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Texas Flood

from the magazine

Texas Flood

The state is once again the key producer in the global oil market. Texas Rising 2016
Texas
Economy, finance, and budgets
Infrastructure and energy

Back in 2008, Daniel Day-Lewis won the best-actor Oscar for his role in There Will Be Blood, a movie about the early days of the oil industry in the United States. Eight years later, there’s plenty of blood being shed in the oil and gas sector. Oil prices are down about 50 percent since June 2014, and huge job losses have followed. Last year, the global oil and gas sector lost about 250,000 jobs. In Texas alone, about 100,000 oil and gas jobs have been lost since 2014. For comparison, that’s more jobs than the entire domestic wind industry claims (88,000). Since early 2015, more than 40 Texas oil and gas companies have filed for bankruptcy, and some 75 others are on what consulting firm Deloitte calls its “danger list.”

Of course, no one in Washington is calling for subsidies to the oil and gas sector or worried about saving oil-patch jobs. By contrast, in December, Congress made sure to protect the wind industry by passing a five-year extension of the production-tax credit, a lucrative subsidy that pays wind-energy firms $23 for each megawatt-hour of electricity that they produce. For some easterners, hard times in Texas are cause for celebration. In mid-2015, when oil prices dropped under $60 per barrel amid layoffs in the oil and gas sector, New York Times columnist Paul Krugman crowed about news that the state’s employment growth had fallen below the national average. The explanation, he said, was “all about hydrocarbons.”

Krugman and others may delight in the misfortune of Texas’s oil and gas producers, but they forget that the main reason oil prices have fallen so far, so fast, is due to good old ingenuity—much of it developed in Houston, Dallas, and Midland. Technological innovation in everything from drill bits and mud pumps to seismic analysis and digitally controlled drilling rigs has unlocked galaxies of energy that have helped transform America into an energy superpower. The U.S. now has an energy-price advantage on commodities like natural gas, propane, ethane, and even electricity over nearly every other country. That advantage is a direct result of the dynamism of the domestic oil and gas business, the epicenter of which remains in Texas.

Indeed, 11 decades after the gusher at Spindletop ushered in the Texas oil boom, and eight decades after the discovery of the supergiant East Texas field, Texas has reemerged as the global oil market’s key producer. Since 2009, the margin of increase in Texas’s oil output has matched the combined total oil production of four OPEC members: Ecuador, Indonesia, Libya, and Qatar. Between 2009 and 2015, U.S. oil production grew by about 3.9 million barrels per day, and nearly 60 percent of that increase—some 2.3 million barrels per day—came from Texas.

Of course, Texas has long been America’s most important oil and gas province. With some 3.4 million barrels of output per day, the state now accounts for about 37 percent of daily U.S. oil production. North Dakota, which has also seen a big increase in oil output over the past few years, is the nation’s second-largest oil producer, producing about 1.1 million barrels per day. California (550,000 barrels per day) ranks a distant third. Texas also dominates in natural-gas production, accounting for about 27 percent of all domestic output.

Texas has not only retaken a leadership role in global production; in an echo of its storied past, the Lone Star State is once again exerting outsize influence on global prices. The recent collapse in oil prices recalls what happened after a Bible-quoting promoter named Dad Joiner discovered the East Texas Field in 1930. Within a year of Joiner’s discovery, oil flooded the market, and prices plummeted. Today’s oil-price plunge is largely due to the shale revolution, which started in Texas and has made the U.S. the world’s biggest oil and natural-gas producer—leading to record levels of oil in storage. Just as it did in the 1930s, oversupply has sent prices falling. But this time around, and contrary to the wishes of Krugman and other critics, the pace of development of new technologies suggests that we may be headed into a new era of higher oil production and lower prices—with Texas leading the way.

By early 1930, Columbus Marion “Dad” Joiner had been drilling for oil in East Texas for three years, and all he had to show for it were some good stories and a lot of heartache. But the rotund, loquacious, 60-something promoter from Alabama kept drilling. He knew that there was oil in Rusk County, and he believed that if he could get his drill bit below 3,500 feet—more than three times the depth of the state’s first great oil well, drilled at Spindletop three decades earlier—he’d have success. A geological formation known as the Woodbine, he believed, was where he’d find treasure.

Joiner’s first well, the Daisy Bradford No. 1, failed when his drill bit jammed at 1,098 feet. The Daisy Bradford No. 2 was halted at 2,000 feet, when the drill pipe got hung up in the hole. By that time, Joiner was broke again. In May 1929, he started work in the Daisy Bradford No. 3, though he was often restricted to drilling on Sundays, the only day of the week that he could scrounge together a volunteer crew. One scout for a major oil company reportedly visited the site 20 times and never found it operating. Joiner’s progress was slow, and his money was gone. But the locals kept the faith: his was the only oil well for miles around. “As the Depression summer of 1930 passed and winter loomed,” historian Lawrence Goodwyn explained, “Dad’s well was about the only thing people had to look forward to. It was a favorite place for people to gather after church on Sundays.”

In September 1930, 16 months after the Daisy Bradford No. 3 got under way, Joiner’s ragged drill rig passed the 3,500-foot mark; the core samples showed oil. Some 8,000 people crowded around as Joiner’s men worked night and day, bailing mud out of the well. In the late afternoon of October 3, 1930, a gusher of sweet Texas crude blew out over the top of the wooden derrick and onto the nearby pine trees and red clay soil.

Joiner had discovered a gargantuan deposit. The East Texas Field measured 45 miles north to south, from five to 12 miles east to west, and covered 140,000 acres—dwarfing anything that had come before. It contained over 5.5 billion barrels of oil, about a third as much as all the crude produced in the United States up to that time. And the mineral rights to the East Texas Field were highly diffused, with hundreds of individuals and companies owning parts of the land. Within a few months of Joiner’s gusher, wells in East Texas were producing more than 1 million barrels of light-as-kerosene crude oil per day—half of America’s total consumption.

The flood of oil had a predictable result: prices plummeted. In early 1930, before Joiner’s well came roaring in, a barrel of crude oil sold for about $1.30. By mid-1931, the price had come down to 13 cents, and in parts of East Texas, it was selling for as little as 3 cents. Despite the low prices, Texas producers didn’t want to reduce production. All were relying on an old English common law known as the “right of capture.” On the surface, the wells were owned by different people. Below the surface, all were sucking oil out of the same reservoir. If they stopped drilling and producing, their neighbors could simply pump the oil out from beneath their land. So they kept pumping, reducing the oil field’s long-term viability. In its earliest days, the massive field pushed oil out of the ground under its own pressure. But as more wells tapped the field, that pressure was being bled out, like the air from a balloon.

In theory, the Texas Railroad Commission, an agency originally set up to regulate railroads, had the authority to limit the amount of oil that each producer took from his well. The best solution for all producers was for the commission to limit production so that it simply met demand—a system known as prorationing. The commission set quotas several times, but producers in the East Texas Field ignored the directives. On July 31, 1931, a federal court in Houston sided with a group of independent oil producers and ruled that the commission had no right to impose prorationing. A few days later, the Texas Senate—its gallery packed with East Texas producers—agreed with the court and rejected a bill that would have given the commission authority to limit production.

Graph by Alberto Mena

Texas governor Ross Sterling decided that he’d make his own rules. On August 16, 1931, Sterling declared martial law in the East Texas Field, and he dispatched the Texas National Guard with instructions, “without delay,” to “shut down each and every producing crude oil well and/or producing well of natural gas.” Sterling’s move stabilized prices, but it also spawned years of legal and political wrangling. Finally, in 1935, another powerful Texan, U.S. senator Tom Connally, helped pass a federal law that gave the Railroad Commission the authority to proration oil. Every month, the commissioners met at the agency’s office in Austin and set “allowables,” which determined the amount of oil that each operator could produce from his wells. The commissioners adjusted the allowables so that Texas production met demand, and not a barrel more. The system worked: by managing the flow of oil from America’s most important oil fields, the Railroad Commission effectively determined world prices for the next four decades.

That control ended in October 1973, when the Arab members of OPEC, along with Egypt and Syria, began an oil embargo. While the embargo didn’t cause any actual shortages of oil, OPEC forced up prices. By March 1974, global oil prices had risen from about $3 per barrel to about $12 per barrel. OPEC was able to affect prices by restricting supply, and it did so by copying the Railroad Commission’s system of allowables. OPEC had roots in Texas: Abdullah Tariki, the first Saudi educated at the University of Texas in Austin, did an internship at the Texas Railroad Commission. As Saudi Arabia’s first oil minister, Tariki arranged a meeting at a yacht club in Cairo with ministers from Venezuela, Kuwait, Iran, and Iraq that resulted in the formation of OPEC. Years later, when Jim Tanner, a longtime energy reporter for the Wall Street Journal, asked Tariki what he had studied in Austin, Tariki replied, “the Texas Railroad Commission.”

But just as OPEC replaced the Railroad Commission, technology has disrupted OPEC’s ability to regulate the global supply of oil. And the key technologies needed to produce oil and gas from shale deposits—hydraulic fracturing and horizontal drilling—were perfected in Texas. In fact, the shale revolution got under way in the Barnett Shale, a huge deposit located south and west of Fort Worth. Just as Dad Joiner deserves credit for finding the East Texas Field, George Mitchell, who died in 2013, played the key role in discovering how to produce oil and gas from shale.

Mitchell, founder of Mitchell Energy (bought by Devon Energy in 2001 for $3.5 billion), owned multiple leases in the Barnett Shale region. During the 1990s, he spent millions testing techniques to wring oil and gas from shale. In 1997, Mitchell’s crews finally discovered that water injected under extremely high pressure, along with lots of sand and a dash of surfactant and biocide, was the winning formula. That technique, which became known as a “slick water frac,” combined with horizontal drilling, vaulted the Barnett Shale from obscurity into one of the ten most prolific gas fields on the planet, ranking on par with Iran’s giant South Pars field. The lessons that Mitchell Energy learned there have since been applied in shale formations throughout the U.S., including the Eagle Ford Shale in south Texas, the Bakken Shale in North Dakota, the Haynesville Shale in Louisiana, the Marcellus Shale in Pennsylvania, and the Utica Shale in Ohio. U.S. oil production also soared, reversing a four-decade downward slide. Between 1997—the year that Mitchell cracked the shale code with the slick water frac—and 2014, U.S. oil production jumped by about 35 percent.

OPEC was watching the surge in U.S. shale oil production and what it was doing to oil prices. From mid-2010 through early 2014, prices mostly stayed over $80 per barrel. But by mid-2014, surging U.S. production was eroding OPEC’s market share. By the time OPEC ministers met in Vienna that November, the world was oversupplied with oil. Prices had fallen to the mid-$70s and were headed further downward. At the meeting, according to the Wall Street Journal, an official from one Persian Gulf oil producer declared: “The cause of oversupply is not OPEC. It’s shale oil.”

The late 2014 OPEC meeting exposed the cartel’s innate weakness. Some members cheated on their allowables to gain additional revenue at the expense of others. Many oil traders were betting that OPEC would agree to cut production to help stabilize prices. Instead, Saudi Arabia, producer of about a third of all OPEC oil and the cartel’s most powerful member, made clear that it would protect its market share—even if that meant lower prices. The Saudis’ rationale was simple: they knew that if they cut production, the result would be higher prices, which, in turn, would stimulate more shale oil production in the U.S. (and probably more cheating by cartel members).

After OPEC decided that it would keep the oil taps open, prices dropped 7 percent and have kept dropping. Sovereign producers like Russia, Kuwait, Venezuela, Saudi Arabia, Nigeria, and others hope that lower prices will shut down U.S. shale oil production and reduce supply, but that’s unlikely to happen soon, thanks to American entrepreneurialism and ingenuity. Drillers in Texas, North Dakota, Pennsylvania, Ohio, and elsewhere are making drilling faster and cheaper, resulting in more oil and gas production from fewer rigs. Domestic oil producers, particularly the ones in Texas, can survive even amid drastically lower prices.

The Energy Information Administration charts oil production in the Permian Basin in West Texas. From 2007 until about 2013, the amount of oil produced from a new well by an average drilling rig stayed flat, at about 100 barrels per day. But between 2013 and 2016, that figure quintupled, to over 500 barrels per day. Even more remarkable: the productivity boost occurred at the same time that the rig count in the region fell by two-thirds. Similar gains have occurred on drilling rigs targeting natural gas. In February, the EIA published productivity data on gas-well drilling in the Marcellus Shale. Between 2013 and 2016, the amount of natural gas from new wells in the Marcellus doubled, going from about 4.5 million cubic feet per day to about 9 million. That increase occurred at the same time that the rig count in the region fell by more than half. A decade ago, gas production from the Marcellus was negligible. Today, that formation is producing about 16 billion cubic feet of gas per day, a volume nearly equal to the production of Iran, which has the world’s largest gas reserves.

In February 2016, London-based energy giant BP took note of American energy-productivity gains, predicting that U.S. shale oil production would double over the next two decades. “Technological innovation and productivity gains have unlocked vast resources of tight oil and shale gas,” the company wrote in its Energy Outlook 2035, “causing us to revise the outlook for U.S. production successively higher.”

It would, of course, be foolish to claim that oil prices are destined to remain at low or moderate levels indefinitely. A major conflict in the Persian Gulf or the sabotage of Saudi Arabia’s oil fields could send oil prices upward. Furthermore, there are signs that low prices have forced oil producers in the U.S., Latin America, and the North Sea to curtail their drilling programs. That, in turn, will likely reduce this year’s non-OPEC production by about 700,000 barrels per day, according to a recent estimate by London-based research consultancy Energy Aspects. But a case can be made that we have entered a new era. The technologies that were perfected in shale formations in Texas—horizontal drilling and hydraulic fracturing—can now be applied in shale deposits around the world. That matters, because shale is the most abundant form of sedimentary rock on the planet. Further, those technologies can also be used to stimulate production from conventional oil reservoirs in non-OPEC countries like Brazil, Argentina, Canada, and Mexico. Those two realities, according to The Price of Oil, a recent book by Roberto Aguilera and Marian Radetzki, “will have an overwhelming impact on global oil supply.” Aguilera and Radetzki predict that as horizontal drilling and hydraulic fracturing tap conventional reservoirs, global oil production could rise by nearly 20 million barrels per day by 2035. They further expect that moderate oil prices—they predict $40 oil in 2035—will mean that “efforts to develop renewables for the purpose of climate stabilization will become more costly [and] require greater subsidies.”

These forecasts don’t surprise Bud Brigham, a longtime Texas-based driller who helped pioneer the development of the Bakken Shale in North Dakota. Two years ago, Brigham—who sold the company he founded, Brigham Exploration, to Statoil in 2011 for $4.4 billion—had three rigs running in the Permian Basin, and his new company was producing 3,000 barrels of oil per day. By February 2016, his new outfit was utilizing just one rig that produced twice that volume. Brigham said that he was squeezing out a tiny profit, even with oil at $30 to $40. “Texas is setting the cost of the marginal barrel,” he explained. “We’re in the early innings of innovating with horizontal drilling and hydraulic fracturing. We are driving up yields and driving down costs.”

Texas drillers, along with their colleagues in Oklahoma, Louisiana, Pennsylvania, Ohio, California, Colorado, and elsewhere, remain among the most efficient energy extractors on the planet. The economic and geopolitical ramifications are potentially enormous. If prices rally to, say, $60 or $70 per barrel, U.S. drillers could produce even more oil—and in doing so, undermine efforts by OPEC to limit production.

Today’s oil market, then, looks remarkably like it did in 1931, before Governor Sterling declared martial law in East Texas. A flood of Texas oil has overwhelmed the market. There are no brakes on supply, prices are weak, and producers are acting on their own, hoping to sell as much oil as they can. What’s old is new again—and Texas oil is, once again, in the spotlight.

Top Photo: For nearly 100 years, oil has been central to Texas’s economy. (Granger, NYC — All rights reserved.)

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