Sliding Scale Royalty And Offshore Lease Sale Bidding
Authors: Patterson William E. 
Published: December 2007

This study investigated the effects of a linear sliding scale royalty and a logarithmic sliding scale royalty on hypothetical bids for offshore leases. Both of these systems were used by the U.S. Department of Interior for OCS lease sales in 1978. Results of the study indicated that the logarithmic scale system was the better of the two from the point of view of fostering competition and encouraging the development of marginal prospects. It was concluded that, in some prospects. It was concluded that, in some situations, the linear scale system might actually discourage bidding and reduce competition.

Introduction

The year 1978 brought to a close an era of a relatively simple and efficient bidding system for offshore lease sales in the U.S. Under the provisions of the Outer Continental Shelf Lands Act of 1953, OCS leases could be awarded according to either of two methods: a bonus bid subject to a fixed royalty, or a royalty bid subject to a fixed bonus. In practice, bonus bidding with a constant royalty (usually 16.67 percent) was the only method utilized by the Department of Interior for all but 38 of roughly 3,000 leases awarded through the end of 1977. This period provided a rich source of data for various provided a rich source of data for various statistical analyses of bid distributions, such as those reported by Dougherty and Lohrenz.

Concurrent with the oil crisis and inception of national energy planning efforts in 1973 and 1974, various individuals in the government and academic world began advocating new systems of lease sale bidding. Three motivations were apparently perceived or imagined by people outside the industry for recommending a change:opinions were voiced that the Government was being deprived of revenues from mineral resources because of risk aversion in the private sector;the petroleum industry appeared to be heading toward a shortage of capital for expanding production; anda notion that the industry was production; anda notion that the industry was monopolistic and uncompetitive was politically appealing.

Insofar as risk-taking and competitive aspects were concerned, the proponents of new OCS legislation seemed to rely more on textbook theory them on factual information. The continuing plea of the industry has been for more (not fewer) sales of leases in the frontier exploration areas. Detailed studies of actual results in the offshore, such as by Mead, et al, indicated that the high degree of competition among bidders had resulted in profit rates below those earned in manufacturing generally.

After more than three years of deliberations, Congress approved an extensive list of amendments to the OCS Lands Act which were signed into law on September 18, 1978. Section 8 of the Act now requires that at least 20 percent (and not more than 60 percent) of the total area offered for leasing each year to be on the basis of bidding systems other than the conventional cash bonus with fixed royalty. The following alternative methods are mentioned:royalty bid with a fixed work commitment or bonus,bonus or work commitment bid with a sliding royalty,bonus bid with a fixed share of net profits,net profit share bid with a fixed profits,net profit share bid with a fixed bonus,bonus bid with a fixed royalty and net profit share, andwork commitment bid with a fixed royalty and bonus.

In addition, the Secretary of the Interior cam use any other bidding system determined to be useful unless either the Senate or the House of Representatives passes a resolution of disapproval. The Secretary may defer payment of a cash bonus according to an installment schedule announced before a sale. In order to obtain statistical information, bidders may be required to submit bids in accordance with more than one bidding system for up to 10 percent of the tracts offered each year.