Thought Leadership

Oil Prorationing in the Spotlight at Texas Railroad Commission

Client Updates

On March 30, 2020, Pioneer Natural Resources U.S.A., Inc. (“Pioneer”) and Parsley Energy, Inc. (“Parsley”) filed with the Railroad Commission of Texas (“RRC”) a Motion Requesting a Market Demand Hearing and Market Demand Order for May 2020 Production.   The filing brings to a head the issue of possible production limits by the RRC through prorationing, which has been a hot topic of discussion and speculation since oil prices tumbled earlier this month. The filing raises important issues not only for oil producers, but also for midstream and downstream businesses.  A copy of the filing may be found here.

The two exploration and production companies have requested that the RRC hold a hearing to determine whether “economic waste” is occurring in Texas (in the form of production in excess of market demand) and, if the RRC determines that such waste exists, to enter an order or rule to limit oil production in Texas beginning in May 2020.  Citing supply increases resulting from “a market share war between Russian and Saudi Arabia” and reduced demand precipitated by “the outbreak of the COVID-19 pandemic,” Pioneer and Parsley maintain that a surplus of production “will likely overwhelm the handling, processing and storage capacities” of the industry.  Attaching to their filing two recently prepared research pieces, they claim that “market demand for Texas oil is experiencing a massive collapse that threatens to destroy the state’s oil industry” and ask the RRC “to set a market demand hearing as soon as legally possible to determine the current reasonable market demand in Texas” and issue appropriate orders.

Pioneer and Parsley’s request follows a week or more of increasing attention on the issue of possible production limits by the RRC, which the RRC has not done based on market demand since 1972. In a March 20th op-ed piece,1  RRC Commissioner Ryan Sitton noted that Texas “has the authority to set pro-rationing schedules, thereby limiting production for Texas producers,” and suggested that “this is an opportunity for the U.S., especially Texas, to lead in a way we haven’t in a generation.” He further stated that “[w]e would need our federal government, and our president, to make a deal that stabilizes oil markets.” He concluded that “perhaps it is worth discussing whether pro-rationing for Texas producers is appropriate, if it can return the world back to the market.” 

A few days after Commissioner Sitton’s op-ed piece appeared, RRC Chairman Wayne Christian also addressed the issue publicly2.  "I have many reservations about prorationing crude oil production in Texas,” said Chairman Christian. While declining to rule out production limits entirely, he stated his opposition to “Texas acting unilaterally” and declared that any action by Texas “must be done in lockstep with other oil producing states and nations, ensuring that they cut production at similar times and in similar amounts.”  

The RRC has the authority to impose production limits under the Texas Natural Resource Code (“TNRC”), which authorizes the RRC to limit production to prevent production of oil in excess of reasonable market demand. TNRC § 85.045 (Waste Illegal and Prohibited) provides that the “production, storage, or transportation of oil or gas in a manner, in an amount, or under conditions that constitute waste is unlawful and is prohibited.” TNRC § 85.046(a)(10) (Waste) defines “waste” to include, among other things, the “production of oil in excess of transportation or market facilities or reasonable market demand” and further provides that “the commission may determine when excess production exists or is imminent and ascertain the reasonable market demand.” Under TNRC § 85.049(a), such an inquiry may be initiated on a complaint by any interested person—such as the complaint by Pioneer and Parsley—but the RRC has discretion as to whether to grant the requested hearing.

There are limits on the RRC’s authority to curtail production.  Under TNRC § 85.048 “the commission shall not restrict the production of oil from any new field brought into production by exploration until the total production from that field is 10,000 barrels of oil a day (“bopd”) in the aggregate.” Some observers have claimed that production limits do not apply to any fields producing less than 10,000 bopd in the aggregate. Our analysis of the statute and its legislative history (it was originally enacted in the 1930s) indicates that interpretation may not be correct.  Production limits based on market demand may not apply to fields that have never, since entering production, reached 10,000 bopd in the aggregate.  Fields that have previously exceeded the 10,000 bopd threshold may be subject to production limits even if they now produce less than 10,000 bopd.  Further, since the RRC last exercised its proration authority over 40 years ago, many new shale wells have been drilled and designated by operators to fields that may have once exceeded that threshold even though the newly drilled shale wells never have, further contributing to confusion around this limitation on the RRC’s statutory authority.  

Were the RRC to grant the requested hearing, TNRC § 85.051 (Adoption of Rule or Order) would generally require notice,3 a hearing, and an affirmative finding of waste before the RRC could adopt an order limiting production. However, emergency rulemaking provisions in the Texas Government Code allow adoption of an emergency rule without prior notice or hearing upon a finding that an imminent peril to the public health, safety, or welfare requires adoption of the rule on fewer than 30 days’ notice.  Such an emergency rule may remain in place for up to 120 days and may be renewed once for an additional 60 days.4  

There are currently significant procedural and logistical challenges to scheduling a hearing at the RRC and obtaining the requested RRC proration order by May 2020. Due to the COVID-19 pandemic, the RRC has suspended in-person hearings, requiring parties to schedule their hearings for a later date or hold a hearing telephonically.  While not impossible, it would be difficult to oversee a telephonic hearing with the number of parties likely wanting to participate in any hearing considering industry-wide limits on oil production. Meeting the request for action before May 2020 also poses challenges.  Hearings normally are held before an administrative law judge (“ALJ”) who then writes a proposal for decision (“PFD”) to be considered and voted on by the Commissioners. Holding a hearing, getting a PFD from the ALJ, and getting it in front of the Commissioners for a decision before May would be very difficult even under normal circumstances. The Commissioners could choose to hear the case themselves, which would eliminate the need for a PFD and potentially expedite the schedule.  However, the RRC previously cancelled its only March open meeting, which was scheduled for today, March 31st. The next scheduled meeting is April 21st, although (as noted above) the RRC could schedule an emergency hearing.  The most recent COVID-19 Response Order from the RRC Hearings Division may be found here.

The potential for production limits has led to questions about the effects on contracts, including oil and gas leases, pipeline agreements, and other midstream and downstream agreements. Some producers may have concerns about what impact production limits could have on the ability to preserve a lease that requires production in paying quantities (i.e., is in its secondary term). This is a complex question that will require careful assessment of each agreement and the individual facts of each situation.  However, while the specific terms of each lease would need to be closely analyzed, there are a number of options that may be available to producers in that scenario, including:

  • shut-in royalty clauses,
  • where permitted, reduction in the number of wells feeding central processing facilities combined with the allocation of oil from those central facilities to all connected leases,
  • reliance on lease provisions and case law allowing the temporary cessation of production to prevent termination where production must be shut in or significantly decreased yet there exists a reasonable expectation of resuming profitable production in the future,  and
  • force majeure clauses or related doctrines of impossibility or commercial impracticability that may suspend the lessee’s obligation to produce in commercial quantities where applicable.

For other contracts as well, such as those between producers and their pipelines, producers and their downstream customers, and pipelines and downstream customers, regulatory out provisions and force majeure clauses (or the related doctrines noted above) could become the source of significant claims and controversies.  For prior Baker Botts thought leadership regarding force majeure, see our Force Majeure Webinar and for COVID-19 related concerns and issues visit our COVID-19 Resources page

Baker Botts will continue to monitor this issue and be available to counsel our clients on the questions it raises.


1 https://www.bloomberg.com/opinion/articles/2020-03-20/oil-price-war-is-u-s-s-chance-to-protect-free-markets?sref=5F8Ao01j 

https://www.worldoil.com/news/2020/3/25/texas-rrc-chairman-wayne-christian-we-must-stabilize-worldwide-oil-markets  

3 Tex. Gov’t Code § 2001.034(a) (Emergency Rulemaking).

4 Tex. Gov’t Code § 2001.034(c). 

 

ABOUT BAKER BOTTS L.L.P.
Baker Botts is an international law firm of approximately 725 lawyers practicing throughout a network of 13 offices around the globe. Based on our experience and knowledge of our clients' industries, we are recognized as a leading firm in the energy and technology 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.

Industries

Related Professionals