In Contentious Debate, Texas Oil Considers Mandated Cuts

The Texas oil industry remains deeply divided over mandated oil production cuts, a 10-hour hearing by the Texas Railroad Commission showed Tuesday, as the Commission weighed imposing OPEC-style production cuts on Texas oil producers in an attempt to stabilize a shell-shocked oil and gas industry. If enacted, this would be the first time Texas prorated oil production in nearly 50 years.

“OPEC’s cut was a good first step,” said Matt Gallagher, President and CEO of Parsley Energy, a large Texas-based independent, one of the companies arguing for proration at the meeting.

“The railroad commission taking action as the largest producing state would be the next leadership stance. This would be temporary — you could review if others are coming along in the G20 and essentially reverse the order after a 30-day period if other states and other countries are not acting properly.”

The meeting of the Railroad Commission, the agency that regulates oil and gas activities in Texas, comes as the United States and other G20 states look to cut a ballpark of 3.7 million barrels of oil per day from a glutted oil industry, and after OPEC agreed to cut 9.7 million barrels of oil per day from their October 2018 baselines beginning in May. Though the U.S. has maintained any production cuts will be market-driven, many Texas independents are urging for a more organized approach that, they say, would be fairer to smaller independents likely to bear the burden of a true market crash.

In contrast, IOCs and larger oil companies are firmly against the cuts. Lee Tillman, CEO of Marathon Oil — which has operations in Texas, Oklahoma, New Mexico, North Dakota and Equatorial Guinea — said mandated cuts undermine operators’ ability to shut in the least profitable wells in their portfolio. He also argued that demand will fall naturally as a result of the free market. The Energy Information Agency is forecasting at least 2 million barrels of oil will be cut from U.S. production by the end of the year.

“Texas operators are already shutting in the least profitable wells in response to market forces, the way a free market should work,” Tillman said. “Supply and demand imbalances will always occur, and in those times, some companies will succeed, and others will fail. So, we have to ask: What will be the threshold to compromise free market principals in the future?”

US storage is expected to be full in the next 4-6 weeks, further escalating concerns over oil shut-ins, as refineries start refusing new supplies.

Like international oil markets, Texas oil has been rocked by COVID-19, as governments across the globe have ordered about 4 billion residents to shelter at home, nonessential industries to close and sharply restricted travel. Oil demand has plunged by about 30 million barrels per day. WTI was trading at $22.61 on Tuesday, a price that will send many Texas oil and gas companies into bankruptcy.

Scott Sheffield, CEO and President of Pioneer Resources, also argued for proration, saying shale companies need $30 to survive. At $20, he said, the industry will see 80% bankruptcies and about 250,000 workers laid off. “At $30, we are crippled but could survive,” he said.

The Railroad Commission does have power to prorate production within the state of Texas when ‘waste’ is demonstrated in the market, a power even the federal government does not possess.

Still, such action in Texas is very rare and the last time it was attempted was in 1973. Others concerned about the cut argued that Texas could be the only state that moves forward with such a decision, as production cuts legally cannot be mandated at the federal level. In which case, a fragmented approach to production cuts in the United States and from other G20 nations would further jeopardize Texas-based companies.

In fact, one of the largest shale companies in Texas, Diamond Back Energy Inc., threatened to stop all drilling and cancel all service contracts if the Commission decides on proration, a decision that would gravely impact jobs in the state.

In potential coordination with the OPEC+ agreement, Sheffield said Texas should implement a 20% cut, or the equivalent of 1 million barrels of oil per day.

The highly contentious issue is further complicated by the logistics of such a deal with, Commissioner Christi Craddick pointing out the complexity of implementing and enforcing cuts in a state made up of thousands of companies that produce anything from a few barrels per days to 1.2 million barrels of oil per day.

“We don’t even know how to do it anymore,” she said.

OPEC+ Struggles to Stabilize Market

OPEC+ finalized a deal on Easter Sunday that, in conjunction with efforts from the G20 and International Energy Agency and in combination with cuts and aggressive oil storage, could see between 19-20 million barrels of oil per day removed from an overwhelmed oil market. But oil traders are doubting the deal will have enough of an impact to counter the drop in demand caused by COVID-19.

OEPC+ will cut 9.7 million barrels of crude per day from an October 2018 baseline, for an initial two-month period. The real number, however, is higher, as several countries have been producing higher than the October 2018 baseline. Saudi Arabia, for example, produced 12.3 million barrels per day in March, and will be cutting to 8.5 million barrels from a baseline of 11 million barrels. The real cut stands at around 12.5 million barrels per day, collectively.

Additionally, nations in the G20, including the United States, Canada and Brazil, have agreed to act on the oil crisis, though specific quotas have not been agreed upon.

Despite the aggressive cuts, oil prices continue to lag. Brent was trading at $28.40
on market open, while WTI was trading at $19.57 on Wednesday morning.

The Texas Railroad Commission is set to vote on the mandated cutes at their next meeting on April 21.