Oil Prices and the Texas Railroad Commission
The recent dramatic collapse of oil prices (particularly West Texas Intermediate) spurred me to revisit some thoughts about the oil and gas business in Texas and the state’s deceptively named Texas Railroad Commission (TRRC). It is unfortunate that whenever I write about the Railroad Commission, I feel compelled to commit valuable print space making sure my readers know what the Railroad Commission actually does. No, it’s not railroads. Don’t feel badly though. Even Texas voters — who elect our Commissioners — are largely in the dark as well.
Though the Texas Railroad Commission was established in 1891 to regulate railroads, the last remnants of the Commission’s responsibilities over railroads were transferred to the Texas Department of Transportation in 2005. In spite of its misleading name, the Commission’s actual authority and jurisdiction is over the state’s oil and natural gas industry, transportation pipelines, the natural gas and hazardous liquid pipeline industry, natural gas utilities, the LP-gas industry, and coal and uranium surface mining.
Today the Commission remains an openly and enthusiastically avowed champion of the oil and gas industry, even as it also regulates the industry it champions. It’s the only regulatory agency in Texas (other than the Alcoholic Beverage Commission) that Republicans seem to like. From the 1930s through early 70s, the TRRC even played the role OPEC came to play in supporting worldwide oil prices by restricting production from Texas oilfields.
Since the 1970s the TRRC has declined to use its authority to prorate the state’s production of crude oil based on market demand. This was largely due to the fact that with declining state production and increased worldwide production, the state lost its ability to control the price of oil by restricting the state’s output.
But market-demand proration has again raised its ugly head in Texas. Some normally laissez-faire oil industry types are asking the TRRC to re-institute market-demand proration. At a meeting on April 21, Commissioner Sitton called for a 20% decrease in statewide production — granted, only if other states and countries around the world agreed to do the same.
But even with Sitton’s caveats, this is a really bad idea.
During the decades that Texas restricted production, its relative clout in global oil markets was significant. Production from the giant East Texas field drove oil prices in the 30s to unheard of lows. In 1950, Texas produced nearly 20% of the world’s crude. But even with the dramatic increase in Texas oil production in recent years (now around 5 million barrels of oil per day), the state today accounts for only around 5% of worldwide crude production.
Given the strain that persistently low oil prices will have on national budgets around the world, it’s hard to imagine that any enforceable agreement to cut production something like 20% worldwide would be possible. And if oil prices should fail to rise by at least 20%, the state and its important oil and gas industry lose.
During the decades of market-demand proration by the TRRC, the business plans of oil production companies in Texas reflected knowledge that the Railroad Commission would continue capping total production in the state. But now, after 40 years without market-demand proration, TRRC-imposed proration has not been factor in producer planning. Sudden significant proration would undoubtedly hurt some companies much more than others. Losers will not take kindly to restrictions on their ability to sell oil, possibly to avoid bankruptcy. Imposition of a significant proration cut would create havoc in an industry already in turmoil and under intense stress.
Those of us who made a living in oil and gas know that it is a high-risk high-reward industry. During good times, salaries and profits are high. During bad times, not so much. With prices at the lows we’re now experiencing, there are going to be bankruptcies and layoffs … perhaps a lot. And while we have a societal obligation to help those who suddenly find themselves without an income, we need to let “creative destruction” run its course. Assets of overly extended companies will be acquired by companies who can weather the storm. Oil in the ground will remain there until economic conditions warrant production.
But that said, the political reality is that there will be calls for the TRRC and/or the Texas Legislature TO DO SOMETHING. It will be difficult for elected officials (especially Railroad Commissioners) to resist calls to find ways to support an industry so important to Texas (and, not coincidentally, to their re-elections).
In 1988, the Texas Constitution was amended to establish an Economic Stabilization Fund (ESF), sometimes referred to as the Rainy-Day Fund. Until 2014, the ESF received 75% of oil and gas production severance taxes in excess of those collected in 1987. The ESF is capped by statute at 10% of the State’s biennial general revenue budget, i.e., around $19 billion. The current balance is just over $10 billion.
After 2014, the Texas Legislature began diverting half of the severance taxes earmarked for the ESF to the State Highway Fund, choosing to fund a significant portion of highway construction out of severance taxes instead of general revenues — forgoing the opportunity to build up a more significant ESF during a period of rising oil production and general economic prosperity. This was done before the Fund achieved its mandated cap. It appears that the Legislature failed to understand what “Rainy Day” means.
The idea behind funding the ESF from oil and gas production taxes is fiscally sound. Oil and gas activity has historically been subject to boom and bust cycles. To increase the ESF during boom cycles is prudent. What’s troubling is that legislators couldn’t resist the temptation to raid the Fund even during an economic boom.
There will undoubtedly be calls during the next Legislative Session (beginning in Jan 2021) for the state to dip into the ESF. If the coronavirus pandemic doesn’t qualify as a rainy day, the argument will be, then what does? Those calling for the ESF to fund some portion of Texas government will have a pretty compelling case. Some of the calls will surely be to use state funds to support the state’s ailing oil and gas industry.
Here’s an idea … use a smidgen of that rainy-day money to address a long-standing environmental hazard.
When an oil and gas company ceases operations, it sometimes leaves behind wells that have not been properly “plugged and abandoned”. The abandonment process requires, among other things, filling a well with cement so that the wellbore does not provide a future path for hazardous subsurface fluids to migrate up to groundwaters. Companies are required to plug and abandon wells that no longer produce, a process regulated by the TRRC. Wells that are left in an un-plugged state by a bankrupt company are called orphan wells.
The Texas Natural Resources Code now requires Plug and Abandonment Surety Bonds on new wells. But no bonds exist for wells drilled before this requirement was enacted. The responsibility for plugging orphan wells has been delegated by the Legislature to the Railroad Commission and funded by state revenues.
The orphan wells backlog, a moving target that changes with economic conditions and industry activity, generally runs in the thousands. In 2019, the TRRC plugged more than 1700 wells. We’re still years away from catching up, especially since the list of orphan wells will undoubtedly increase dramatically should oil prices remain low.
What better time to address this impending environmental problem than now, when oil and gas activities are grinding to a halt. Oilfield services businesses are always hit hard during bust cycles, and they’ll be needed when oil prices rebound. And during bust cycles, they’ll be looking for business opportunities. Plugging and abandoning services can likely be acquired at bargain prices.
This type of modest support for our state’s ailing oilfield services sector could go a long way toward addressing a long-standing issue that continues to threaten the state’s groundwater resources. And while we’re at it, Texas Legislature, how about returning to the original funding mechanism of the ESF so we can take advantage of the next oilfield boom cycle to build up the cushion for the next rainy day.
And while you’re at it, Texas Leg, can we please change the Commission’s name already?
