U.S. Offshore Oil and Gas Lease Royalty Bidding

Abstract

U.S. offshore oil and gas lease royalty bids were analyzed. Bids appear to be normally distributed. Using a simple investment model, the trade-off between bonus and royalty bids for an investor was examined. Higher royalties can result in lost recovery when (1) marginal deposits are not developed and (2) productive leases are shut in earlier. Introduction U.S. offshore oil and gas leases were issued exclusively as a result of bonus bids from 1954 to 1974. Since then, leases have been offered and issued to royalty bidders in two sales, although bonus bidding has remained the predominant system. With the emergence of royalty bidding, we undertook to examine the character of the royalty bids that have been submitted and to assess the impact of royalty bidding on subsequent production. In this study, we examined the statistical distribution of royalty bids. Government presale estimates of royalty bid leases were compared with royalty bids received; the results of this comparison are contrasted to the corresponding finding with bonus bids. We used a simple investment model to predict the trade-off between royalty and bonus that predict the trade-off between royalty and bonus that a bidder would bid. Finally, we examined how royalty affects recovery in two ways:decisions not to initiate production anddecisions to cease production that would continue if the royalty were production that would continue if the royalty were lower. Statistical Analyses of Royalty Bids The two sales in which leases were offered by royalty bidding were held Oct. 15, 1974, in Louisiana and Oct. 27, 1977, in Alaska. Of the 10 such leases offered in the Louisiana sale, eight received a total of 57 bids and all were issued. Through 1979, six of the eight leases were relinquished. Of the two leases still active, one had production starting in 1979. In the Alaska sale, 46 leases were offered to royalty bids. Of these, 30 received a total of 98 bids, and all leases receiving bids were issued. Through 1979, none of these Alaska royally bid leases were relinquished or had any production. Detailed data about these leases, the bids, and bidders are available. Fig. 1 is a plot shown on normal probability graph paper of the bids received for lease OCS No. G2905 paper of the bids received for lease OCS No. G2905 (Oct. 15, 1974, Louisiana sale). Thirteen bids were received for this lease, the largest number of bids for any of the royalty bid leases. The linearity of the plotted points in Fig. 1 is typical and suggested the plotted points in Fig. 1 is typical and suggested the hypothesis that royalty bids for leases may be normally distributed. Analogously, bonus bids have been treated as log-normally distributed. Taking the royalty bids as normally distributed, the pooled standard deviation of the bids on the 32 leases with two or more bids in both sales was 13%. Detailed statistical results have been given elsewhere. That result provides a crude but pragmatic measure of the disagreement between bidders' royalty bids.