The United States federal government has been selling offshore gas and oil exploration rights to the private sector since 1954. The sales in the form of auctions are handled by the Department of the Interior, which announces and specifies the tracts for sale. A tract is defined as either a block or half a block, where a block is usually either 5,000 or 5,760 acres of land.
There are three kinds of oil and gas lease sales: wildcat sales, developmental sales, and drainage sales. A wildcat sale refers to the tracts whose geological and seismic characteristics are not well known. A developmental sale covers the tracts which were previously sold but are being reoffered by the government, either because the winning bid was rejected by the government or because the lease was relinquished. A drainage sale is the sale of tracts in which oil or gas deposits have been found. Apparently, the tracts in the drainage sales are more valuable than those in the developmental sales (Porter, 1995).
Firms who are willing to participate in wildcat sales are allowed to carry out a seismic investigation before the sale date. The investigation is often performed by a geophysical company which is hired to “shoot” a seismic survey of a large area, normally around 50 blocks. The cost, approximately $12 million, may be shared by several oil companies or financed by a geophysical company in anticipation of selling the report in the future (Hendricks, Porter and Tan, 2003). Each firm evaluates the tracts using the seismic report.
In a given sale, all of the announced tracts are sold simultaneously by first-price sealed-bid auctions. There may be a reservation price of $15 or $25 per acre for wildcat tracts and $25 for drainage tracts (Porter, 1995). The reservation price is the same across all tracts within a sale but may be different across sales. A bid is the amount of dollars a firm is willing to pay for the exploration right. Firms have not been allowed to submit bids jointly since 1975 (Hendricks, Porter, and Pinkse, 2003). At the sale date, the Department of the Interior announces the values of all submitted bids and the identities of the firms. A tract is awarded to the bidder who offered the highest bid. Resale of the exploration rights is allowed, although very little reselling occurs other than through mergers or acquisitions.
The government can, and sometimes does, reject the winning bid as insufficient. The government’s decision depends on its estimate of the value of the tract, as well as the bids submitted. Rejections usually occur on marginal tracts that have only one bidder. The rejection rate is about 8% on wildcat tracts. Tracts in which the highest bids are rejected may be reoffered at future sales.
The winner usually has to start the exploration of the tract within five years. If no exploration is done within that period, the tract is relinquished and the lease reverts to the government for future reoffering. The owner of the lease has to pay a nominal rental fee till the production begins, normally $3 per acre per year for wildcat tracts and $10 per acre per year for drainage tracts (Porter, 1995). A fixed portion of the revenue is claimed by the government as royalty payment.
The OCS data set contains information on the auctions of the oil and gas tracts off Texas and Louisiana. The file records lease characteristics, bidding, drilling, production, and cost information of 3036 oil and gas auctions from 1954 to 1979.
Hendricks, K. and R. Porter (1992), “Joint Bidding in Federal OCS Auctions,” American Economic Review, 82, 506-511.
Hendricks, K., R. Porter, and G. Tan (2003), “Bidding Ring and Winner’s Curse: The Case of Federal Offshore Oil and Gas Lease Auctions,” NBER working paper 9836.
Hendricks, K., J. Pinkse, and R. Porter (2003), “Empirical Implications of Equilibrium Bidding in First-Price, Symmetric, Common Value Auctions,” Review of Economic Studies, 70, 115-145.
Porter, R. (1995), “The Role of Information in U.S. Offshore Oil and Gas Lease Auctions,” Econometrica, 63, 1-27.