For the last decade and a half, U.S. oil and gas companies have relentlessly improved the efficiency of the wells they drill. They’ve applied hydraulic fracturing technologies in newly-discovered shale formations, are continuously learning how to use these technologies better, and many of the biggest producers invest hundreds of millions of dollars into research and development every year. However, firms with the best technology can only get value out of it if they have mineral resources to deploy it on. Unfortunately, the market for mineral leases, contracts between land owners and oil and gas companies, is surprisingly inefficient. Why? The vast majority of mineral leases transact in informal and decentralized negotiations, instead of centralized auctions.

Most undeveloped mineral resources in the United States lie underneath privately-owned land. To develop an area, oil and gas companies must first figure out who owns mineral rights, and then bargain over the terms of mineral lease contracts with thousands of individual landowners.  With such dispersed land ownership, and no central body organizing these negotiations, the situation truly resembles the “wild west,” with dozens of oil and gas companies racing to sign landowners by any means possible. Some of the biggest oil and gas companies in the world, like Exxon and Chevron, compete against much smaller companies, some of which may be much less productive. In this environment, it’s quite possible, perhaps even likely, that the best users of a given parcel are not successful in signing a lease on it. Thus, even though the market for mineral leases is certainly “free,” in the freedom sense, its lack of organization may hinder its efficient development.

Decades of economic theory suggest an alternative approach to matching oil and gas companies to mineral leases: auctions. By design, an auction awards a mineral lease to the company whose valuation for it (i.e., its ability to produce from it) is highest. Because auction participants compete against each other, they also may steer more economic benefits to landowners than informal negotiations do. However, while there is no administrative data on how mineral leases transact (auction vs. informal negotiation), survey evidence suggests that auctions are rare in private mineral lease transactions. In contrast, leases for minerals in public lands nearly always transact in transparent, centralized auctions. State and federal government organizations publicly announce which parcels are available for lease, solicit bids from all interested companies, and award leases to the high bidders.

My colleague Richard Sweeney and I decided to see if auctions actually perform better than negotiations in real-world data, comparing thousands of auctioned and negotiated leases that were signed in Texas between 2005 and 2016. Our analysis found that not only do landowners gain millions of dollars more when leases are negotiated through auctions, but these auctioned leases actually produce more. That means the oil and gas industry is missing out on substantial revenues when they lease by negotiation instead of by auction.

Continue reading at Forbes…

Areas of Focus: Energy Markets
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Energy Markets
Well-functioning markets are essential for providing access to reliable, affordable energy. EPIC research is uncovering the policies, prices and information needed to help energy markets work efficiently.
Fossil Fuels
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Fossil Fuels
Under current policies, fossil fuels will play an important role in the energy system for the foreseeable future. EPIC research is exploring the costs and benefits of these fuels as...