« Back to Results
Pennsylvania Convention Center, 203-A
Hosted By:
Industrial Organization Society
Using detailed data on lease contracts and the timing of drilling, we first show empirically that primary term expiration dates have an economically significant impact on firms’ drilling decisions: a large share of wells are drilled just prior to expiration. This systematic pattern is difficult to fully explain by other factors such as information or common pool externalities. We then develop a model to explain why primary terms and royalties can help maximize the landowner’s expected revenue from a lease, despite the distortions they generate. Intuitively, the optimal contract strikes a balance between extracting the firm's private information and distorting its incentive to exert effort. To achieve this balance, payments are tied to observable production outcomes and drilling timing decisions. Finally, we use a structural model of firms’ drilling decisions to quantify the impacts of these contractual provisions and evaluate alternative lease designs.
Empirical Studies of Contracting: The Case of United States Oil and Gas Leases
Paper Session
Friday, Jan. 5, 2018 12:30 PM - 2:15 PM
- Chair: Kenneth Hendricks, University of Wisconsin-Madison
Information Asymmetry and Second-best Contracts in the Oil and Gas Industry
Abstract
During the last decade, the “fracking boom” has substantially increased U.S. oil and natural gas production. These resources are often owned by private landowners, who sign lease contracts with firms to extract the oil and gas. This paper estimates the impacts and explains the presence of two pervasive features of these contracts: the royalty and the primary term. The royalty is a percentage of hydrocarbon revenue that is paid to the landowner, driving a wedge between the landowner’s and firm’s incentives. The primary term is the period granted to the firm to exercise its option to drill a well on the lease. If the firm does not begin production by the end of the primary term, it loses the lease, and the landowner is then free to sign a new contract with another firm. If, however, the firm does commence production, the lease enters a “secondary term”, which lasts until the firm ceases operations.Using detailed data on lease contracts and the timing of drilling, we first show empirically that primary term expiration dates have an economically significant impact on firms’ drilling decisions: a large share of wells are drilled just prior to expiration. This systematic pattern is difficult to fully explain by other factors such as information or common pool externalities. We then develop a model to explain why primary terms and royalties can help maximize the landowner’s expected revenue from a lease, despite the distortions they generate. Intuitively, the optimal contract strikes a balance between extracting the firm's private information and distorting its incentive to exert effort. To achieve this balance, payments are tied to observable production outcomes and drilling timing decisions. Finally, we use a structural model of firms’ drilling decisions to quantify the impacts of these contractual provisions and evaluate alternative lease designs.
Royalties, Investment, and Land Quality
Abstract
In the natural resource industry, the value of land can vary across space due to differences in underlying geology, and over time through changes in natural resource prices and emergence of new extraction technologies. One way to compensate landowners when land is more valuable is to raise the royalty rate, the fixed percentage of output paid by developers to landowners in the typical contract form in the industry. However, a tension here is that a higher royalty is analogous to a higher tax rate, and can potentially distort the incentives of a developer to invest. In this paper, we develop a simple theory of royalty rates that accounts for both investment incentives and variations in land quality. We apply the theory in a quantitative analysis of the shale oil fields of North Dakota. Our research highlights the importance of the intensive margin of investment, i.e. the quantity of investment per unit land, as opposed to the extensive margin about whether to drill at all. In our application, landowners with better land to a remarkable degree enjoyed higher payment through greater intensive margin investment. Investment incentives at the extensive margin are highly dependent on the curvature of the production function and we use detailed well-level investment and output data to obtain estimates of production parameters. We use additional data from auctions of public land, where royalty rates are fixed, to infer the distribution of land quality. With production and land quality estimates in hand, we use the model to provide a quantitative analysis of royalty rates on contracts in the private sector.One-to-Many Matching with Complementary Preferences: An Empirical Study of Market Power in Natural Gas Leasing
Abstract
In a two-sided market with private, multidimensional contracting, what are the costs and benefits of market concentration? I study this question in the context of firms negotiating leases for natural gas mineral rights with landowners. Firms benefit from signing geographically proximate contracts, leading to economies of density. Firms facing fewer competitors offer less desirable contracting terms to their negotiation partners. Using newly-collected data describing the location and contents of private contracts, I model firms negotiating with landowners as a one-to-many, non-transferable utility match. I extend this matching framework to allow estimating a model with complementary preferences among firms valuing sets of geographically proximate leases. The model estimates imply there are substantial benefits to market concentration that come at a cost to landowners through fewer landowner concessions. Policy simulations requiring an additional concession reveal that the gains to landowners outweigh the costs to firms, increasing average welfare by 8%.Discussant(s)
Matt Gentry
,
London School of Economics
Kenneth Hendricks
,
University of Wisconsin-Madison
Daniel A. Ackerberg
,
University of Texas-Austin
Kosuke Uetake
,
Yale University
JEL Classifications
- L1 - Market Structure, Firm Strategy, and Market Performance
- L7 - Industry Studies: Primary Products and Construction