Introduction
Except, perhaps for the case of my similarly long series of columns dealing with the Buxton Proposal on direct cash transfers to the poor, I have never received so many requests to re-cap a series in order to aid comprehension of the many new concepts introduced in my presentation on an individual topic, as in the case of my discussion of the treatment of the planned public auctions of oil and gas rights. For those persons with a direct interest in the topic, whether financial or skills-improvement based, I hasten to remind them that these columns are not designed to circumvent professional guidance and advice.
The public auction series began weeks ago on June 11. And in several consecutive Sunday columns I have addressed several auction issues ranging from the Stabroek Production Sharing Agreement, PSA, in place, the estimated Government Take ratio up to seeking to learn lessons from a review of public auctions theory and practice. However, this re-cap will focus on addressing four broad issues, in the sequence they are presented here. These items are namely, 1] basic auction theory and formats 2] taking stock of Guyana’s prevailing Government Take ratio, estimated recoverable resources of oil and gas; and the opportunity time-window for oil and gas exports under the ruling PSA; 3] the fiscal metrics of the PSA intended for use at the proposed public auctions; and 4] empirical review and theoretical synthesizing of public oil blocks auctions in emerging petroleum states.
Basic Auction Theory
Auctions in Competitive Markets
Starting from their simplest notion, I had indicated to readers that Investopedia describes auctions as basically ‘sales events wherein potential buyers place competitive bids on assets in an open or closed format. The key takeaways highlighted are:
Buyers compete by placing bids.
Auctions can be both live and online.
Closed auction bidders are not aware of competing bids.
Open auctions are aware of other bids.
Auctions are widely used.
There are both advantages and disadvantages of auctions as competitive market instruments.
Pros of Auctions
Seller controls process
Find rare items
Buy at a discount
Seller can maximize bargaining power
Cons of Auctions
Competitive process can deter some buyers
Cost of running an auction is significant
Competitive bidding process can drive up price
Of note, there are activities which are considered illegal; for example, 1] ring bidding [that is bidding on one’s own object to increase competition]; chandelier bidding [that is raising false bids to create the appearance of greater demand]. 2[collusion, [that is a small group of bidders banding together to manipulate the auction].
Oil Block Rights Auctions
The literature identifies four broad types of auctions, where these are utilized as a means for maximizing revenues. First, there is the English or ascending auction. Here buyers make progressively higher bids, and drop out when the bid rises past the value they attach to the object on sale. This continues until only one bidder remains. That bidder then pays the price at which the second highest bidder dropped out.
Second, there is the Dutch or descending auction. Here the auctioneer calls out a very high price, which is then progressively lowered. The first bidder to accept a particular price wins the auction at that price.
Third, there is the first-price sealed bid auction. This is similar to the Dutch auction where buyers submit sealed bids. On opening the bids, the highest wins at the price suggested.
Fourth, the second-price sealed bid similar to the English auction, where sealed bids are submitted, but the highest bidder pays the price proposed by the second-highest bidder.
In practice, combinations and variations of the different auction types prevail. These include online auctions, the use of rounds, and the setting of reserve prices, time limits per round or bid which are progressively raised.
Oil Rights Auctions Merits and De-merits
In regard to oil block rights there is a widespread presumption that the available evidence, based on global practice, reveals auctions are by no means uniformly fool-proof, thereby guaranteeing a fair exchange. Always the design of the auction matters; and, a poorly designed one often leads to bad and even perverse outcomes. This is the reason why 1] bidders have to satisfy technical standards to qualify; and 2] the discretionary power of the assessing authority or procurement committee is a sine qua non. This power can be used to exclude certain players or promote some at the expense of others, even unintentionally.
Furthermore, analysts acknowledge there is “always the possibility of rigging through collusion, unless rules have been very carefully devised”.
One of the most infamous examples cited in the literature is the 1994 telecom spectrum licence auction in New Zealand, where the government made the mistake of not fixing a reserve price. While the winning bid was for NZ$ 7 million ($4.9 million at current rates), the second highest was a mere NZ$ 5,000. Since this was a second-price sealed bid auction, the winner got the spectrum at the drastically lower price offered by the second highest bidder, suggesting collusion between the two.
Winners Curse
I had referenced the phenomenon of the ‘winner’s curse’. That is where a participant bids aggressively and finds the asset is not worth the bid; due to, post-auction collapse in oil prices.
Conclusion
Next week I move on to the second topic in this re-cap effort. That is, taking stock of the current state of play in regard to Government Take; estimated recoverable petroleum resources; and, the opportunity time window for crude oil exportation from Guyana.
