Allocation of E&P Rights

113 Pages·2009·1.3 MB·English

C ’
OUNTRIES EXPERIENCE WITH THE ALLOCATION
OF PETROLEUM EXPLORATION AND PRODUCTION
:
RIGHTS STRATEGIES AND DESIGN ISSUES

World Bank Working Paper- Draft

Silvana Tordo
with the collaboration of
David Johnston and Daniel Johnston

June 2009

World Bank Working Paper- Draft.
This paper is a work-in-progress,
and this draft version has been published to inform the public debate on good practice in
the allocation of petroleum exploration, development and production rights. A revised
version of this paper will be published in October 2009. Additional examples or
references, where these will add to the strength of the paper, are welcome. For further
information on this paper please contact the author at [email protected] .
Abstract

Governments often pursue a variety of economic, social and political objectives through their
allocation policies that go beyond the maximization of the net present value of the economic rent.
There is little empirical documentation on the design and relative effectiveness of alternative
systems for the allocation of petroleum exploration, development, and production (E&P) rights
and their policy implications. This paper analyzes the available evidence on the advantages and
disadvantages of various practices used by petroleum producing countries to allocate petroleum
E&P rights, and draws conclusions about the design of E&P allocation systems. We find that the
optimal allocation policy depends on a range of country specific and exogenous factors. Bur
despite the variety of factors influencing optimal design, most countries use similar solutions. In
particular, when auctions or administrative procedures are used, most governments opt for simple
simultaneous multi-object sealed-bid rounds. While this may appear to be paradoxical, there is a
practical explanation. It is true that more complex bidding forms might increase rent capture at
bidding. However, the potential marginal gain is often limited, owing to most E&P projects’ high
level of uncertainty and risk. In addition market mechanisms, such as joint bidding and secondary
markets, and the fiscal regime are widely used in the petroleum sector to correct inefficiency at
the time of allocation. This paper aims to provide a framework for policy discussion while
leaving implementation issues for subsequent papers.
Copyright © 2009
The International Bank for Reconstruction and Development/The World Bank
1818 H Street, N.W.
Washington, D.C. 20433, U.S.A.

All rights reserved.

This paper is an informal document intended to improve the understanding of the factors
that affect the efficient and transparent allocation of petroleum exploration, development,
and production rights and their relative importance for policy makers. The manuscript of
this paper has not been prepared in accordance with the procedures appropriate to
formally edited texts. Some sources cited in this paper may be informal documents that
are not readily available.

The findings, interpretations, and conclusions expressed herein are those of the author(s)
and do not necessarily reflect the views of the International Bank for Reconstruction and
Development or the World Bank and its affiliated organizations, or those of the executive
directors of the World Bank or the governments they represent. The World Bank does not
guarantee the accuracy of the data included in this work.

This paper may not be resold, reprinted, or redistributed for compensation of any kind
without prior written permission from the World Bank. For free downloads of this paper
or to make inquiries, please contact:

Oil, Gas, and Mining Policy Division
The World Bank
2121 Pennsylvania Avenue, NW
Washington, DC, 20433
Telephone: [phone]
Fax: [phone]
E-mail: [email protected]
Web: http://www.worldbank.org/noc.
Table of Contents

Abbreviations and acronyms ______________________________________________ vi
Executive summary ____________________________________________________ viii
Conclusions _______________________________________________________________ xii
1. The exploration, development, and production of petroleum resources ________ 1
1.1 Uncertainty and risk: Key elements of petroleum exploration, development, and
production _________________________________________________________________ 1
1.2 The decision to explore for petroleum resources ___________________________ 3
1.2.1 Exploration and inter-temporal depletion policies ________________________________ 3
1.2.2 Exploration and inter-generational equity ______________________________________ 4
1.2.3 Exploration and the maximization of the resource rent _____________________________ 4
1.3 Who carries the risk of exploration? _____________________________________ 6
2 Alternative approaches to the granting of petroleum exploration, development,
and production rights ____________________________________________________ 8
2.1 Legal regimes for petroleum E&P _______________________________________ 8
2.1.1 Concessions ______________________________________________________________ 9
2.1.2 Production sharing contracts _______________________________________________ 10
2.1.3 Service agreements _______________________________________________________ 10
2.2 Fiscal regimes for petroleum E&P _____________________________________ 11
2.2.1 Taxation instruments and methods ___________________________________________ 11
2.2.2 Comparison of key fiscal elements of concessions, PSCs, and SAs ___________________ 13
2.3 The allocation of petroleum E&P rights _________________________________ 14
2.3.1 Open-door systems _______________________________________________________ 14
2.3.2 Licensing rounds _________________________________________________________ 15
2.3.3 Biddable or negotiable factors ______________________________________________ 18
2.3.4 Some countries’ experience _________________________________________________ 22
3 The design of appropriate allocation systems ____________________________ 29
3.1 Allocation system objectives ___________________________________________ 30
3.1.1 Consistency with petroleum sector policy ______________________________________ 31
3.1.2 Selecting the most efficient operator __________________________________________ 32
3.1.3 Keeping compliance and administrative costs down ______________________________ 34
3.1.4 Minimizing distortionary effects _____________________________________________ 35
3.1.5 Addressing market deficiencies ______________________________________________ 37
3.2 Key issues in allocation systems design __________________________________ 39
3.2.1 Open-door systems or licensing rounds? _______________________________________ 39
3.2.2 Auctions or administrative procedures? _______________________________________ 39
3.2.3 Which form of auction is more likely to lead to higher bids? _______________________ 40
3.2.4 Are planning and commitment important? _____________________________________ 41
3.2.5 What really matters for the design of licensing rounds? ___________________________ 44
3.2.6 What does this mean in practice? ____________________________________________ 47
4 Conclusions ______________________________________________________ 49
Appendix I – Life cycle of a typical oil and gas project ________________________ 51
Appendix II – Main fiscal instruments: Advantages and disadvantages __________ 52
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Appendix III – World average fiscal terms __________________________________ 54
Appendix IV – Select countries’ experience _________________________________ 55
Australia _________________________________________________________________ 55
United Kingdom ___________________________________________________________ 59
United States ______________________________________________________________ 64
Brazil ____________________________________________________________________ 70
Mexico ___________________________________________________________________ 77
Yemen ___________________________________________________________________ 83
Appendix V – Allocation systems design: Example ___________________________ 88
Glossary _____________________________________________________________ 89
References ___________________________________________________________ 93

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Tables

Table 1 – Objectives of fiscal systems_______________________________________ 11
Table 2 – Fiscal elements of petroleum agreements ____________________________ 13
Table 3 – Overview of allocation systems in select countries ____________________ 23
Table 4 – Alternative bid design ___________________________________________ 65
Table 5 – Overview of Brazil’s licensing rounds ______________________________ 74
Table 6 – Bidding rounds summary ________________________________________ 80
Table 7 – Biddable parameters ____________________________________________ 85

Boxes

Box 1 – Licensing policy as a means to promote local content ___________________ 33
Box 2 – Tax implications of the transfer of E&P rights _________________________ 33
Box 3 – Administrative complexity _________________________________________ 34
Box 4 – Examples of bidding parameters ____________________________________ 34
Box 5 – Minimum bidding requirements _____________________________________ 35
Box 6 – Excessive royalty rates ___________________________________________ 35
Box 7 – Over-sized work programs ________________________________________ 36
Box 8 – Fiscal incentives to cost saving _____________________________________ 36
Box 9 – Information and risk perception ____________________________________ 37
Box 10 – Joint bidding or a forced marriage? ________________________________ 38
Box 11 – Example of sequential auction _____________________________________ 41
Box 12 – Issues with the planning of licensing rounds __________________________ 42
Box 13 – Changing the rules of the game ____________________________________ 43
Box 14 – Reserve prices _________________________________________________ 46
Box 15 – Transparency mechanisms________________________________________ 46

Figures

Figure 1 – Allocation policy flow chart _____________________________________ 30

Acknowledgments
This paper presents the results of a study aimed to collect information on countries’ experience with
the allocation of petroleum exploration, development, and production rights. The paper was
undertaken and written by Silvana Tordo (lead energy economist—Oil, Gas, and Mining Division, the
World Bank). Input was provided by petroleum sector expert consultants David Johnston and Daniel
Johnston. The comments of peer reviewers Alan H. Gelb (director, Development Policy) and Robert
W. Bacon (consultant, Oil, Gas, and Mining Division), both with the World Bank; Clive Armstrong
(lead economist, Oil, Gas, Mining and Chemicals, International Financial Corporation); Charles P.
McPherson (senior adviser, Fiscal Affairs Department, International Monetary Fund); Willy Olsen
(consultant); and Kjell J. Sunnevåg (senior adviser, Norwegian Competition Authority) are gratefully
acknowledged. Comments were also provided by Robert M. Lesnick (adviser, Global Gas Flaring
Reduction Initiative, Oil, Gas, and Mining Division, the World Bank) The author wishes to
particularly thank Wayne W. Camard (senior economist, Africa Department, International Monetary
Fund) for his helpful comments and suggestions during the preparation of this paper. Special thanks
also go to Fayre Makeig and Stephen Spector for their editorial suggestions. Finally, the author owes a
debt to Professor Paul Kemperer, Oxford University, whose theoretical and practical work on auctions
provided inspiration for this paper.

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Abbreviations and acronyms

Technical terms:

CIT Corporate income tax
E&P Exploration, development, and production
EPC Engineering, procurement, and construction
ERR Effective royalty rate
FPWC Financed public works contract
GoM Gulf of Mexico
GTL Gas-to-liquid
JVs Joint ventures
LCV Local content vehicle
LNG Liquified natural gas
LPG Liquid petroleum gas
MOU Memorandum of understanding
NPV Net present value
OCS Outer Continental Shelf
PRRT Petroleum resource rent tax
PSA Petroleum-sharing agreement
PSC Petroleum-sharing contract
RJBL Restricted joint bidders list
R-factor Ratio-factor
RoR Rate of return
SA Service agreement
SLD Straight line decline
UKCS U.K. Continental Shelf
USGoM U.S. Gulf of Mexico

Government agencies and other entities:

AAPG American Association of Petroleum Geologists
ABARE Australian Bureau of Agricultural and Resource Economics
ANP Agencia Nacional do Petróleo (Brazil)
API American Petroleum Association
ARC Aden Refinery Company (Yemen)
BERR U.K. Department for Business, Enterprise & Regulatory Reform
CNPE Conselho Nacional de Política Energética (Mexico)
CRE Comisión Reguladora de Energía (Mexico)
compraNET Government Procurement Electronic System (Mexico)
DECC Department of Energy and Climate Change (U.K.)
DOI Department of the Interior (U.S.A.)
EIA Energy Information Administration (U.S.A.)
MMS Minerals Management Service (U.S.A.)
MoM Ministry of Oil and Minerals (Yemen)
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MRC Marib Refinery Company (Yemen)
PEMEX Petróleos Mexicanos (Mexico)
PEPA Petroleum Exploration and Production Agency (Yemen)
PETROBRAS Petróleo Brasileiro (Brazil)
SEC Security Exchange Commission (U.S.A.)
SECODAM Secretaría de Contraloría y Desarollo Administrativo (Mexico)
SENER Secretaría de Energía (Mexico)
SHCP Secretaría de Hacienda y Crédito Público (Mexico)
SPE Society of Petroleum Engineers
WPC World Petroleum Congress
YC Yemen Company
YGC Yemen Gas Company
YOC Yemen Oil Company
YOGC Yemen Oil and Gas Company
YPC Yemen Petroleum Company

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Executive summary
Petroleum has become an integral part of today’s global economy and a key
component of many national economies. Hence, the presence of petroleum in meaningful
quantities can have important economic, developmental, and strategic consequences for a
country. While a country’s petroleum resource base is a gift of nature, translating this
resource into saleable crude oil requires investment and effort. Whether governments
choose to invest directly or allow private investors to do so, their primary concern should
be to maximize the social benefits derived from the exploitation of the resource base. In
practice, however, defining what constitutes maximum social welfare is essentially a
political question, which helps explain the variety of objectives pursued by governments
over time.
In order to exploit their natural resources efficiently, many governments rely on
private oil companies. Governments have a challenging task in deciding which
companies should be awarded the exclusive rights to explore, develop, and produce their
resources, and on what conditions such rights should be awarded. There is little empirical
documentation on the design and relative effectiveness of alternative systems for the
allocation of petroleum exploration, development, and production (E&P) rights and their
policy implications. This paper analyzes the available evidence on the advantages and
disadvantages of various practices used by petroleum producing countries to allocate
petroleum E&P rights, and draws conclusions about the optimal design of E&P allocation
systems.
The first crucial set of decisions a government faces is whether or not to explore
for petroleum, at what pace to explore, and who should undertake such exploration. There
are several reasons why policy makers should promote oil and gas exploration:
 Exploration provides information on the existence, likely size, and
distribution of petroleum reserves, which can be used to guide the
definition of efficient inter-temporal depletion policies;
 Better knowledge of the size of petroleum reserves provides an input for
the design of sustainable macroeconomic policies and for improving inter-
generational equity through the choice of current consumption rates;
 Information about an area’s geological potential affects the perception of
geological risk and related market interest in—and competition for—E&P
rights in the specific area; and
 Improved knowledge of the geological potential of an area allows the
government to design appropriate strategies for the promotion and
licensing of petroleum E&P rights, including delineation of blocks to be
licensed, licensing procedures, and licensing terms that reflect the risk
profile of the specific areas.
Clearly, exploration generates valuable information for policy makers, investors, and the
public at large.
Who should undertake the risk of exploration, and in what measure, is another
important policy decision. Companies hedge against risk by investing in a diverse
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portfolio of projects—often in several countries—and by involving partners. Countries
rarely have the same ability to diversify their petroleum investments. Hence, often
governments hedge against exploration risk by transferring part of it to private oil
companies through contract and fiscal system design.
Indeed, the uncertainty and risk that characterize petroleum E&P activities pose
special challenges to the design of efficient allocation policies. At the time of allocating
exploration rights, neither the resource owner nor the investors know whether oil or gas
will be found, in what quantities, at what cost it will be produced, and at what price it will
be sold. Moreover, the resource is non-renewable, and a large portion of the total risk is
project specific. For these reasons, even if a hypothetical social welfare function could be
determined with precision, the uncertainty surrounding the existence and value of
petroleum resources makes their management a complex endeavor.
Risk is not, however, the only challenge that governments and investors must
face. Exploration and development activities require specialized, high-tech equipment
and skills that are often not available in the host country, and are, in any case, limited in
quantity. Capital investment is usually high and the largest investments occur several
years before production. As a consequence, governments and investors are much more
likely to observe higher levels of activity (and ultimately faster economic growth and
higher profits) if they can spread their investment over several projects through
partnering with other market participants. For governments, this strategy translates into
the need to design efficient policies for the allocation of petroleum E&P rights to
investors.
Countries allocate petroleum E&P rights in various ways; some use different
forms of public tenders or licensing rounds, others use direct negotiation, and most use a
combination of these systems. The conditions for award can vary substantially: some
countries adopt rather rigid systems with very limited biddable items that affect the
sharing of the rent between investors and owner of the resource; others award rights on
the basis of work programs; in others, ―everything is negotiable.‖ Poorly conceived legal,
regulatory, and fiscal frameworks may lead to inefficiency and loss of economic rent,
which may not be mitigated through the allocation system. The most common allocation
systems and biddable parameters include cash bonuses, work programs, royalties, and
profit shares. Bundle bidding—that is, linking access to petroleum resources with
downstream or infrastructure investments—is also used, particularly in developing
countries.
In this paper, allocation systems are grouped into two categories: (i) open-door
systems (E&P rights are allocated as a result of negotiation between the government and
interested investors through solicited or unsolicited expression of interest); and (ii)
licensing rounds. Two types of licensing rounds can be identified: (i) administrative
procedures, in which E&P rights are allocated through an administrative adjudication
process on the basis of a set of criteria defined by the government; and (ii) auctions, in
which rights go to the highest bidder. In open-door systems, the criteria for award are
often not pre-defined and known to market participants; the government retains
considerable discretionary power and flexibility in awarding E&P rights. Open-door
systems are likely less competitive than licensing rounds and are generally considered
less transparent and more vulnerable to corruption. Such systems can, however, be made
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