[Editor's note: A version of this story appears in the May 2020 edition of Oil and Gas Investor. Subscribe to the magazine here.]
Discussion in Texas among a handful of Permian producers and at least one commissioner with the Texas Railroad Commission is calling for reinstitution of proration as an administrative tactic to adjust to the crippling global oversupply in oil.
Proration is an administrative policy that adjusts hydrocarbon production to market demand.
Proration is an obtuse, nebulous term to anyone born after 1960. However, Texas oil production operated exclusively under proration from 1928 unofficially and officially in the 1930s until the U.S. imported its first barrel of oil four decades later in the 1970s. At that point, the railroad commission lifted production restrictions other than for conservation.
The Texas model incorporated allowables—production quotas—tied to acreage. At the core, and reflecting free market oil patch politics, all producers regardless of size are guaranteed market access. However, their share of access depends on the productive potential of an arbitrary acreage parcel and its relation to the whole.
A century ago, proration was a conservation measure. Production controls were developed to conserve hydrocarbons by preventing waste, either through reservoir damaging production methods that cut short a field’s potential and stranded hydrocarbons, or for producing oil that went to economic waste in an oversupplied market.
Proration prevents an economic collapse in the market as occurred in the U.S. after the East Texas oil field was discovered. Here, production was so large it overwhelmed the national market. Independents ran “hot oil” to sell for whatever they could get, which was below 10 cents/bbl, or about $1.50/bbl today. It took the Texas National Guard and judicial rulings in favor of the Texas Railroad Commission at the state and federal level to bring proration and rational business practices to the oil patch in East Texas and, by extension, the U.S.
The Texas model operated successfully even though, by the early 1970s, producers were restricted to one day of restricted pumping per month. Texas, as the world’s largest oil producer, set national market conditions under direction of the Texas Railroad Commission, which administered proration and made the agency a factor in the global oil market.
The proration concept originated as a response to a 19th century legal decision in Appalachia, birthplace of oil and gas. Faced with legal wrangling on how to apportion ownership of ground related minerals (and groundwater), courts adapted English hunting law to fit U.S. minerals. This law—the Rule of Capture—held that if a wild and migratory animal crossed property lines and was successfully hunted by the adjacent property owner, the kill was rightfully his, and he owed no compensation to the owner of the land where the migratory animal originated.
When applied to oil, the ruling encouraged wildcatters to drill as many wells along property lines as quickly as possible to capture as much oil as possible, including oil originating underneath adjacent land where a competing producer was pursuing the same strategy. This resulted in dissipation of reservoir pressure, stranded resource and led to the perennial boom/bust nature of hydrocarbon development.
Oil plays lasted three to five years at most, then collapsed, creating economic disarray. Producers moved boom to boom from Appalachia to Oklahoma, to the Texas Gulf Coast and North Texas by the 1920s. Then came discovery in the Permian Basin of two giant San Andres fields, Yates in Pecos County and Hendricks in Kermit County, one week apart in 1926.
Yates was the U.S. equivalent of Saudi Arabia’s Ghawar Field with a potential 5.5 million barrels per day. Excess production from both fields led to a price collapse by 1928 and threatened early depletion in both reservoirs. Producers at Yates opted for voluntary proration based on newly developed reservoir pressure measurement techniques that provided all producers market access, prevented water encroachment and was tied to the productive potential in 100-acre parcels. Separately, Hendricks producers opted for 40-acre spacing until one producer balked, which brought a court fight that resulted in mandatory prorationing in the field by the Texas Railroad Commission.
Fast forward three decades. When OPEC organized global producers in the early 1960s, the organization based its quota system on the Texas model, which created the OPEC cartel. What goes around apparently has come around again today.
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