Influence of Offshore Leasing Regimes on Commercial Oil Activity: An Empirical Analysis of Property Rights in the Gulf of Mexico and the North Sea, The

Georgetown International Environmental Law Review, Fall 2004 by Richardson, Christopher F

I. INTRODUCTION

This note investigates the extent to which the regulatory frameworks governing property rights, and the transaction costs these frameworks produce, impact natural resource development on government land. This note examines the legal regimes for offshore petroleum exploration and production as conducted by the governments of the United States and the United Kingdom to determine how the resource management policies of these two countries affect commercial oil activity in their respective national waters, focusing specifically on continental shelf leasing in the Gulf of Mexico and offshore licensing in the North Sea. ' Both the United States and the United Kingdom obtain a significant amount of their domestic oil production from these offshore areas,2 but they have chosen to pursue substantively and procedurally dissimilar lease arrangements. Most important, leases in the Gulf are much smaller than North Sea license blocks.3 This note analyzes the primary differences between the two systems, and the incongruities and inefficiencies they produce, by examining several variables to determine the extent to which the legal regimes manipulate natural resource development. Scholars of the subject point out that a closer study of these distinctions and their influence will have "important implications for leasing policy, especially for the [Outer Continental Shelf], because changes in the block sizes will affect the probability that there will be competitive exploitation,"4 but heretofore it does not seem the topic has been addressed in legal literature.5 The regime in the Gulf of Mexico, as compared with the regime in the North Sea, should engender economic inefficiencies that will result in both (a) higher costs for companies through redundant capital investment in production facilities and excessive administrative compliance costs, and (b) faster depletion of oil reservoirs because of competitive extractive behavior. These two factors remain distinct and are examined separately in this note, but both factors should reflect the inefficiencies created by higher transaction costs in the U.S. system. This note empirically examines these factors and predicts that the regime governing leasing in the Gulf of Mexico will create economic inefficiencies and thus U.S. policy should be reformed to resemble more closely the offshore legal regime of the United Kingdom.

At the outset, it may be helpful to employ some simple visual examples of what the regimes look like in operation.6 The following figures roughly illustrate how in the Gulf of Mexico oil fields can easily lie beneath a number of leases, each with potentially a different owner, whereas in the North Sea it is much less likely that an oil field will lie beneath more than one license block or be controlled by more than one owner.7 The figures demonstrate how problems of competitive ownership can arise when the existing leasing frameworks are overlaid onto geologically identical offshore oil fields. Notice how the large oil reservoir, Field A, lies under a large number of leases in the Gulf, with possibly a different owner for each lease, while in the North Sea the field is only split between two blocks.8 Field B faces a similar problem in the U.S. system, but not in the U.K. system where it lies wholly within a single block. The two smallest fields in the example, C and D, are completely controlled by a single license holder in the British system, but two leases control C under the American regime and only Field D lies in the hands of a single owner.

This basic configuration should allow the reader to more clearly understand the arguments and descriptions in this note.

This note is separated into five parts. Part II of this note will give a description of the two regimes. The most important differences between the U.S. and U.K. systems involve the size of the blocks leased or licensed, the level of the government's control over plans for the development of those resources, and the nature and mechanics of the leasing or licensing process. The American government auctions off small grid blocks of the Gulf of Mexico continental shelf defined by geographically uniform latitudinal and longitudinal lines that measure only about 5000 acres. The British government, in contrast, grants discretionary licenses to develop large areas of seabed of several hundred square kilometers, which is more than ten times larger than the typical leases in the Gulf,9 and these leases can be tailored when needed to match oil field contours. In Britain, offshore oil development is more centralized and oriented towards maximizing the utilization of the resources, whereas the United States pursues more of a more free market system that leaves the private sector free to manage resources and encourages individual risk- taking by "wildcatters." This note attempts to analyze the effects of these different regimes on commercial oil activity.

Part III of this note presents the analytical framework and theoretical background of how the predictions will be tested. It begins with the Coase theorem, which posits that in a perfect system the legal regimes governing property are of no consequence because private parties will simply contract around them to reach the optimal outcome; but, as Coase admitted, we do not operate in a perfect world, and transaction costs will often prevent optimum efficiency through private action. Thus, legal frameworks do indeed matter. Transaction costs in the Gulf regime, it is predicted, will influence the efficiency of commercial oil activity. This section also includes a brief introduction to the special nature of property rights in oil and some solutions to the challenges of competition among oil producers, namely unitization to prevent unnecessary overinvestment and a race to capture the resource.