America’s 1926 Oil Glut: Drive for Mandatory Proration by Independents Begins

By Robert Bradley Jr. -- August 26, 2015

“Beginning in late 1926, the rapid development of the large Seminole field in Oklahoma made the pendulum swing the other way. Voluntary proration­ was first tried with little success. Local producers appealed to the Oklahoma Corporation Commission for compulsory action. Output of one‑half million barrels per day was driving prices down, which threatened many firms.”

Mandatory proration, a government intervention re­stricting open‑flow production to a predetermined “market demand,” began almost simultane­ously in the sister oil states of Oklahoma and Texas in 1927. Other important oil states followed – except for California and Illinois that either practiced voluntary production cutbacks or none at all. [1]

California’s  free-market position did not result from free-market ideology; it was the victory of integrated Standard Oil of California (now Chevron) over the dogged mandatory-proration lobbying of their non-integrated rivals. For or against, it was industry pressure leading government and not government (reformers or agents of the public good) leading industry.

The Texas‑Oklahoma oil community, and hence their locally elected officials, [2] was divided over the importance of limiting the natural flow of production in the pre‑1926 period. Numerous wells and full production, many believed, constituted efficient practice. This conclusion was expressly stated in the final report by the American Petroleum Insti­tute’s “Committee of Eleven,” which investigated industry production prac­tices in 1925. [3]

Consequently, the majority of oilmen were against regulatory programs to curtail production, such as Henry L. Doherty’s plan for mandatory unitization, first presented before the American Petroleum Institute in 1923. (Unitization is where all reservoir co-owners submit to one plan of production, presumably to lower costs to drill fewer wells and at slower rates. A mandatory order requires a certain threshold of consensus.)

A special resolution of the American Petroleum Institute denounced Doherty’s proposal as “not resulting in the production of more oil and gas than is produced by present methods,” while having the unfavorable potential of “eliminating the small producer.” [4]

Beginning in late 1926, the rapid development of the large Seminole field in Oklahoma made the pendulum swing the other way. Voluntary proration­ was first tried with little success. Local producers appealed to the Oklahoma Corporation Commission for compulsory action. Output of one‑half million barrels per day was driving prices down, which threatened many firms.

A commission hearing found waste, and a manda­tory proration order was given pursuant to the 1915 Act on August 9, 1927. This action represented the first major attempt by a state or federal agency to restrict oil production outside of public land withdrawals. [5]

Development of the Seminole field signaled a major change in the outlook of oil men from just a short period before. As historian Norman Nordhauser noted:

Those optimistic API members who had, a few months earlier, testified that there was neither waste nor shortage of American oil, now cried that there was an urgent need to check overproduction and to prevent prodigal practices. Only the rapid change in price and production of the industry wrought by the wealth of oil at Seminole could explain this turnabout. [6]

With this turnaround came the beginning of another bellwether transformation: the serendipitous discovery by the oil community that stabilization of production, by restricting the open‑flow of producing wells, preserved reservoir energy that could increase future crude oil recoverability. Petroleum legal scholar Robert Hardwicke described the nature of this second development:

A great movement often originates largely through accident. It is evident that the enforcement of conservation stat­utes was originally urged by most oil men, and attempted by most public officials, as a smoke screen for achieving stabilization, but with the result that the industry finally awoke to the realization that the conservation policies were, for themselves alone, highly desired ends. [7]

Now the previously vague terms “underground waste” and “economic waste” could have meaning, the former being the dissipation of crude‑recovering reservoir energy and the latter being unnecessary drilling costs. But it took more than Seminole to change the face of conservation. It took other major fields to continue to make the stabi­lization of price ‑ and therefore production ‑ the utmost priority.

Conclusion

Mandatory wellhead oil proration was largely suspended during World War II but returned in the postwar period to support higher prices for producers (there were winners and losers, of course, with small independents gaining what larger more disciplined integrated producers lost). It would not be until the early 1970s when a reversal of conditions sent prices upward and oil states such as Texas, Oklahoma, Louisiana, and Kansas set their allowables at 100 percent, where they have remained with rare exceptions ever since.

Might calls for oil or natural gas proration return in the oil states? There are several problems with going back to the bad old days. First, there is an incentive for a state to hold out (or just have a higher allowable) to free-ride on the cutbacks of others. Second, U.S.-side actions would encourage unregulated oil exports.

Short of an oil tariff and/or oil quota (which propped up restrictionist state policies from 1929 through 1971), U.S.-side policies would be partially self-defeating. Finally, a political firestorm and possible federal antitrust action might result from some oil states going it alone with market-demand proration.

———–

[1] For the interesting case of California, see J. Howard Marshall, “Legal History of Oil and Gas in California,” ibid, pp. 28‑36; see also Myron Watkins, Oil: Stabilization or Conservation? (New York: Harper & Brothers, 1937), pp. 230‑46. Illinois, like California, operated solely on rule‑of‑capture competition until 1942 when federal wartime planning instructed state officials to prorate crude output.

[2] The influence of dominant oil interests on local politics is a major theme of the conservation movement. Virtually every major regulation passed and enforced in the period has organized industry support behind it.

[3] “The cheapest oil produced is that obtained by flowing, hence every effort is made to keep wells flowing naturally . . . . Present production methods are as efficient as is warranted by the value of the product handled. The waste in the industry is virtually negligible and the oil left in the ground becomes a reserve for the future.” Committee of Eleven, American Petroleum: Supply and Demand (New York: McGraw‑Hill, 1925), p. 55.

[4] API Special Resolution (December 1924). Quoted in Leonard Logan, Stabilization of the Petroleum Industry, pp. 144‑45.

[5] In Oklahoma, isolated proration orders occurred in 1915, 1921, and 1923 for smaller fields, but the l927 order began “the period of continuous pro­ration.” W. P. Z. German, Legal History – 1939, pp. 149‑51.

[6] Nordhauser, The Quest for Stability, pp. 27‑28. Elsewhere, Nordhauser refers to the Seminole experience as “the great reversal.” “Origins of Federal Oil Regulation,” p. 68. The first Oil & Gas Journal editorial espousing wellhead proration was on April 28, 1927.

[7] Robert Hardwicke, “Legal History of Proration of Oil Production in Texas,” Proceedings Texas Bar Association, October 1937, p. 99.

—————-

NOTE: This post is taken from the author’s Oil, Gas, and Government: The U.S. Experience (1996), published by the Cato Institute.