Will Texas Cap Oil Production?

The original OPEC may be forced to rise to an old task. Plus updates from around the world.

Hi folks. Busy week here. I spoke with Bob Trebilcock at Supply Chain Management Review about how COVID-19 is accelerating political forces that were already reshaping global supply chains. I also appeared on my friend Dhanur’s podcast to talk about how to deal with COVID-19 misinformation. I’ll have some exciting news to share next week on what I have been up to lately, but in the meantime, I have changed up the format here, going more in-depth on a single story. Smaller updates on important developments in the past 7 days and references for the in-depth report are below the main feature. Take care. — JLS

In-Focus: The Texas Railroad Commission Returns to its Roots

“James Mann, who spoke Tuesday on behalf of the Texas Pipeline Association, said he’s old enough to remember when the state commission focused on prorationing. ‘Just about everyone at the commission back then generally understood how it worked,’ Mann said. ‘They’re all dead now.’”[1]The Texas Tribune, 15 April 2020

This past Tuesday, the Texas Railroad Commission (RRC) met to consider whether to impose a limit on oil production in Texas. The formal request for consideration was submitted by Pioneer Natural Resources and Parsley Energy, but by the end of Tuesday’s proceedings, RRC commissioners had heard 10 hours of testimony from over 55 interested parties both for and against market intervention.[2] The RRC is due to render its decision next week on April 21, which could potentially mean a 20 percent reduction of output as soon as May 1.[3] Contrary to Mr. Mann’s lament, one does not have to be old (or dead) to know something about the Texas Railroad Commission’s (RRC) history – and how that may inform the future of oil production not just in Texas but in the world.

Larger U.S. energy companies like Chevron, Exxon Mobil, and Occidental have come out publicly against curtailing output.[4] In the words of the President of Exxon’s shale division, the free market is “the most efficient means of sorting out the extreme supply and demand imbalance.”[5] Of course, it is relatively easy for companies as large and diversified as Chevron and Exxon to extol the virtues of the “free market.” Unlike smaller, Texas-based oil companies, big players like Chevron and Exxon can credibly expect to weather the crisis produced by the Russia-Saudi oil price war and COVID-19. In a truly “free” market, smaller companies would either fail or figure out a way to survive long enough for demand to recover. Here, however, is the catch: that is simply not how U.S. oil production has historically worked, though the reflexive genuflections to the virtues of the free market recently on display might lead one to conclude otherwise.

To be clear: this is not to say that Chevron, Exxon, and opponents of prorationing are wrong. That is a question the RRC commissioners were elected to wrestle with. It is simply to say that until 1972, the RRC and other regulatory bodies in American oil producing states routinely fixed prices. That did not just make Texas the most influential producer in the United States (in 1953, for instance, Texas was responsible for 45 percent of total US production).[7] It made Texas the most powerful oil producer in the world. In 1948, U.S. oil production and reserves accounted for 64 percent and 34 percent of the global total respectively.[8] Unsurprisingly, that generated a number of global admirers – one of whom was a Venezuelan official named Juan Pablo Pérez Alfonzo.

Exiled from his country after a military coup in 1948, Pérez Alfonzo spent 10 years in the US and in Mexico. While in the US, Pérez Alfonzo became enchanted with the RRC, so enchanted in fact that when he returned to Venezuela in 1958 to serve as Ministers of Mines and Hydrocarbons under a new, democratically elected government, he hired an RRC engineer named Jack Baumel to travel to Venezuela. Baumel’s job was ostensibly to “carry out a study on the most effective way to proceed for the conservation of oil and gas fields.”[9] Pérez Alfonzo’s real motive however was not for Baumel to advise him on maximizing the use of Venezuela’s oil and gas deposits, but rather “to explicate the mysteries and wonders of prorationing and how to apply it in Venezuela.”[10] Pérez Alfonzo hoped to replicate the RRC on a global scale, and when the Eisenhower administration put quotas on foreign oil imports in 1959, Pérez Alfonzo attempted to convince the US (its most important trading partner) to join an effective cartel of Western hemispheric oil producers.

The US was not interested and gave Pérez Alfonzo the cold shoulder. And so, a few months later, Pérez Alfonzo took his talents to a 1959 Arab Oil Congress in Cairo and pitched a similar idea, this time to the man who was soon to become Saudi Arabia’s first Minister of Petroleum and Mineral Resources: Abdullah Tariki. 16 months later, OPEC was founded in Baghdad, with five inaugural members: Venezuela, Saudi Arabia, Iran, Iraq, and Kuwait. OPEC, in other words, is a mirror-image of the RRC, a novel application of the domestic regulatory apparatus that controls U.S. oil production on a global scale.

At first, the United States did not pay much attention to OPEC. After all, from 1957-1963, the US still had a surplus capacity of 4 million barrels of oil per day and was by far the dominant global producer.[11] But as the 1960s progressed, global demand for oil skyrocketed, U.S. oil fields became less productive, and more countries (Qatar, Indonesia, Libya, the UAE, and Algeria) joined OPEC. RRC production quotas adjusted accordingly and allowed Texas to pump more and more oil.[12]

By 1972, the global situation had transformed completely. The U.S. share of global production declined to 22 percent and the U.S. share of global reserves declined to 7 percent.[13] To meet domestic demand, the US was importing almost one-third of total consumption.[14] U.S. surplus capacity, which less than a decade prior had averaged 4 million barrels per day, evaporated. OPEC, meanwhile, was producing half the world’s oil.[15] On March 16, 1972, Texas finally waved the white flag. For the first time since 1948, the RRC increased the allowable oil production in Texas wells to 100 percent of their maximum efficient rate (the previous month’s rate had been 86 percent).[16] The RRC’s Chairman, Byron Tunnell, described the move a few days later as “an historic occasion. Damned historic, and a sad one. Texas oil fields have been like a reliable old warrior that could rise to the task when needed. That old warrior can’t rise anymore.”

In other words, the reason the RRC has not cut oil production in the state of Texas since the 1970s is not because free market prophets suddenly revealed the wisdom of abandoning production quotas to the masses. The RRC stopped regulating Texas oil production because demand grew beyond supply and it was in the interest of both Texas oil producers and U.S. national security to produce as much oil as possible. Every extra barrel meant one less barrel the US had to import from abroad and every barrel produced had a buyer. From the early 1930s until 1972, there had been a global oil surplus, and it was the job of the RRC to make sure that “only enough oil [could] be drawn out of the ground to satisfy the current demand at the current price” for U.S. oil producers.[17] In the context of a global oil deficit and demand far greater than U.S. domestic production could satiate, it no longer made economic or geopolitical sense for Texas oil wells to limit their overall production.

The RRC stopped limiting production because it lost its power, not its authority.

Today, as a result of the shale revolution, the US and Texas both remain formidable global producers. Ironically, U.S. oil production in 2019 was 19 percent of the world total, and Texas was responsible for 41 percent of U.S. crude – roughly where both stood in 1972.[19] The difference however is that there is once again a worldwide oil surplus. Even before COVID-19 crippled global demand for oil, OPEC was struggling to extend production quotas that could more accurately be described as preventing the bottom from falling out of oil prices rather than propping them up at a desired level. COVID-19 caused the bottom to fall out, and the prolonged decline in demand promises to keep oil prices low for a protracted period. According to Pioneer’s CEO at Tuesday’s hearing, his company needs oil to be around $30 per barrel to survive, and he believes OPEC’s production cut agreement last week is not going to do the trick by itself.[20] (The price of West Texas Intermediate was $21 a barrel the morning he was making his case.)[21]

It is unclear what the RRC will decide to do next week, or in the weeks and months ahead. If it does utilize its authority to impose production cuts on Texas producers, it will be interesting to see if other U.S. states follow suit. Before 1972, they almost certainly would have, precisely because all U.S. state regulatory authorities were aligned in a de facto interstate cartel.[22] They probably would again: Texas, after all, is still the dominant oil producing state in the union. Then again, COVID-19 has reignited state-level competition in the US in other ways, and no doubt such competition, even if its emergence is unlikely, will be at the front of the RRC commissioners’ minds.

No matter what the RRC decides, the overall take-away is that the current U.S. regulatory framework is still operating under the mentality of a previous era, when the U.S. was dependent on oil imports and could exert limited influence over the price of oil. That is not the world the US finds itself in today. The old warrior has risen. It is only natural that the warrior is now asking for orders.

Honorable Mention:

British Telecommunication PLC (BT) has signed a deal with Ericsson to provide the equipment for the UK’s core 5G network; BT also said however that it would take until 2023 (it had originally said removal would be completed by 2020) to remove Huawei equipment from its core network. Key take-away: the UK is not going along with the U.S. on banning Huawei outright from its 5G roll-out even as the British government mitigates previously identified risks specific to Huawei gear. In the meantime, Rule Ericsson! Rule Britannia’s (radio)waves!

EU Finance Ministers finally came to a deal on an emergency rescue package for Eurozone governments, but the 500 billion euro package does not include issuing joint debt and limits how funds can be used. Key take-away: The Dutch Finance Minister tweeted afterwards that the compromise showed that Europe’s response to COVID-19 was “united, sensible, and powerful.” I doubt the EU’s response will be remembered that way, especially in Spain and Italy, where COVID-19’s impact has been most devastating.

Romania became the latest country to impose limits on food exports after a military ordinance was passed that banned the export of wheat, barley, oats, corn, soybeans, flour, seed oil, and sugar, among others. Key take-away: Romania’s top cereal importers are Spain, Egypt, Italy, Saudi Arabia, and Jordan; its top oil seed importers are the Netherlands, Germany, France, Portugal and Bulgaria. While global food supply is still capable of satisfying demand, protectionist momentum could jeopardize that in the short to medium term.

Smithfield announced it was closing down one of the largest pork processing facilities in the U.S., responsible for approximately five percent of U.S. pork production. China announced it bought double the amount of U.S. agricultural product in Q1 2020 compared to last year — and nearly six times more pork. Key take-away: As with the previous item, keep an eye out. The issue right now is decreased demand and COVID-19 logistical bottlenecks for U.S. meat, especially pork, and while it is not likely in the short-term to result in shortages, the tough decisions facing U.S. farmers today could have significant impact 6 to 12 months down the road.

The Japanese newspaper Mainichi Shimbun reported that the US and Japan are discussing the possibility of a U.S. deployment of medium-range missiles in Japan. China sent a carrier strike group to train in the South China Sea; Taiwan was sufficiently unnerved that it “scrambled” warships and monitored the group’s activities. Key take-away: Neither China nor Russia will like the Japan-U.S. missile development one bit if true. China-Taiwan tensions are key to watch going forward — especially with U.S. naval preparedness suffering from COVID-19.

References:

[1]https://www.texastribune.org/2020/04/15/texas-oil-production-cuts-not-happening-yet-railroad-commission/

[2]https://rrc.texas.gov/media/56969/final-agenda-for-conference-april-14-2020.pdf

[3]https://www.marketwatch.com/story/next-up-for-oil-market-texas-regulator-to-decide-on-crude-output-cuts-2020-04-13

[4]https://www.wsj.com/articles/exxon-cuts-capital-spending-by-30-in-response-to-coronarivus-11586259633

[5]https://www.reuters.com/article/us-global-oil-exxon/exxon-mobil-opposes-texas-production-cuts-letter-idUSKCN21Q3D9

[6]https://www.jstor.org/stable/pdf/2122740.pdf?refreqid=excelsior%3A58e71eb66e5f80f7b644eb0377f9e2b9

[7] David F. Prindle, “Petroleum Politics and the Texas Railroad Commission,” 1980, chapter 4.

[8] Daniel Yergin, “The Prize: The Epic Quest for Oil, Money, and Power,” 1990, chapter 25.

[9] Ramón Rivas Aguilar, Venezuela, apertura petrolera y geopolítica, 1948-1958, p. 73.

[10] Yergin

[11] Yergin p. 549

[12]https://www.rrc.state.tx.us/about-us/history/history-1960-1979/

[13] Yergin 482

[14] Thomas O’Toole, “Domestic Oil Gap to Grow,” Washington Post, 27 November 1972.

[15]https://geopoliticalfutures.com/opecs-prisoners-dilemma/

[16]https://www.nytimes.com/1972/03/17/archives/texas-oil-rate-at-100-for-first-time-since-48.html

[17] Prindle, introduction, emphasis added.

[18] Hearings Before the Committee on Interstate and Foreign Commerce, U.S. House of Representatives, Eighty-Second Congress, June 11-12, 1951, p. 19.

[19]https://www.eia.gov/tools/faqs/faq.php?id=709&t=6 and https://www.eia.gov/state/print.php?sid=TX

[20]https://www.wsj.com/articles/opec-allies-look-to-resolve-saudi-mexico-standoff-and-seal-broader-oil-deal-11586695794

[21]https://www.texastribune.org/2020/04/15/texas-oil-production-cuts-not-happening-yet-railroad-commission/

[22]https://www.jstor.org/stable/pdf/2122740.pdf?refreqid=excelsior%3A58e71eb66e5f80f7b644eb0377f9e2b9

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