BIG U.S. GAS PRODUCING STATES FAN PRORATIONING CONTROVERSY

The biggest gas producing states in the U.S. are embracing wholesale changes in prorationing rules.

And their actions have stirred controversy and warnings among key energy lawmakers in Washington.

The Texas Railroad Commission last week unanimously approved new rules for setting production volumes for gas wells. Texas is the country's No. 1 gas producer.

TRC commissioners eliminated a system that prorated production based on monthly nominations by gas purchasers. But they left the door open for further debate on factors that might be considered in determining market demand.

Commissioners expect the new prorationing system to more closely match gas production to market demand. The changes are intended to simplify complex, decades old production rules, protect correlative rights of adjoining producers in a common reservoir, and allow more accurate determination of each gas well's deliverability.

The Office of Conservation in Louisiana, the No. 2 ranked producer, recently conducted a hearing on a prorationing proposal supported by Gov. Edwin Edwards. Conservation Commissioner Herbert W. Thompson is expected to disclose the state's plans by the end of this month.

No. 3 Oklahoma enacted a law last March restricting production from unallocated wells in the 4 winter months to the greater of 1 MMcfd or 40% of the calculated absolute open flow and the rest of the year to the greater of 750 Mcfd or 25% of the calculated absolute open flow (OGJ, Mar. 30, p. 37).

The effect of the law mainly will be to reduce production of about 1,000 high flowing wells.

Together the three states accounted for 13.737 tcf, or 74% of U.S. marketed gas production of 18.702 tcf during 1991, Energy Information Administration figures show.

MIXED SIGNALS

Industry spokesmen say the controversy over prorationing occurs in part because the word means different things to different people.

To state regulators, it means rationally allocating production among wells to prevent reservoir damage and protect property rights. Most states with production have prorationing laws to ensure that different producers don't inequitably produce gas from the same formation.

To smaller producers, prorationing means an end to outdated production rules they say have created gas surpluses that have kept prices artificially low and strangled exploration.

To major producers, prorationing means less production and loss of markets. They say for one state to limit production will only enable producers in adjoining states to increase flows to fill the void.

To consuming state congressmen, prorationing smacks of a producing state cartel like the Organization of Petroleum Exporting Countries with the goal of restricting production to increase prices.

Their views have been reinforced by small producers' statements expressing hope that prorationing will result in higher prices.

Although some key energy policymakers in Congress are openly hostile to gas prorationing, it appears there is little they can do to block it.

TEXAS PRORATIONING

Under revised proration rules, TRC will determine market demand using its statistical data and production history of each field in the corresponding month of the previous year. In addition, producers may help TRC more accurately, estimate market demand by filing a forecast of how much gas they expect to sell.

Production allowed for each Texas gas reservoir will be based on the resulting estimate of market demand.

TRC staff members said the new system could be in effect as early as July. That would require commissioners to calculate market demand, set production limits, and distribute allowables to producers in June.

Action still is pending on prorationing revisions published as proposed Rule 29, also known as the Nugent Plan. Rule 29 would base monthly allowables on a year long total. It also contains provisions that some operators say equate to statewide gas prorationing.

TRC Chairman Lena Guerrero said revisions of Texas gas prorationing will neither restrict production to raise wellhead prices nor create artificial shortages.

"Any attempt by the commission to do so would violate state and federal law," Guerrero said. "We want to allow as much gas to be produced as the market demands, while protecting the rights of neighboring producers.

"We believe the time has come to revise our proration system, find new and expanded gas markets, and write a state energy policy."

OTHER TRC VIEWS

TRC Commissioner James E. Nugent, a long time advocate of changing gas prorationing in Texas, said the commission's action removes many mechanisms in the state's gas prorationing system that allowed discrepancies and inequities in production, caused waste, and infringed on correlative rights.

Nugent said the revisions will help assure that each Texas producer has a chance to serve his fair share of gas markets in the state. But he said more changes are required.

Commissioner Bob Krueger said the new rules strengthen producers' correlative rights and simplify procedures for producers, purchasers, and pipelines but stop short of establishing a statewide prorationing system.

Krueger said the TRC eliminated the so-called "alphabet allowables" that in the past had unnecessarily restricted gas supplies. He said the commission's plan for setting monthly market demand based on recent past production allows adjustments for special circumstances but does not specify how allowables will be adjusted.

"I support allowable adjustments that consider the amount of gas in storage, storage capacity, weather conditions, and other operational conditions that might affect a gas reservoir," Krueger said. "However, I continue to oppose any rule changes that would allow market demand to be allocated between fields."

Such changes, Krueger said, would amount to statewide prorationing, putting some producers at a disadvantage while benefiting others and allowing TRC to allocate market supply and demand.

By adjusting allowables to remedy unlawful purchaser discrimination, TRC would be inviting federal litigation that could diminish commission authority, he said.

"Unlawful discrimination by purchasers must be remedied through orders directed at the offending purchasers, not at producers," Krueger said.

Statewide prorationing would raise fears that TRC would restrict supplies to raise gas prices and encourage utility commissions in net gas consuming states to build nuclear and coal fired electric power plants, he said.

"We must not tell electric utilities-our biggest potential customers-they cannot trust us," Krueger said.

Prorationing revisions adopted last week by the TRC were derived from more than 600 pages of written public comment submitted during the past year. Since 1975, four blue ribbon panels appointed by TRC have studied Texas gas prorationing rules to find means to improve the way the commission sets production allowables.

Texas has prorationed gas production since the early 1930s, when the state legislature authorized TRC to determine gas market demand and prorate production accordingly.

PRODUCERS' REACTIONS

Many Texas producers are reserving comment on TRC gas prorationing revisions until the final rule is published this week in the Texas Register. But advocates on all sides held their positions in the debate over changing the way Texas sets gas production allowables.

Leaders of the Texas Independent Producers and Royalty Owners Association (Tipro), Austin, said the TRC vote solved two major problems.

"First, demand forecasts should become more accurate rather than exceeding demand by 15% or more, as has been the case recently," said Tom Coffman, Tipro president. "Second, the commission will no longer be reducing allowables of operators who save their production rights for use in months when demand increases."

After recommending a change in gas prorationing for more than a decade, Tipro at its summer policy meeting last August passed a resolution urging TRC to take immediate action (OGJ, Sept. 2, 1991, p. 45).

Boone Pickens, chairman and chief executive officer of Mesa Inc., Dallas, applauded the TRC vote.

Pickens said TRC efforts to better match gas supply with market demand will prevent unnecessary depletion of gas reserves in the state and provide U.S. consumers with a long term, stable supply of clean burning domestic energy.

He said the new rules will better protect correlative rights. And ultimately, Texas will collect more severance tax revenue because of increased demand for gas in transportation and other markets.

Pickens downplayed predictions that Texas prorationing changes will be criticized widely in the nation's capital.

"Proration reform in Texas is well justified," he said. "I'm guessing Washington is a lot more interested in creating new markets for gas and cleaning up the environment than in protecting foreign oil imports."

But John Nabors, a partner in Gardere & Wynn law firm, Dallas, and outside counsel of TransAmerican Natural Gas Corp., Houston, said, "I strongly suspect we'll be in the courthouse over this. That's all I can say until I see how the commission applies the rules by setting allowables, and that might not happen until June."

TransAmerican has been one of the most outspoken critics of TRC plans to change Texas gas prorationing rules. The company has maintained that proposed changes would curtail production of Texas gas and substantially reduce drilling for tight sands gas in the state.

TRC early in April published a correction notice to proposed Rule 31 (d)(1)(G) that said, "In determining the amount of the adjustment to any reservoir, the commission shall act without discrimination in favor of one producer or person or against another producer or person in the same field without unjust or unreasonable discrimination between fields in the state."

TransAmerican said the correction amounted to statewide prorationing. Because of that correction and other revisions Mar. 30, the company said the commission should formally republish proposed changes and delay a vote until industry had an opportunity to study how the rules would affect allowables.

However, TRC commissioners in the final vote did not approve the correction.

"While there's not going to be statewide prorationing per se, that is not to say the commission can't go in on a field by field basis and achieve the same results," Nabors said.

"I think it's naive to assume that just because we've prevented the scheme to work on a global or statewide basis, they won't go back into significant fields and achieve the same thing through field prorationing rules.

"My common sense suggests we're going to be in litigation, but I can't say that for sure because stranger things have happened."

LOUISIANA REVIEW

Meantime, Louisiana's Thompson has started a review process expected to lead to extensive changes in Louisiana gas prorationing rules contained in Statewide Order 29-F.

Following a review of comments offered at an Apr. 6 public hearing, Louisiana Conservation Commission district managers, engineers, and lawyers have concluded that considerable changes should be made to Order 29-F so proration rules will fit today's gas markets, said C. Wayne Harmon, president of the Louisiana Association of Independent Producers and Royalty Owners (Laipro).

Harmon said Thompson plans to convene a task force early this month to work out differences over how Order 29-F should be changed. Because proposed changes are expected to be extensive, after a 30 day comment period the new rule will require approval by an oversight committee of the Louisiana Legislature.

"As I understand it, Commissioner Thompson wants to get this in place by July 1," Harmon said.

At the April hearing chaired by Thompson, Laipro recommended revising Order 29-F because:

Waste of gas was occurring in Louisiana due to premature abandonments of wells, bypass of recompletion zones, scaled down fracture designs, failure to use more costly advanced technologies, and removal of or failure to install compressors on marginal wells.
Conservation department records showed production allowables in 1990 exceeded production by 140% and in 1991 by 145%.
Producers who chose to sell gas seasonally were unable to catch up because they could not force other operators or working interest owners to reduce production.
Laipro said historical production from each reservoir is a more accurate and verifiable way to forecast demand than purchaser nominations. The association recommended that conservation district managers base individual allowables on production for the same quarter of the prior year, subject to:
Adjustments for decline in deliverability.
Trends in statewide or historical production.
Weather fluctuations.
New, recompleted, or abandoned wells.
Changes in contract demand for sale of gas from individual reservoirs,
Laipro also recommended 14 steps district managers should follow when assigning allowables,
"Only by reducing allowables to a market demand production based system may the rights of those who wish to market on a seasonal basis be protected and the balancing mechanism viably maintained," Laipro said.

"Then the commissioner may fulfill his obligation to preclude waste, enhance ultimate recovery of Louisiana reserves, protect correlative rights, and give every mineral owner the opportunity, to produce his fair share of reserves in each reservoir."

OPPOSITION IN WASHINGTON

Reps. John Dingell (D-Mich.), chairman of the House energy committee, and Phil Sharp (D-Ind.), chairman of the energy and power subcommittee, have been very vocal against prorationing. They are supported by a number of consuming state congressmen.

Their trump card would be to amend the omnibus energy bill pending in the House to include antiprorationing legislation. But senators likely would object to such a provision when the bill goes to a House-Senate conference committee.

Sens. Bill Bradley (D-N.J.) and Jim Jeffords (R-Vt.) have circulated an antiprorationing "dear colleague" letter among fellow senators, prompting Sens. Don Nickles (R-Okla.) and David Boren (D-Okla.) to send colleagues a letter explaining Oklahoma's move.

The Senate energy bill, passed before Oklahoma approved its changed prorationing law, is silent on the issue. And Sen. Bennett Johnston (D-La.), Senate energy committee chairman, wants to keep it that way.

Testifying before the Louisiana House natural resources committee in mid-April, Johnston supported Louisiana's right to require gas prorationing but said it was a misguided effort.

He said, "If I were here, I would vote against prorationing. To the extent it's for conservation, it should be done. But as a price measure, it is doomed to fail."

The Bush administration opposes prorationing as "market interference" and said gas production should be encouraged by expansion of end uses.

CONSUMERS CONCERNED

As long ago as last October, 15 consuming state congressmen asked the Federal Energy Regulatory Commission to intervene on behalf of consumers in TRC prorationing hearings.

The Northeast-Midwest Congressional Coalition recently released a study saying that gas price increases from prorationing could cost the nation's consumers $3.8 billion/year. That estimate assumes prorationing would result in a 20% increase in natural gas prices.

It noted that since Oklahoma's legislature passed gas prorationing legislation, the state's gas prices have increased 20/MMBTU or 16%. The increase is believed to be the market's reaction to shut-ins, the coalition said.

The coalition noted Oklahoma, Texas, and Louisiana account for a big share of U.S. gas production, with Oklahoma having the smallest share.

"The result of Texas and Louisiana adopting similar measures could be devastating to the Northeast-Midwest region," it said.

The analysis estimated that Oklahoma would gain $341 million, Texas $566 million, and Louisiana $758 million, while consuming states would be hard hit. New York would pay an additional $173 million, Illinois $193 million, and California $310 million.

In particular, the consuming states of the New England, mid-Atlantic, and Midwest regions would pay an additional $1.2 billion/Year.

The coalition said, "When Congress reconvenes, members of Congress from northeastern and Midwestern states are expected to introduce legislation prohibiting prorationing for the purpose of increasing prices."

DINGELL'S, SHARP'S CONCERN

Dingell and Sharp sounded a stem warning against prorationing when they reported out the House omnibus energy bill in late March.

They said, "The increased use of domestic natural gas is greatly threatened by the current activities of several states to institute and expand prorationing schemes statewide. We believe firmly that statewide prorationing is unwise, anticompetitive, and anticonsumer and will jeopardize our nation's economic recovery.

"After years of debate on the merits of price controls on natural gas it would be quite ironic if downward federal price controls are replaced with upward state price controls."

They claimed the goal of current prorationing moves is simply to limit competition in production of gas destined for the interstate market, thereby artificially boosting prices throughout the nation.

"Such activities differ from the traditional state role of regulating production within a single reservoir in order to protect the legitimate correlative rights of producers within that single reservoir.

"Statewide prorationing is in effect an OPEC-style price support plan that would allow state regulators to 'turn off the valves' and mandate the shutting in of gas production in their states.

"For each additional nickel in gas prices, costs increase by $1 billion for consumers.

"In recent years we have felt that the regional controversies that once characterized the gas industry had finally been laid to rest. We regret that they now seem to be reappearing and we hope that reasonable-and competitive-solutions can be worked out."

SYNAR REPLIES

Rep. Mike Synar (D-Okla.) responded that the new Oklahoma law is not intended to restrict gas supplies.

Synar said in 1988 the Oklahoma Supreme Court overturned a 1987 Oklahoma Corporation Commission action reducing allowable production to 25%, ruling that a 1981 law blocked the commission from changing the percentages of production up or down.

Synar said the new Oklahoma law restores the corporation commission's powers to adjust production allowances and sets an interim percentage of 30% of annual unrestricted flow but 40% in the 4 winter months when demand is higher.

He said, "Enactment of the new Oklahoma law coincides with record low wellhead natural gas prices and severe economic distress in the exploration and production industry. This coincidence has led some to conclude this action is intended to restrict supply and increase prices.

"While there is indeed a relationship between the need for more effective protection of correlative rights and low prices, it is not correct to conclude that the state' action is intended to interfere with the market.

"The fact is that gas prices are currently below the production or replacement costs for many producers.

"Consequently, some producers are losing money on each cubic foot of gas they sell, and their losses are exacerbated by the fact that without effective state prorationing they are forced to sell gas into an oversupplied market to preserve their ownership rights. Without such sales they risk losing their developed gas reserves to other producers who choose to produce gas into the market without constraint.

"The Oklahoma law is not expected to result in curtailment of supply to customers nor would it be in the long term interest of producers to attempt to restrict supplies and thereby disadvantage our customers.

"It is my understanding that the rules resulting from this law would ensure that Oklahoma producers would be restricted to approximately 140% of demand statewide. In other words, its purpose is not to create artificial shortages, although it is expected to lead to a redistribution of supply among producers."

FEARS REMAIN

Oklahoma Gov. David Walters visited Washington in April and met with congressmen to reassure them about the state's law.

But he failed to convince Dingell and Sharp the law is benign. Afterwards, the two congressmen wrote Walters, "Our concern is that the new state law has little to do with drainage and a lot to do with OPEC-style production cutbacks.

"In decontrolled energy markets, a tiny shortage can translate into a steep price increase. A tiny glut can spell a price collapse.

"For example, many Oklahoma producers oppose coal seam gas tax credits because this supply is flooding the market and lowering all U.S. prices. Perhaps it is. But it makes up only 1% of U.S. supplies. In sum, small cutbacks can critically affect consumer prices."

Dingell and Sharp agreed the Oklahoma law might affect only a few high flowing wells but said they are substantial national energy assets.

"They may be the most efficient wells, with the cheapest per unit costs of production. They may be just the kind of competitive new technology we intended to foster with federal wellhead decontrol. We wanted them to be winners and gain market share. State law makes them losers with less market share."

AGENCIES CAUTIOUS

Dingell and Sharp also queried FERC, the Justice Department, and the Federal Trade Commission on prorationing issues. They got little satisfaction.

The agencies replied that individual state prorationing plans enacted to conserve oil and gas are lawful. But they said states could not join in formal prorationing schemes without approval from the federal government.

FERC even saw a silver lining to prorationing.

"It is true that to the extent prorationing programs lead to somewhat higher gas prices, there could be a temporary decrease in consumption. However, if higher gas prices also result in greater drilling, this could lead to a more stable supply of gas over the longer run. This would reduce the potential that shortages would occur in the future that could cause greater price increases.

"The increased ability of customers to rely on adequate gas supplies at reasonable prices could, in the long run, lead to more gas usage and thus an increase in demand for gas as gas and pipelines become more available to more consumers."

The Justice Department said a state's prorationing laws are sovereign acts outside the scope of federal antitrust laws.

But it noted states cannot entirely escape or circumvent the constitutional requirement that Congress approve interstate compacts simply by avoiding formal prorationing pacts.

The Federal Trade Commission said, "There may be a legitimate reason to coordinate output among wells in an individual reservoir. Such coordination can minimize the capture problem, permitting producers to time their production without fear of undue drainage from other producers in a given reservoir.

"While there may be administrative reasons for imposing controls at the state rather than the field level, statewide limits on production do not appear to address directly the capture problem.

"They may, however, diminish competition in natural gas markets and inflict harm on consumers of natural gas and may cause underinvestment in gas burning facilities and overinvestment in gas production and exploration."