Shale giants clash over oil-supply cut to survive crude rout

At issue is whether the Texas state should restrict crude output for the first time in roughly 50 years

HOUSTON • One of the biggest Texas shale explorers warned it will halt all drilling if the state imposes OPEC-style production caps, raising the stakes in a debate over a contentious proposal to arrest free-falling oil prices.

The stark pronouncement from Diamondback Energy Inc’s finance chief stunned observers of Tuesday’s virtual hearing by the Texas Railroad Commission, which oversees oil output in the Lone Star state. At issue was whether the state should restrict crude output for the first time in roughly 50 years.

The proposal has deeply divided an industry already grappling with a global oversupply, escalating financial losses and the demand-killing Covid-19 outbreak.

Diamondback CFO Kaes Van’t Hof said the company already is in the process of shutting down 30% of its drilling and would take it to zero if the state clamps down on production. Such a move would have dire consequences in the form of lost jobs and disrupted families, he said.

In the event of quotas, “we’d let all our service providers go through the period of proration,” Van’t Hof said. “That turns that industry, the service industry, on to the same issues that the restaurant industry is facing today where they’re completely shut down with zero revenue and zero employment.”

On a practical note, Railroad Commissioner Christi Craddick wondered whether the agency even retains the expertise to enforce a statewide output limit. “We don’t even know how to do it any- more,” she said.

Force Majeure

Meanwhile, opponents of quotas insinuated that some drillers are supporting such restrictions for selfish reasons such as voiding contractual obligations.

Without naming specific companies or executives, Enterprise Products Partners LP co-CEO Jim Teague suggested that advocates of mandatory output cuts maybe just asking for a government order that will allow them to negate contracts. Marathon Oil Corp’s Lee Tillman voiced similar concerns.

A state order to curtail oil output would presumably provide drillers with justification to declare force majeure, the so-called “act of God” provision in contracts that relieves a party of liability for events outside their control.

Web of Contracts

The hearing began with executives from the biggest pro-quota companies: Pioneer Natural Resources Co and Parsley Energy Inc CEOs from both firms urged the commission to cap production or risk deep and long-lasting damage to the industry and economy.

“Are they really trying to fix a problem?” Teague asked more than two hours into the marathon hearing. Oil explorers ensnared by the sudden slump in oil prices still must honour contracts with pipeline networks, storage operators and hard-hat contractors that drill and frack their wells.

The OPEC+ agreement this past weekend to cut 9.7 million barrels of daily output won’t make a notable impact on prices given the stark impact the Covid-19 contagion is having on energy demand, Pioneer CEO Scott Sheffield argued.

Texas should start with a 20% cut, which would amount to more than one million barrels a day, he said. Parsley CEO Matt Gallagher agreed.

“If we slam into a train wreck at full speed at a peak rate that we can predict, then it’s going to be much worse,” Gallagher said. — Bloomberg