Zaid Mahayni - The Discretionary vs The Auction Licence Allocation Methods - CEPMLP 2000-2001

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

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
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
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
35
36
37
38

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
44
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

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).

22
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

23
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.).

Zaid Mahayni - The Discretionary vs The Auction Licence Allocation Methods - CEPMLP 2000-2001

Recommended

Recommended

More Related Content

Similar to Zaid Mahayni - The Discretionary vs The Auction Licence Allocation Methods - CEPMLP 2000-2001

Similar to Zaid Mahayni - The Discretionary vs The Auction Licence Allocation Methods - CEPMLP 2000-2001 (20)

Recently uploaded

Recently uploaded (20)

Zaid Mahayni - The Discretionary vs The Auction Licence Allocation Methods - CEPMLP 2000-2001