CENTRE FOR ENERGY, PETROLEUM AND MINERAL LAW AND POLICY

STATEMENT OF ORIGINALITY

FOR RESEARCH PAPERS

NAME OF STUDENT: Zaid Mahayni

MATRICULATION NUMBER: 009943036

PROGRAMME: LL.M. in Petroleum Law and Policy

TITLE OF THE RESEARCH PAPER:

The Discretionary and Auction Licence

Allocation Methods: A Comparaison

ABSTRACT OF THE RESEARCH PAPER:

The differences between the auction and the discretionary licence allocation methods are

far from just being theoretical. The choice between these two systems will depend on

many factors such as the political and economical objectives of the host government and

the expected potential of the ‘advertised’ acreage. This paper will start by highlighting

the differences between the two licence allocation systems and will then enumerate the

circumstances that will justify the adoption of each system. The United Kingdom’s

auction experiment will also be investigated to offer the reader an overall view of how

these methods are applied in practice.

WORD COUNT: 4,694

PRESENTED TO: Professor Peter Cameron

TITLE OF THE COURSE: International and Comparative Petroleum Law and Policy

I, Zaid Mahayni, have read the Code of Practice regarding plagiarism contained in the

Students’ Introductory Handbook. I realise that this Code governs the way in which the

Centre for Petroleum and Mineral Law and Policy regards and treats the issue of

plagiarism. I have understood the Code and in particular I am aware of the consequences,

which may follow if I breach that code.

Signed:________________

Date:__________________

1

Table of Contents

List of Abbreviations ------------------------------------------------------------------------- 2

1. Introduction --------------------------------------------------------------------------------- 3

2. The Auction and the Discretionary Methods: Comparison of their Functioning - 4

2.1 Licence Arrangements in General ----------------------------------------------------- 4

2.2 The Discretionary Licence Allocation Method -------------------------------------- 5

2.3 The Auction Licence Allocation Method --------------------------------------------- 7

3. Comparison of the Auction and the Discretionary Methods in the Achievement

of Government Objectives ------------------------------------------------------------------- 9

3.1 Capture of Economic Rent -------------------------------------------------------------- 9

3.1.1 Initial Capture of Economic Rent ---------------------------------------------------- 9

3.1.2 Recapture of Economic Rent --------------------------------------------------------- 10

3.1.3 Problems with the Recapture of Economic Rent ---------------------------------- 13

3.2 Avoidance of Licensee Working Capital Depletion --------------------------------- 13

3.3 Promotion of Small and Medium Sized Applicants --------------------------------- 14

3.4 Promotion of Local Suppliers ---------------------------------------------------------- 15

3.5 Limitation on the Entry of Foreign Oil Companies --------------------------------- 16

4. Case Study: The UK Experience -------------------------------------------------------- 16

5. Conclusion ---------------------------------------------------------------------------------- 18

Annexe A -------------------------------------------------------------------------------------- 20

Bibliography ----------------------------------------------------------------------------------- 21

2

List of Abbreviations

CEPMLP ---------------- Centre for Energy, Petroleum and Mineral Law and Policy

IOC ----------------------- International Oil Company

UK ----------------------- United Kingdom

US ------------------------ United States of America

3

1. Introduction

Generally, individual governments are vested with the ownership of the oil

resources within their jurisdiction. Exceptions may be possible, as in the United States,

where surface landowners also own the natural resources below the surface. Still, even in

the United States, oil discoveries will seldom be on private lands and are more likely to

be on public lands or, if applicable, on the continental shelf.1

For economic or political purposes, a government will seek to obtain knowledge

about the oil-bearing potential of its territory. If the exploration results seem promising

and if the government decides to put an oil industry on its feet, some basic decisions need

to be taken. Should a national oil company be created? And, if the answer is positive,

should private oil companies be allowed to participate in the exploitation activities?

It should be noted that even when a government creates a national oil company to

extract the oil, this new company would often lack adequate experience and expertise.

Hence, private companies will inescapably be called in.

As Professor Kenneth W. Dam states:

“Whatever their capacity to govern, governments have no capacity to drill oil wells, build

pipelines, or perform any of the other highly technical tasks required to exploit petroleum

resources”2

It is rare that a government completely bars private or foreign participation. It is

however possible as in the case of Mexico. Nevertheless, since individual governments

most often need private companies to develop their oil industry, they will either enter into

service contracts or establish a licensing procedure.

The service contract will not involve the issue of a licence. Here, the selected

private firm is perceived as a contractor and does not own interest in the resources

extracted.3 A good example of the use of service contacts would be the Indonesian model.

1 K., W., Dam, Oil Resources: Who Gets What How?, p. 3. 2 Ibid.

4

Alternatively, under a licensing procedure, the oil companies will be given the

right to explore for or exploit petroleum, or, as Article 2 of the UK Petroleum

(Production) (Seaward Areas) Regulations 19884, words it: “to search and bore for, and

get petroleum”. Therefore, even exploration activities will be licensed.

In awarding licences, a government will have the choice between two major

allocation methods: the auction method, typical of the United States and the discretionary

method, typical of the United Kingdom.

In an auction system, licences are awarded to the highest qualified bidder.

Conversely, in the discretionary system, government officials award licences according to

a body of pre-determined criteria, political or administrative. This paper will offer a

comparison between the auction and the discretionary methods of allocation.

In a first section, we will describe the functioning of these two methods of

allocation. Under a second heading, we will examine the typical objectives sought by

governments and consider which licence allocation method is most suitable in achieving

these objectives. Then, in a third section, we will present a case study based on the

United Kingdom’s licensing experience.

2. The Auction and the Discretionary Methods: Comparison of their Functioning

2.1 Licence Arrangements in General

Just as a clarification point, various terms are used across the world to describe

licensing arrangements. In Australia, Norway and the UK, the term ‘licence’ is used. If

the grant is restricted to exploration, it may be called a ‘permit’. On the other hand, if it

refers to exploitation activities, it may be referred to as a ‘lease’. This will be the case in

countries such as the United States and Canada.5

3 Ibid, p. 16. 4 S.I. 1988 No. 1213. 5 P., Cameron, Petroleum Licensing: A Comparative Study, p. 5.

5

Licences may be sought either through a government invitation (invited

applications) or by the own initiative of the persons interested (non-invited applications).

Non-invited applications will have a tendency to be non-competitive in nature. In fact,

they will seldom be used in the discretionary licence allocation systems. In addition, they

certainly contradict the spirit of the auction method.6

It is important to note that governments will benefit more from increased

competition between applicants. In an auction system, the applicants will tend to bid

higher. Conversely, in a discretionary system, competition will encourage applicants to

submit more attractive offers.

2.2 The Discretionary Licence Allocation System

In the discretionary system, government civil servants are assigned the task to

rank the applicants according to a defined set of criteria, sometimes referred to as the

‘bidder dimensions’. Basically, the ‘bidder dimensions’ represent the civil servants’

examination of the following characteristics:

- The applicant’s past performance;

- The applicant’s competence to explore the area offered for licensing;

- The applicant’s exploration plan for the area; and

- The applicant’s financial strength.7

It is important to note that the above criteria may somewhat contain an element of

bidding in them. The exception would be where the government needs to make a

qualitative assessment of an application.8 Let us present a few words on each of the

criteria enunciated above.

6 T., Daintith, and G., Willoughby, Manual of United Kingdom Oil and Gas Law, p. 21. 7 K., Sinding, Auctions and Discretion in Oil and Natural Gas Licensing,, p. 26. The selection

criteria that may be used are enumerated in detail in P., Cameron, supra note 5, pp. 25-26. 8 Ibid.

6

First of all, the evaluation of past performance will include the examination of

such things as the applicant’s record of compliance with diligence requirements,

economic performance, support of local suppliers, etc. This information is difficult for

governments to gather but it nevertheless constitutes valuable information in assessing an

application.

Secondly, when exploring the competence of an applicant, the government will

ensure not only the availability of adequate experience and technology, but also that of

sufficient staff aptitude.

Thirdly, the nature of the work plan itself has to match the expectations of the

government. This assessment, qualitative in nature, will verify that the work proposed is

suited for the local conditions.

Fourthly and finally, the licensing authority must verify the solidity of the

applicant’s financial capacity. This is to ensure that the work program will indeed be

carried out as proposed.9

The above criteria have been incorporated in the European Union Licensing

Directive10. Actually, according to this directive, if two oil companies present equally

valid applications, then the award must be made following the introduction of additional

criteria. Therefore, the government will have to introduce other requirements just as a

‘token of fairness’ to the applicants.11

When granting rights, the European Union Licensing Directive, will require that

the government base its decision on objective criteria. The requirement for objectivity in

the evaluation criteria aims at limiting civil servant discretion in evaluating

9 Ibid, p. 27. 10 94/22/EEC. 11 M. A., Bunter, The Promotion and Licensing of Petroleum Prospective Acreage, p. 9.

7

applications.12 Annexe A of this paper illustrates a typical evaluation form used by civil

servants under the discretionary system.13

One important point of worry with the discretionary system is the fear of

corruption in the civil servants’ body. This is especially a concern in countries run by

dictatorships. Interestingly, it is believed that mere suspicions of corruption might reduce

the efficiency of the entire licensing system.14

Actually, Michael Bunter notes on the subject that:

“I am aware that many countries draft prescriptive legislation, particularly where

financial provisions are concerned. There is a danger that by drafting overly prescriptive

legislation the Minister’s hands will be unduly fettered in negotiations so that the best

outcomes are difficult to achieve. For the avoidance of corruption it will be necessary for a

Cabinet to have an oversight role over the negotiations.”15

2.3 The Auction Licence Allocation Method

The auction mechanism includes various types of bidding. The government may

choose to conduct bonus bidding, royalty bidding or profit bidding. In the bonus type of

bidding, the winner of the bid has to pay the bonus at the outset for the licence. On the

other hand, in the royalty type of bidding, the applicants will specify the royalty rate they

are willing to pay if a discovery is made. Finally, in the profit bidding scheme, the

applicants will specify what share of profits they are willing to transfer to the

government. 16

When it comes to royalty bidding, it is thought to be very attractive to the

applicants. Indeed, a royalty will shift risk from the licensee to the government.

Generally, this is an acceptable result since governments are better able to carry risk than

12 Ibid. 13 This Annexe is extracted from the unpublished work of M. A., Bunter, supra note 10, p. 228. 14 P., Cameron, supra note 5, p. 19. 15 M. A., Bunter, supra note 11, pp. 42-43. 16 P., Cameron, supra note 5, p. 17.

8

private companies. However, this might not always be the case, especially if the public

treasury of the host country is poor.17

One essential worry with the auction system is the risk of collusion in the bidding.

As Geoff Frewer writes:

“[O]wnership of infrastructure provides consortia with strategic assets giving significant

market power in the vicinity of the infrastructure. As a consequence, the number of

consortia bidding for acreage may be quite small even though there are a larger number of

companies involved, and this gives rise to concerns about collusion between bidders

reducing the level of the bids”.18

When it comes to fair play on the part of the government, the auction mechanism is

thought to be relatively transparent. According to Geoff Frewer, transparency is achieved

since it is more difficult for governments to discriminate under an auction system, in

favour of a certain specific group of applicants.19

With regards, we disagree with this opinion. We also disagree with Michael Bunter

when he writes:

“Having said all thus we can point out that there is one huge advantage to the

Discretionary system over the Auction system. This advantage is that government may

arbitrarily reject an otherwise bid-qualified IOC giving no reason as within its discretionary

powers, or it may entertain unusual offers. It provides a flexibility not available otherwise.

It allows government to consider an application no matter how startling a departure from

accepted practice and no matter how small the IOC concerned.”20

These opinions take as an assumption that under the auction method, the licence

can only be awarded to the highest bidder. In reality, the auction method may incorporate

some discretionary elements in the selection of licensees. Therefore, even under the

auction mechanism, the ‘bidder dimensions’ may be evaluated. We take Professor

Kenneth W. Dam’s opinion when he argues that:

17 K., Sinding, supra note 7, p. 15. 18 G., Frewer, Auctions vs. Discretion in the Licensing of Oil and Gas Acreage, in G., MacKerron,

and P., Pearson,(eds.), The International Energy Experience: Markets, Regulation and the

Environment, p. 168. 19 Ibid. 20 M. A., Bunter, supra note 11, p. 229.

9

“One could use a simple formulation such as that to be found in the U.S. Outer

Continental Shelf Lands Act of 1953 permitting the licensing authority to reject bidders

who are not ‘qualified’ and ‘responsible’. The discretion granted to the licensing authority

would not be greater than it was under the British system. But one could also impose more

detailed requirements. Just as one could easily exclude from bidding eligibility all

corporations not incorporated locally, so one could also if blessed with skill in legal

drafting, assure that all bidders had the requisite financial resources and technical know-

how and could specify in advance a minimum level of drilling activity for each block.”21

It is crucial for the reader to keep this last quote in mind throughout the rest of this

paper. As we will demonstrate, this last contention constitutes the backbone of many

arguments in support of the auction mechanism.

Now that we have compared the functioning of the auction and discretionary

methods of award, let us now examine which one is more efficient in achieving the

typical governmental objectives sought in licensing arrangements.

3. Comparison of the Auction and the Discretionary Methods in the Achievement of

Government Objectives

Let us start by examining which licence allocation method is better able to

conciliate the interests of both the licensees and the government in the sharing of

economic rent.

3.1 Capture of Economic Rent

3.1.1 Initial Capture of Economic Rent

Economic rent occurs when the value of the extracted resources exceeds all

operating and management costs. When costs are just slightly greater than costs, then we

will speak of a ‘marginal field’.

The auction mechanism is believed to be an efficient way for the government to

capture economic rent from the outset of the licence. This is an important advantage,

21 K., W., Dam, supra note 1, p. 33.

10

since, as Geoff Frewer mentions, timing of the receipts may be important, especially

when government finances are under pressure.22

When it comes to bidder psychology, each applicant is ready to sacrifice a certain

amount of the expected economic rent in return for the licence. As applicants try to

outbid each other, larger part of the economic rent is transferred to the government.

One risk faced by applicants is to bid higher than the real value of the economic

rent. This, however, should be of rare occurrence since applicants usually apply a large

degree of cautiousness. Moreover, as Professor Kenneth Dam notes:

“A company that consistently overestimates the value of oil properties will tend to

disappear from the business. At the very least, it will hire better geologists.”23

Furthermore, Geoff Frewer, speaking of the harms overbidding, warns that:

“In the short run, [overbidding by applicants] might inflate the revenues received by the

government but in the longer term it could depress industry returns and lead to sub-optimal

or cyclical investment levels.”24

In comparison with the auction system, the discretionary method is thought to be

less effective in capturing economic rent early in the life of a licence. Governments

applying the discretionary method will therefore have to seek, after the licence has been

awarded, alternative methods to recapture the economic rent. These various methods will

be studied in the following section.

3.1.2 Recapture of Economic Rent

The principal recapture methods used are royalties, taxation and government

participation. These instruments can be used either in combination or separately.

First of all, in the case of royalties, they have the advantage of generating revenue

for the government from the very beginning of production. Hence, a given amount of

22 G., Frewer, supra note 18, p. 169. 23 K., W., Dam, supra note 1, p. 6. 24 G., Frewer, supra note 18, p. 167.

11

royalty will have more impact than the same amount in income tax on notions such as the

internal rate of return or on the net present value.25

One disadvantage with royalties, and it applies to royalty bidding as well, is that

royalties do not encourage the maximal development of marginal fields and may lead to

premature abandonment. Indeed, since royalties are a form of excise tax, costs are not

subtracted from revenues when calculating royalties. For a licensee, royalties constitute a

marginal cost. As production costs increase towards the end of the life of a field, the

addition of a royalty cost to the licensee might render the production unprofitable.

One solution would be to establish a system of sliding scale royalties. A sliding

scale royalty will vary depending on the size of the field. A larger field will have to pay

higher royalties than a smaller one. One problem with this ‘solution’ is that larger fields

may have higher development costs. For instance, a large field may be situated in deeper

water or perhaps on a risky terrain. Moreover, large fields will often necessitate the

construction of pipelines, contrarily to small fields which could be very well served with

tanker loading. Pipeline construction is a large expense that must take place early in the

life of a field, whereas tanker loading costs may be spread out over the life of a field. In

summary, even when sliding scale royalties are introduced, such as in the Netherlands

and Norway, these may still fail to prevent early abandonment of a field.26 As a

correction, we suggest a sliding scale royalty that decreases in accordance with the total

remaining recoverable reserves.

Second of all, on the topic of taxation, the hosting government may either tax the

oil companies as if they were part of any other sector of the economy or they could

establish a distinct taxation system strictly for petroleum revenues. The licensees may be

imposed in accordance to one or both of these systems.

25 K., W., Dam, supra note 1, p. 133. 26 Ibid.

12

An income tax will be calculated according to profits. Therefore, the costs will be

deducted from the revenues. For the licensee, one advantage to be faced with income

taxes, instead of for example higher royalty rates, is that the income taxes will only have

to be paid many years after the investment is made. Since a dollar spent tomorrow has

less value than a dollar spent today this is of great importance to the oil companies,

especially since the amounts in question are often in terms of hundreds of millions of

pounds.27

Income taxes, just like royalties, can lead to the early abandonment of marginal

fields. According to Professor Dam, this is particularly possible when the tax applied on

oil production is higher than that applied on other sectors of the economy.28

Thirdly, when it comes to government participation, it is important to note that the

governments will not normally share all of the incurred field costs. The government,

through its participation will seek to gain some control over the activities of the private

oil companies. Government participation implies the creation of a national oil company.

The governing petroleum legislation may oblige a certain percentage of the interests in a

field to be transferred to the created state company.29

As an illustration of government participation, the Norwegian government used in

the period prior to 1969 a system of net profit sharing. Under this system, a certain

percentage of net profit was paid to the government. Beyond doubt, this system closely

resembles an income taxation measure. Norway, after 1969, introduced a new system of

carried interest. Under this new system, the licensee carries the government’s potential

interest during the exploration phase. If a discovery occurs then the government has the

option to participate or not. If the government decides to participate, then it must

contribute to part of the costs. The question that still remains unanswered is to what

extent will the government be responsible for the costs? Also, must the government

27 Ibid., pp. 135-136. Please see also, P., Cameron, supra note 4, p. 11. 28 Ibid., p. 137. 29 P., Cameron, supra note 5, pp. 9-10.

13

contribute to exploration costs? This has mostly depended on the percentage of the

interest carried and has varied from one field to the other.30

Finally, in the capture of economic rent, the government may also impose

mandatory surrender or area rentals. However, these ways have been described as being

inefficient in capturing economic rent.31

3.1.3 The Problem with the Recapture of Economic Rent

As we saw in the previous section, the government may try to recapture economic

rent that has not been seized from the outset of the licence. For the oil companies, these

‘retrospective measures’ constitute an important risk. If this risk is too great, the whole

licence may seem unattractive to the oil companies. Any licensing strategy, even when it

guarantees the maximal transfers of economic rent to the government, still has to seem

attractive to the oil companies.

This is especially true at the present moment, where it is not the states that have

the upper hand but the oil companies. Indeed, worldwide, governments today are in

desperate search of investments and compete between themselves to attract oil

companies. The result is much more lenient licensing conditions. Mr. Michael Bunter

describes this phenomenon in the draft of his book yet to be published: The promotion

and Licensing of Petroleum Prospective Acreage32. Mr. Bunter emphasises the need for

governments to put forward an attractive licensing strategy. If an individual government

fails to do so, the international oil companies will simply look elsewhere. They have

plenty of other investment opportunities all around the world.33

3.2 Avoidance of Licensee Working Capital Depletion

30 K., W., Dam, supra note 1, pp. 56-62. 31 Ibid., p. 141. 32 M. A., Bunter, supra note 11. 33 Ibid, pp. 165-184.

14

It is important for any government to maximise investment in exploration and to

achieve a fast rate of development and production. One traditional argument in favour of

the discretionary method of allocation is that it avoids the depletion of the licensees’

working capital. The reasoning behind this argument is that the licensees do not have to

spend large amounts of money from the outset of the licence as it is done under the

auction method.34

Such an argument is based on many assumptions that compromise its validity.

The first assumption is that the auction mechanism imposes the full payment of the bid

from the outset of the licence. As Professor Dam notes, the bid can very well be paid in

instalments over the span of the licence. Moreover, the bidding may take place in terms

of royalty instead of cash.35

This argument also assumes that the applicants in the auction mechanism will go

as far as to compromise their exploration resources just to win the licence. Actually, even

if this was the case, trading in licences may still be possible.36

As a final point on this topic, it has been advanced that:

“[F]inancing problems that have arisen in obtaining large-scale funds for development are

largely a consequence of the discretionary licensing system itself or of the uncertainty

created by the threat of new government regulation and taxes.”37

3.3 Promotion of Small and Medium Sized Applicants

The discretionary method is thought to be more efficient in the promotion of

small and medium sized applicants. The reasoning behind this argument is that smaller

companies do not have the financial resources to outbid large companies. A barrier to

entry is thus created.38

34 K., Sinding, supra note 7, p. 19. 35 K., W., Dam, supra note 1, p. 33. 36 K., Sinding, supra note 7, p. 19. 37 K., W., Dam, supra note 1, p. 33. 38 K., Sinding, supra note 7, p. 22.

15

Here again, the auction approach may adopt some discretionary dispositions

favouring these small and medium sized companies. Actually, this argument ignores two

important facts. Firstly, the smaller companies may enter into joint bidding in order to

increase their chances to win the licence. Secondly, smaller companies may simply refuse

to bid higher than the larger ones simply because they do not have the same estimations

of tract value.39

3.4 Promotion of Local Suppliers

Another argument in favour of the discretionary approach is that it may better

protect the local industry. Knud Sinding identifies two implications in pursuing a ‘buy

local’ policy: rule-making and enforcement.40

A ‘buy local’ policy may either be found within the body of the licence or in

external statutory rules. Such a policy may take various forms. Under one possibility, the

licensee may be obliged to buy local supplies when they are competitive with foreign

suppliers. Another possibility would be to impose a tariff on imported foreign supplies.41

Scholars have advanced many doubts on the efficiency of ‘buy local’ obligations.

In some cases, local suppliers, of either goods or services, may just be unable to supply

the minimal level of quality required by the government or the licensee. In such case, an

exemption could be justified. The problem now is: who is in position to grant an

exemption? Should the host government create a special administrative body to monitor

purchasing decisions? Indeed, it could be very difficult to enforce ‘buy local’ policies.

Certainly, the text of the licence or the statutory rule containing the ‘buy local’ policy

cannot be specific enough to enumerate all possible scenarios that may arise in practice.42

39 Ibid. 40 Ibid., p. 23. 41 Ibid. 42 Ibid.

16

Is the discretionary method really this much more capable to implement a ‘buy

local’ policy? In response, we will offer the following two statements: A ‘buy local’

policy can be described as a control mechanism after the licence has been awarded.

Nothing keeps governments running under the auction approach either from specifying

before the start of the bidding that the winner must carry a “buy local’ policy. Host

governments may also enact such a policy in a statutory rule (private or public). It might

seem unattractive to the industry but nonetheless it is possible.

3.5 Limitation on the Entry of Foreign Oil Companies

The limitation of the entry of foreign oil companies is thought to be best achieved

under the discretionary method of allocation. It has especially been an objective among

the North Sea countries. As Professor Peter Cameron notes:

“It is not simply a desire to avoid having profits flow out of the country at some future

date. A government will probably wish to give its domestic industry a stake […] or let its

domestic concerns learn on the backs of foreign oil companies e.g. through joint

ventures.”43

Here again, under the auction approach, all that is required to achieve the same

result is to draft the appropriate conditions on bidder qualifications. Therefore, one could

exclude from bidding eligibility all corporations that are not locally incorporated.44

4. Case Study: The UK Experience

In the United Kingdom, licences are sought strictly in pursuance of an invitation

(licensing round) from the Secretary of State for Trade and Industry. Nevertheless, non-

invited applications are possible in exceptional circumstances. For example, if a licensee

discovers a field underlying both his block and an unlicensed block, then it is possible for

him to apply for the unlicensed block without invitation. (the masculine tense includes

the feminine). 45

43 P., Cameron, supra note 5, p. 16. 44 K., W., Dam, supra note 1, p. 33. 45 T., Daintith, and G., Willoughby, supra note 6, p. 20.

17

Regulations up to 1976 required all applicants to be “resident citizens of the

United Kingdom and Colonies or companies incorporated in the United Kingdom”.

However, this requirement was abolished in order for the United Kingdom to comply

with the obligation not to discriminate against EEC nationals and companies.46

Interestingly, the criteria used in evaluating applications do not have any legal

force. In other words, the applicants cannot complain in the courts if the minister departs

from these criteria.47

The United Kingdom has conducted three auctions since the first round in 1964.

These three auctions took place in the fourth, eighth and ninth rounds. In each of these

rounds, fifteen blocks were offered for licensing. The United Kingdom chose to auction

blocks in mature areas that contain lower exploration risks.48

The auctions in many ways proved successful. In the fourth round, licence

allocation by auction generated 37 million pounds and all fifteen blocks were allocated.

In the eighth round, the award of seven licences generated 33 million pounds. Finally, in

the ninth round, 121 million pounds were generated through the award of thirteen

licences.49

One essential concern with the auctions conducted is the low level of competition

in the bidding. On average, two or three bids were presented for each block, in

comparison with the discretionary approach, which attracted far more participation.50

In spite of the overall success licensees had under the auction system, some cases

were marked with outstanding failures. For instance, in the eighth round, Amerada paid

46 Ibid., p. 21. 47 Ibid., p. 24. 48 G., Frewer, supra note 18, pp. 169-170. 49 Ibid. 50 Ibid.

18

10.1 million pounds and BP paid 25 million pounds for blocks that yielded no significant

discoveries.51

When it comes to exploration drilling, the fourth round demonstrates that more

has been done under the auction mechanism. The eighth and ninth round show no

significant differences between the two systems. Actually, on the auctioned blocks, there

was more appraisal drilling as would be expected in mature areas.52

Another important observation to be made is that the frequency of second well

drilling has been much lower under the auction system. Indeed, as Geoff Frewer

observes:

“Obligations undertaken by consortia under the discretionary system appear to

have led explorers to seek out additional prospects on the block when the first well failed.

By contrast, in the auction blocks initial failure has tended to shift management’s attention

to more favourable area or troublesome obligations on other acreage.”53

For example, in the eighth round, 86% of discretionary blocks have had second wells in

comparison with 60% when it comes to auction blocks. In the ninth round the

corresponding numbers were 63% and 33% respectively.

On the results of the auction experiment in the United Kingdom, Professor Dam

draws our attention to the fact that:

“[I]t can be seen that the discretionary system is a costly way to subsidize exploration. The

cost of the subsidy is represented by the payments foregone – here 37 million pounds for

fifteen blocks. How much exploration activity could have been purchased for 37 million

pounds?…Using averages from the previous three rounds, the amount would have been

less than 12 million pounds…In other words, it costs at least twice as much as the

companies will actually spend to induce exploratory expenditure.”54

5. Conclusion

51 Ibid., p. 171. 52 Ibid., p. 172. 53 Ibid., p. 171. 54 K., W., Dam, supra note 1, p. 39.

19

We have to admit that we started our research more inclined towards the

discretionary method, but Professor Kenneth Dam was able to change our opinion in

favour of the auction approach.

The auction mechanism may incorporate discretionary conditions that allow

governments to benefit from the ‘best of both worlds’. For instance, nothing keeps a host

government from conducting an auction on the condition that the winner adopts a ‘buy

local’ policy. Similarly, the host government can limit participation in bidding only to

small or medium sized companies.

We believe that, under the auction system, governments can still maintain a

reasonable level of control after the award of the licence. Actually, since the auction

approach allows for the capture of economic rent from the outset of the licence, the

undesirable effects of recapture methods are avoided to a certain extent.

Even when it comes to acreage on which little information is available or acreage

in frontier areas, the auction mechanism through its royalty bidding option may still be an

advisable solution. It effectively ‘spares’ companies from the risk of losing money both

on the award of the licence and for the exploration of the acreage.

20

ANNEXE A Criteria for evaluation of bids for awards of petroleum exploration

licences

Reproduced from: Bunter, M. A., The Promotion and Licensing of Petroleum Prospective

Acreage, (Conwy, United Kingdom: B and R Co. Ltd.), page 228.

21

Bibliography

1. Primary Sources

1.1 Legislative

The Hydrocarbon Licensing Directive, (94/22/EEC).

Petroleum (Production) (Seaward Areas) Regulations 1988, (S.I. 1988 No. 1213), (U.K.).

2. Secondary Sources

2.1 Books

Al-Chalabi, F. J., OPEC and the International Oil Industry: A Changing Structure,

(Oxford, England: Oxford University Press, 1980).

Ballem, J. B., The Oil and Gas Lease in Canada, Second Edition, (Toronto, Ontario:

University of Toronto Press, 1985).

Cameron, P., Petroleum Licensing: A Comparative Study, (London, England: Financial

Times Business Information Ltd, 1984).

Crommelin, M., Non-Competitive Allocation Systems: A Critique, in Gaffney, M., Oil

and Gas Leasing Policy: Alternatives for Alaska in 1977, 1977.

Daintith, T., (ed.), The Legal Character of Petroleum Licenses: A Comparative Study,

(Dundee, Scotland: Centre for Petroleum and Mineral Law Studies, 1981).

Daintith, T. and Willoughby, G., Manual of United Kingdom Oil and Gas Law, (London,

England: Sweet & Maxwell, 1984).

Daintith, T. and Willoughby, G., United Kingdom Oil and Gas Law, Third Edition,

(London, England: Sweet & Maxwell, 2000).

Dam, K. W., Oil Resources : Who Gets What How?, (Chicago, USA: University of

Chicago Press, 1976).

Frewer, G., Auctions vs. Discretion in the Licensing of Oil and Gas Acreage, in

MacKerron, G. and Pearson, P., (eds.), The International Energy Experience: Markets,

Regulation and the Environment, (London, England: Imperial College Press, 2000).

Huie, W. O., et al., Oil and Gas: Cases and Materials, Second Edition, (St. Paul,

Minnesota: West Publishing Company, 1972).

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Kuntz, E. O., et al., Cases and Materials on Oil and Gas Law, (St. Paul, Minnesota: West

Publishing Co., 1986).

Laitos, Jan, G., Natural Resources Law: Cases and Materials, (Saint Paul, Minnesota:

West Publishing Company, 1985).

Lowe, J. S., Oil and Gas Law in a Nutshell, Second Edition, (St Paul, Minnesota: West

Publishing Company, 1988).

Ramsey, J. and Sawhill, J. C., Bidding and Oil Leases, (Greenwich, Connecticut: JAI

Press, 1980).

Robinson, C., and Morgan, J., North Sea Oil in the Future: Economic Analysis and

Government Policy, (London, England: Billing & Sons, 1978).

Rocky Mountain Mineral Law Foundation (The), Law of Federal Oil and Gas Leases,

(Denver, Colorado: Lexis Publishing, 2000)

Shell International Petroleum Company, The Petroleum Handbook, (Amsterdam, The

Netherlands: Elsevier Science Publishers, 1983).

Sinding, K., Auctions and Discretion in Oil and Natural Gas Licensing, (Dundee,

Scotland, Centre for Energy, Petroleum and Mineral Law and Policy, 1999).

United Nations, Petroleum Exploration Strategies in Developing Countries, (London,

England: Graham & Trotman Limited, 1982).

2.2 Graduate Thesis

Jok, J. L., The Concession and The Licence as Oil Production Titles, (Dundee, Scotland:

Centre for Petroleum and Mineral Law and Policy, 1982).

Khan, R. U., The Introduction and Analysis of Petroleum Licensing Regime of Pakistan,

(Dundee, Scotland, Centre for Petroleum and Mineral Law and Policy, 1991).

Lynch, J. C., Ministerial Discretion in the United Kingdom Licensing Regime, (Dundee,

Scotland, Centre for Petroleum and Mineral Law Studies, 1979).

Steel, J. D., Government Use of Petroleum Licensing to Promote Local Goods Services

and labour: A UK Perspective, (Dundee, Scotland, Centre for Petroleum and Mineral

Law Studies, 1983).

2.4 Internet Sources

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Tata Energy Research Institute, New Exploration Licensing Policy: Will it strike oil?,

July 1999, http://www.teriin.org/energy/nelp.htm, (Last Visited on December 18, 2000).

2.5 Conferences

Armstrong, J., UK Petroleum Licensing, Presented in the Course UK Oil and Gas Law,

(Dundee, Scotland, Centre for Petroleum and Mineral Law and Policy, September 1995).

2.6 Unpublished Material

Bunter, M. A., The Promotion and Licensing of Petroleum Prospective Acreage, (Conwy,

United Kingdom: B and R Co. Ltd.).