The Auction System and North Sea Gas: A Comment

Abstract

PROFESSOR Dam at the conclusion of his article on Pricing of North Sea Gas in Britain, argues that, had the grant of licenses to exploit gas and oil been determined by an auction system, in which licenses were awarded to the highest bidder, the allocation of resources would have been better than it was with the procedure actually followed, in which licenses were awarded as a result of an administrative decision of the Ministry of Power.1 It is not the purpose of this comment to suggest that Professor Dam's conclusion is wrong but rather to consider what the factors are that lead to this conclusion. The Gas Council, within the constraints which have been imposed on it, such as the ban on the use of natural gas for the generation of electricity, would appear to act as a perfectly discriminating monopolist, or, at any rate, comes very close to this.2 The misallocation of resources is not therefore likely to result from holding price above marginal cost for marginal units of consumption. The source of this misallocation is on the supply side. The fact that the rights to exploit oil and gas were awarded to the oil companies without charge has created a felt need to put the price paid for gas supplied by these companies below the market price, that is, the price that would emerge if production expanded to the point at which the marginal cost of supply was equal to the marginal demand price for that quantity of gas. The misallocation comes about because the oil companies at this lower price will not produce as much gas, through more intensive exploitation of existing fields or the discovery of new fields, as they would at the higher market price, even though consumers would be willing to pay for the additional quantity an amount greater than the costs that would be incurred in producing it. One feature of the institutional arrangements for the purchase and sale of North Sea gas in Britain is that it is in the interest of the Gas Council that the quantity of gas should be produced that would be produced at the