Oil boom on UT’s West Texas lands raises revenue and questions


Day and night, for the better part of a month, the drilling rig grinds away to bore a mile and a half deep and a similar distance horizontally into oil-rich shale beneath the endlessly flat, endlessly scrubby West Texas terrain. Once this well 55 miles southeast of Midland begins pumping, it is expected to be productive for years to come.

The 217-foot-tall rig is one of dozens operating at any given moment these days on the University of Texas System’s vast land holdings. The system’s 2.1 million acres, three-fourths of them in an oil patch known as the Permian Basin, were a gift from the state, an educational endowment established in the 1800s.

It’s a gift that keeps on giving. Oil and natural gas production — which had been petering out — has soared in recent years, thanks to advances in hydraulic fracturing and horizontal drilling that have unlocked resources once thought out of reach. Annual royalty payments and other revenues from companies that lease the UT System’s mineral rights have increased 400 percent since 2006 to a record $1.1 billion last year.

For all of the boom’s benefits, it raises questions about the UT System’s oversight. The system’s Board of Regents doled out $511.9 million more from the Permanent University Fund in a four-year period than the board’s own rules permit, an analysis by the American-Statesman found. The fund holds oil and gas proceeds and other assets for the benefit of UT System and Texas A&M University System institutions.

What’s more, a consulting firm concluded that the UT System’s Midland-based university lands office, which currently has 41 employees, faces “significant core challenges” in overseeing the stepped-up oil and gas activity, including “no engineering staff” and an awkward governance structure.

Environmental impacts — especially on water supplies and the aesthetics of these wide-open spaces — are also getting more attention. And, although UT System officials meet periodically with the holders of surface and mineral leases, they haven’t formally sought public input as they work to reorganize the operation and management of a publicly owned resource worth many billions of dollars.

In addition, the boom has stirred concern about the future place on these lands for ranchers who for generations have leased the surface of UT System lands to graze cattle, sheep and goats. The new well sites, access roads and pits for storing water used in drilling disrupt ranching operations and leave less space for livestock.

“No question there’s a great feeling of history and culture that those lands represent and that we’re going to protect,” said UT System Regent Alex Cranberg, chairman of the University Lands Advisory Board, which was established by the regents in July. “I think this is an important opportunity for the university to show leadership in how both the surface and subsurface are managed with best practices, and to harness the intellectual power of UT and A&M. All those questions need to be asked in a new and fresh fashion with each uptick in activity and impact.”

A $19.6 billion resource

The Statesman’s analysis found that, as the flow of oil and gas revenue has increased, the UT board has opened the spigot on the Permanent University Fund wider than its rules allow and against the advice of its investment advisers. A total of $2.9 billion has been allocated from 2012 to 2015, about 22 percent more than would have been permitted by the regents’ rules.

The rules don’t have the force of law, and UT System officials say the board is within its rights to override them. Regents say the higher payouts from the permanent fund are justified by the increased oil and gas revenue, rising estimates of mineral reserve values, a desire to minimize tuition increases at a time of constrained legislative appropriations and the need for money to support such initiatives as new medical schools in Austin and the Lower Rio Grande Valley.

It’s not as if the permanent fund is about to go broke. The fund’s stocks, bonds, gold bullion and other assets were valued at $17.4 billion at the end of August. On the other hand, it takes a stout fund to help support 14 UT campuses, seven A&M schools and six A&M agencies. And, as its name implies, the fund is supposed to last forever.

Under the Texas Constitution, the UT System gets two-thirds of the fund’s proceeds for new buildings and other initiatives, while the A&M System gets one-third.

To ensure that the fund’s purchasing power isn’t eroded by inflation, the regents’ rules stipulate that either 4.75 percent or 5 percent of its average value during the preceding 12 quarters “shall be” distributed in any given year. Such payouts are typical for endowments and pension funds.

The Texas Constitution, which does have the force of law, has limited permanent fund payouts to 7 percent under an amendment approved by voters in 1999. The regents allocated that percentage for the first time when they authorized an $877.4 million distribution for the fiscal year that ended Aug. 31.

UT-Austin and other beneficiaries of the fund welcome the higher proceeds. But the nonprofit investment company that the regents established in 1996 to manage the permanent fund and other higher education assets has counseled against such largesse.

Bruce Zimmerman, CEO and chief investment officer for the University of Texas Investment Management Co., told regents at a meeting in February that a strong argument can be made for lowering payout percentages during flush times. That’s because the money distributed to the university systems will still be substantial owing to the revenues that have swelled the fund.

By contrast, he said, a higher payout percentage would make more sense when revenues decline, thus keeping the dollar amount of payouts stable.

“The West Texas lands were set up, and are set up constitutionally, to be a revenue source into the endowment,” Zimmerman told the regents, adding that the amount of the revenue and the value of the lands shouldn’t influence the payout rate. “I am basing my view on the law and endowment principles.”

Instead, the regents have taken the view that mineral reserves — oil and gas still underground — should be considered when deciding how much to allocate from the permanent fund. A report by Netherland, Sewell & Associates Inc., a consulting firm, estimated the value of the reserves and future production at $19.6 billion as of Aug. 31. That is double what the firm estimated a year earlier, due mainly to drilling activity that firmed up additional reserves and, to a modest degree, higher oil prices — which have since dipped.

“It is substantial,” Cranberg said of the regents’ allocations, “but it is justified. The bulk of this money is going into long-term investments. For example, we’re building a new engineering building in Austin that is designed to last 50 years. That building will last longer than some of these oil and gas wells.”

A ‘fundamental shift’

When it comes to ranching on UT lands, Jimmy Sterling is a newcomer. He paid $1.2 million to take over an 80,000-acre grazing lease in 2006 and $900,000 for a 60,000-acre lease in 2012, both in Andrews County, which borders New Mexico. In addition, he pays rent to the UT System according to a formula that factors in the size of his herd and average market prices for livestock.

Since Sterling acquired the leases, oil and gas companies have drilled hundreds of wells on the land.

“They told me that there might be wells drilled, but they never said there’d be anything like this,” Sterling said of UT System officials as he steered his pickup around well sites, drilling-water storage ponds, tank batteries and pits for excavating caliche to build access roads. “They bring in real big rigs, tear up cattle guards that keep cows from getting onto the highways and leave debris behind. Cattle will eat just about anything that’s laying around.”

The drilling leaves less space for grazing, which means Sterling can run fewer cattle. And although his rent is lower as a result, Sterling said he has certain fixed costs for employees, equipment and maintenance.

Despite the disruption, he has no regrets. “I want to ranch,” Sterling said. “I can’t afford to go buy a ranch. I like the land, and for the most part it’s been pretty good dealing with the university lands people. I get along with them, and we work together. I’d rather the oil field wasn’t here, but money talks.”

Joe Petersen, a senior range conservationist for the UT System, sympathizes with ranchers. “No telling how many times we get a call from a rancher who says somebody cut their fence and cattle got out,” he said.

Petersen, two other range conservationists and five energy staffers must keep track of about 320 oil and gas operators, 112 grazing lessees and several hundred other surface lessees such as motels, service stations and even a winery. By necessity, the UT System relies on ranchers to serve as unpaid eyes and ears, Petersen said. As damage reports come in, officials work with oil and gas operators to obtain compensation for ranchers.

When the UT regents established the University Lands Advisory Board, they appointed five oil industry executives — including two who are also regents — and one system executive, but no ranchers. Yet grazing has a longer history than the oil industry on UT lands and is deeply embedded in the region’s culture. Some of the grazing leases have been held by the same families for more than 100 years.

Scott Kelley, the UT System’s executive vice chancellor for business affairs, said ranchers will always have a place on university lands. He said the advisory board doesn’t have a ranching representative because its charge is to focus on oil and gas activity, which generated roughly 40 times as much revenue as leases for grazing and other surface uses during the 2013-14 budget year.

“We’ve seen a fundamental shift with this new method of drilling,” Kelley said. “It became more like mining than exploration. The shale was there. It was about how best to drill into these shale plays to extract the most product. The expertise was sought around those areas where we thought it would have the biggest bang for the buck. Our leases with ranchers will continue.”

Although the advisory panel is playing an important rule — among other things, interviewing candidates for a newly created position of chief executive officer for university lands — its meetings and deliberations aren’t open to public scrutiny. Advisory panels aren’t required to hold public meetings.

Kelley said public input isn’t needed for what he described as management responsibilities that fall to him and his staff, including the employees of the Midland office. The new CEO would report to him.

Changes in order?

Hiring a CEO and expanding the Midland-based staff are among a laundry list of recommendations by Opportune LLP, a Houston-based consultancy that the system paid $743,714 to review its university lands unit and about $8.2 million more to develop a comprehensive royalty reporting and accounting system, including customized software.

Opportune’s report on the lands unit didn’t pull punches: “The organization has no engineering staff, no one focused on analyzing geologic data for oil and gas targeting purposes, minimal dedicated lease administration staff, no one dedicated to business development and is dependent on the university system to provide auditors, who may or may not have the necessary experience and industry knowledge … and who do not have the time to follow up on audit recommendations.”

The report said salaries need to be boosted, noting that the Midland office has lost a number of employees to better-paying industry jobs. Although beefing up the staff would cost millions, the report said this expense would be dramatically offset by the resulting ability to pursue revenue-enhancing opportunities, such as retooling older leases with minimal or no production. Under some of those older leases, the UT System gets a royalty of one-eighth of the price the commodity fetches, in contrast with newer leases that pay a one-fourth royalty.

Opportune also called for changes in the governance of university lands to create a more nimble organization. Oversight is currently provided not only by the UT System and its Board of Regents, but also by the Board for Lease of University Lands, a four-member panel that ultimately signs off on all leasing. The Board for Lease consists of two UT regents, one A&M regent and the state land commissioner, who chairs the panel.

Land Commissioner Jerry Patterson described the university lands unit as well-run and said any major changes in governance would require legislation.

“Maybe there’s something that needs fixing,” Patterson said. “I’d be more comfortable fixing what we’ve got than coming up with something new and different.”

A call for conservation

Environmental activists say much needs fixing.

It’s “incredible” that the UT System hasn’t sought wide public input as it “doubles down on fossil fuels” at a time of growing concern about the contribution of such fuels to global warming, said Luke Metzger, director of Environment Texas, a nonprofit advocacy group.

He said the system should be a leader in requiring drilling and production methods that protect air quality and water supplies. System officials say they have tightened some environmental standards attached to mineral leases but acknowledge that more needs to be done, especially to conserve water supplies in a semi-arid region.

It can take as much as 9 million gallons of water to drill and hydraulically fracture, or “frack,” a single well, and the need for more water recycling is great, according to the Opportune report.

Drillers are already required to use brackish, or salty, water rather than freshwater more suitable for household or municipal purposes, said Jim Benson, the UT System’s director of university lands. But he acknowledged that more “produced water” — water that comes out of wells along with oil and gas — needs to be recycled for drilling purposes rather than disposed of via deep-well injection.

Benson said he can recall only two instances of freshwater contamination — both affecting windmill-driven wells used for livestock — in his 28 years with the system.

Addressing another concern, Benson said there has been no apparent uptick in earthquakes on UT lands as fracking has expanded. In fracking, a mixture of water, sand and chemicals is typically pumped down a well under pressure to create fractures in rock that promote the flow of oil and gas.

Environmentalists want the UT System to prohibit the flaring, or burning off, of natural gas, whose main component is methane, a potent contributor to climate change. Flaring is sometimes done to get rid of natural gas from wells that primarily produce oil.

Benson said most flaring is short-term, maybe lasting a month or so until a pipeline can be connected to capture the natural gas.

“We work with the industry to try to reduce flaring,” said Kelley. “We feel we are extraordinarily good stewards of that land.”



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