The Fuse

Texas Explores Return of Rationed Oil Production

by Nick Cunningham | March 23, 2020

The crisis afflicting the U.S. oil industry has become so severe that some drillers are requesting the Texas state government step in to regulate production, a unthinkable development until only recently.

The Texas Railroad Commission once tinkered with supply levels in order to achieve some measure of market stability, but it has been decades since regulators used that authority. With shale drillers suddenly facing an existential crisis, calls have gone out for a return of government intervention. However, restricting supply faces numerous obstacles, making it unlikely that Texas regulators step in.

Texas Railroad Commission explores regulation
Several oil companies have asked the Texas Railroad Commission (RRC) to implement mandatory production cuts for the first time since the 1970s, including the executives from Parsley Energy and Pioneer Natural Resources, according to Reuters. Without action, oil prices could continue to fall, which would “absolutely decimate the American oil and gas industry,” said Matt Gallagher, chief executive of Parsley.

One of the three commissioners on the RRC, Ryan Sitton, warmed to the idea. An avowed ally of the industry, Sitton wrote in Bloomberg Opinion on March 19, suggesting that his commission could order a 10 percent cut in production by Texas drillers, and if Saudi Arabia and Russia followed suit, “it would return the market to pre-crisis levels.”

A day later, On Friday, March 20, OPEC’s Secretary-General Mohammed Barkindo spoke with Sitton and invited him to the OPEC meeting in June. Sitton also reportedly spoke with White House advisers. “My recommendation is we come to the table,” Sitton told Bloomberg. “An exceptional situation calls for exceptional solutions.”

The proposal garnered a lot of attention in the trade press, but there are several reasons why a Texas-OPEC deal is unlikely. First of all, two of the other three members on the RRC panned the idea. “While I am open to any and all ideas to protect the Texas Miracle, as a free-market conservative I have a number of reservations about this approach,” Wayne Christian, chairman of the Texas RRC, said in a statement. “Texas does not operate in a vacuum. If we prorate our oil, there is no guarantee other nations, or even states will follow suit.”

Second, only some companies in Texas actually want the RRC to intervene. Others, such as EOG Resources, rejected the idea. The American Petroleum Institute, a powerful lobby group representing the oil and gas industry, said the proposal was “shortsighted” and “anti-competitive.”

Third, it would also be difficult to implement. Commissioner Wayne Christian noted that the RRC has not regulated oil in the state in over forty years. “[W]e do not have staff at the agency with experience in this process and our IT capabilities to handle this process are limited at best,” he said.

In addition, federal anti-trust law prohibits companies from coordinating production, either with each other or with foreign producers. The RRC could order cuts in Texas, but in an interview with the Wall Street Journal, Sitton said “I’m not advocating for Texas to do anything on its own.” Moreover, while it’s not clear that killing shale was a main driver of the Saudi-Russian price war, Riyadh and Moscow may not want to throw a lifeline to indebted drillers that are on the ropes.

Ultimately, all of these obstacles could conceivably be overcome if cuts were thought to be successful. However, the crash in the oil market is so severe, and demand has evaporated to such a historic degree, that marginal cuts to Texas supply may not move the needle.

“The despair of the Texan oil industry…is understandable,” Commerzbank wrote in a note. But “given the sheer size of the surpluses, it would probably not even have any great impact at the moment.”

“We are now looking at surplus in Q2 2020 at a scale that we have never seen before,” Bjarne Schieldrop, chief commodities analyst at SEB, said in a statement. “With such a decline in demand, it almost won’t matter whether OPEC, Russia or US shale oil cuts 5m bl/day or not.”

Industry in decline
A group of 13 U.S. Senators recently sent a letter to Saudi Crown Prince Mohammed bin Salman urging him to reconsider the Saudi government’s decision to ramp up production. Senator Kevin Cramer sent another letter to President Trump calling on him to embargo oil from Russia, Saudi Arabia and other OPEC nations.

Like the proposal for the Texas RRC to regulate production in the state, these gestures are mostly symbolic and of little consequence. Moreover, the fact that the U.S. Senate is both pleading with Riyadh but also calling for an embargo on Saudi oil undercuts any notion of American “energy dominance,” a mantra pushed by U.S. policymakers in recent years.

Just as the decision by the Department of Energy to buy oil for the strategic petroleum reserve is a trivial response to the crisis, so too would be mandatory production cuts from the state of Texas. After all, many U.S. oil and gas drillers cannot survive at today’s prices. Their production is set to decline this year…with or without orders from regulators.