Bidding system is one specialised kind of systems, which goverments use to allocate petroleum E&P rights. This system can be described as pure market-based systems where licenses and contracts are awarded to the highest bidder. Bidding parameters can be single or multiple. Usually these include bonus payments, and/or royalties, and/or various forms of profit sharing.
There are four basic forms of auctions:
– Ascending bid (English auction). The price is raised until only one bidder remains. Prices may be announced by an auctioneer, or may be called by the bidders, or may be posted electronically. With this type of auction, each bidder knows the level of the current best bid at any point in time and can adjust its bidding strategy accordingly.
– Descending bid (Dutch auction). As opposed to the English auction, the price is lowered from an initial high called by the auctioneer until one bidder accepts the current price.
– First-price sealed bid. Bidders submit sealed bids and the highest bidder is awarded the item for the price he bid. Each bidder has only one chance to submit its bid and cannot observe the behavior of other bidders until the auction is closed and results are announced.
– Second-price sealed bid (Vickrey auction). Bidders submit sealed bids and the highest bidder wins the item but pays a price equal to the second-highest bid (Vickrey, 1961).
In practice, many variations of the basic forms exist. Direct negotiation is a reversed form of the bidding system. In negotiated procedures the government may or may not invite investors to submit offers within a specified deadline. Each category has advantages and disadvantages in terms of transparency and economic efficiency.
While using the direct negotiation, it is important to remember that the criteria for award are often not pre-defined and known to market participants. Also the goverment retains considerable discretionary power and flexibility in awarding E&P rights. Direct negotiation system is likely less competitive than bidding systems and are generally considered less transparent and more vulnerable to corruption. This system can, however, be made more transparent through the definition of clear award criteria, the publication of negotiation results, and the use of external oversight bodies. Auctions are generally considered more efficient than direct negotiations in allocating E&P rights, but their relative efficiency depends on the context and the design parametres.However, some of the assumptions that are required to make auctions efficient may not be realistic in the context of oil and gas exploration. Because uncertainty is a very important part of petroleum exploration, there is always a probability that he level of over- estimation of the bidder will be higher than the true value of the deal. (446)
Adopting the system of awarding the E&P rights is a very important step for the country, because the objective in designing the award process is to nd the best candidate, maximize potential revenues resulting from the award, and avoid any distortion of incentives to perform.Also governments must rely on oil companies to effectively and efficiently exploit their natural resources but whether they choose to invest directly or allow private investors to do so, their primary concern should be the maximization of social benefits from the exploitation of their resources. In addition, governments face a complex set of changing constraints and exogenous factors. The relative priorities among objectives and the interaction among the various constraints and exogenous factors influence the optimal design of allocation systems. Optimal design depends on a range of factors and requires the definition of the objectives that policy makers aim to achieve through the allocation of petroleum E&P rights.
In the present case adoption of the lycensing system seems reasonable in many aspects. First of all, this system allows to avoid the frequently used principle of the open-doors system “first came-first served” and provides higher level of transparency of the criteria. In open-door systems, the criteria for award are often not predefined and known to market participants.
Returning to the case of Petroleum Islands, it would be wise to adopt licensing system, where licenses would be awarded to investors by way of administrative processes on the basis of criteria defined by the government. The government has ample latitude to define whatever criteria it deems appropriate. Thus, administrative processes can be very flexible and allow the government to pursue multiple policy objectives.
An example of this type of arrangement can be found in the United Kingdom, where licenses are awarded on the basis of work programs (typically seismic and exploration drilling) proposed by the bidders. This allows the government to retain some control over the level of exploration investment in the industry, but it does require a certain level of technical capacity and resources to evaluate the proposals.
While investigating the licensing system from all the angles, it is important to mention its disadvantages. First of all, auctions are generally more transparent than administrative procedures of licensing. The transparency of the procedure and awarding criteria would make it more difficult for the government to unfairly favor one investor or consortium over others. In addition, a certain level of discretion over the award of future licenses may be a powerful way for a government to influence the behavior of existing investors. Administrative procedures have the advantage of flexibility but, they are more demanding on a government’s resources, and, in general, more vulnerable to potential corrupt practices and to political or lobbying pressures.
However, while the country gives its priorities to the opportunity of to make speedy decisions and to select companies, which are best suited to the country’s particular needs, the licensing system based on the administrative procedures seems to be the most appropriate. (973)
(a) What are the differences between the ‘modern concession contract’ and the ‘production sharing contract’ regimes? What are the distinctive features of each of these regimes and what are the features that they both share? (35)
A concession grants an exclusive license to a qualified investor. The original concession granted rights to petroleum development over a vast area; had a relatively long duration; granted extensive control over the schedule and manner in which petroleum reserves were developed to the investor; and reserved few rights for the sovereign, except the right to receive a payment based on production. The provisions of modern concession agreements are much different from the original model. In addition to reducing the area coverage and the duration of the agreement, modern concessions also contain relinquishment clauses and express obligations to enter into a work program.
One of the main characteristics of concessions is that the state retains considerable liberty to modify, at any time, those terms and conditions that are not negotiated but fixed by legislation. In practice, because a stable investment environment is important to encourage or maintain investments by private companies, states are motivated not to abuse this prerogative.
A contract-based regime envisages an agreement concluded between one or more (usually foreign) oil companies (contractors) and a state party. The state party may be the state itself—represented by its government—or a state authority (such as a government ministry or a special department or agency) or the national oil company. The national oil company may be granted general authority to engage in petroleum operations or the sole right to receive an exclusive license, and the authority to engage the assistance of oil companies.
Like a concession, a PSC grants an oil company or consortium (the ―contractor‖) the right to explore for and produce hydrocarbons within a specified area and for a limited time period. The contractor assumes all exploration risks and costs in exchange for a share of petroleum produced from the contract area. Production is shared among the parties according to formulas defined in the relevant PSC and applicable legislation.
Unlike a concession, a PSC provides the investor with the ownership of its share of production only at the delivery point or export point (as defined in the contract). Changes in the oil and gas price result in adjustments to the investor’s share of reserves and production entitlement. Title to and ownership of equipment and installation permanently affixed to the ground and/or destined for exploration—and production of hydrocarbons—generally passes to the state, usually upon commissioning.27 Furthermore, unless specific provisions have been included in the contract (or in the relevant legislation), the government (or the national oil company) is typically legally responsible for abandonment.
Investors typically prefer regimes that impose less up-front burden and are more pro t-linked, in other words ‘progressive’. Instruments such as a royalty, bonus, carried state participation,20 and low cost recovery ceiling, tend to lengthen payback and make the regime more regressive—as overall profitability goes up the government’s share of profits goes down and vice versa. However, the latter instruments allow the government to generate revenues as soon as production starts, unlike pro t-related taxes. In order to maintain the balance between host governments and investors interests, a combination of several instruments is often used and forms a country’s petroleum fiscal regime.