should lead the way in proposing solutions and other states will follow
  • Storage limitations require decisive action
  • The Texas economy, tax base, and oil and gas industry jobs need the TRRC to act
  • Small and medium producers are disadvantaged due to unfair market access to capital
  • Flaring and other environmentally harmful practices should end and doing so would simultaneously curtail “waste” and reduce production
  • The United States’ role has shifted from being primarily a consumer to being primarily a producer for the global oil markets
  • Proration will not impact prices in the global markets
  • Reducing production cedes market share to other states and the global markets
  • The markets are already responding by shutting-in wells, reducing rigs, and reducing capital
  • The TRRC did not act during past downturns, and should similarly refrain from intervening now
  • Inefficient producers should not be protected through actions by the TRRC
  • Cooperating with Saudi Arabia and Russia could create negative precedent and reduce future options; OPEC will come to expect future cooperation
  • Free markets and limited government intervention should guide the TRRC

Key Questions by the Commissioners 

  • Is economic waste occurring? If so, how can that waste be quantified?
  • At what price is oil production in Texas commercial?
  • How long should proration last?
  • How would proration violations be penalized by the TRRC?
  • If the market is already reducing production due to demand constraints, why issue a proration order?
  • If proration is issued, how will this impact Texas producers in the U.S. and global oil markets?
  • Should any proration order issued by the TRRC be contingent on other states participating?
  • Are there other tools available to the TRRC besides prorationing?
  • How would prorationing operate from a technical perspective?

Legal Implications

Regardless of the outcome, the TRRC’s decision on proration raises a number of legal issues that affect every segment of the energy industry.

From a practical standpoint, proration will trigger immediate questions regarding existing oil and gas contracts. For example, does the order constitute a force majeure event? If so, what rights do operators have to avoid shut-in payments or other penalties? How will the order affect impending lease expirations? The answers to these questions will depend on each particular set of facts. Assuming proration will in fact help stabilize global oil markets, there are legitimate concerns about whether the TRRC has the necessary resources and technology to regulate and enforce the order.

Once the TRRC issues a ruling, these questions may not be immediately resolved as impacted parties may seek judicial review of the order. It also remains to be seen whether the TRRC would be considered to have exclusive jurisdiction over this issue, or if judicial intervention is needed to determine the parties’ rights under existing contracts, including leases, operating agreements, and transportation contracts.

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