1 Project 2 Bidding on an Oil lease

2 Project 2- Description Bidding on an Oil lease Business Background Class Project

3 Business Background- Auctions A Mechanism that facilitates the transfer of goods and services Between buyers & sellers E.g.: United States Treasury auctions Treasury Bills every week The seller's objective - to get the highest possible price for the item being auctioned The buyer's objective – to get the lowest possible price for the item being auctioned An Auction has a variety of potential buyers with different information and/or perspectives about what is being sold

4 Business Background- Types of Auctions first-price sealed-bid auction (We will use this type in Project 2)  each bidder submits a sealed bid  the highest bidder gets the item  pays the highest bid second-price sealed-bid auction  each bidder submits a sealed bid  the highest bidder gets the item  pays the second highest bid

5 Business Background- Types of Auctions English (open outcry) auction  art and livestock  an auctioneer asks for a starting bid and encourages the bidders to raise their bids  The item goes to the bidder who made the last bid  sold at that bid price Dutch auction  a clock starts at a high price and ticks down  The item goes to the bidder who made the last bid, and is sold at that bid price  he or she gets the item at that price E-bay auctions

6 Project 2 – Main Goal Develop stable bidding strategy in a first-price sealed-bid auction Our final goal is to determine a stable bidding strategy, with the following property. If all 19 companies follow this plan, no company could expect to improve its situation by deviating from the given strategy. Strategies were discovered in 2001 Nash Equilibrium 1994 Nobel Prize in Economics. John C. Harsanyi John F Nash Reinhard Selten

7 Simplistic Company Operating Statement Revenue $150 million Operating cost ( $125 million) (cost to explore, extract,distribute) Gross profit $ 25 million Net Profit $15 million General & Admin costs $10million Cost of lease

Project 2. Description, Class Business Background- OIL AND GAS LEASES The Service’s Gulf of Mexico (GOM) Region handles lease auctions on the continental shelf in the Gulf. This area is further subdivided into western (WGOM), central (CGOM), and eastern (EGOM) sectors. The Mineral Management Service offers numbered sales in the CGOM area, with each sale consisting of several tracts. The sizes of the tracts vary, but they are generally close to 5,400 acres, or roughly 8-1/2 square miles each. The average number of tracts offered is around 3,900 (21,000,000 acres), with considerable variation. In most sales, bidding companies must post a security bond with their bid. The amount of the bond depends on the size of the bid, with some bonds as high as $3,000,000

9 Class Project  Auctions for offshore oil leases.  Mineral Management Service runs the auctions  In tracts of sea-bottom off the Louisiana and Texas coasts in the Gulf of Mexico.  U.S Government Mineral Management Services of the department of Interior are the managers/sellers (  Bidders are major oil companies  We will consider 19 major oil exploration companies that are planning to bid on a set of 275 tracts in the central Gulf of Mexico sector.

10 Class Project  Each company conduct their own geological assays  Assays -to estimate the amount of oil in, and the difficulty of extracting that oil from, each tract  The leases are sold in first-price sealed-bid auctions.

11 Class Project Bidding rings  Bidding companies form bidding rings  to share information about their proposed bids. Reserve price  To discourage bidding rings  the United States government sets a reserve price  If the highest bid is less than that price, the auction is off Proven Value  The worth of a lease to make a fair and reasonable profit  to share information about their proposed bids.

12 Class Project- Historical data Historical data is available on 20 prior leases for sets of tracts that are very similar to those which are to be auctioned. These sites have been developed and their proven values are now known.

13 Class Project- Geologists Analysis Estimates signals (Prior to the auction) What is a signal? ‘Geologists prior estimate of fair values of the tracts up for auction. Not necessarily bids

Class Project- Upcoming auction We are one of the 19 bidding companies, say Company 1. We must decide how much we should bid for drilling rights on the 275 tracts in the upcoming auction. Our company geologist estimates that the tracts will have a final proven value of s 1 = $264,900,000. s 1 estimates the amount that the company would be willing to pay for the lease in order to make a fair and reasonable profit on the oil which is extracted. This would sustain the company, neither weakening nor strengthening its circumstances. 14

15 Class Project-Goals  Determine what would be expected to happen if each company bid the same amount as its signal.  Determine the Company 1 bid under several uniform bidding strategies, and explore the expected values of these plans.  Find a stable uniform bidding strategy that could be followed by all companies, without any chance for improvement.

16 Class Project -Historical data 20 prior leases very similar to the future oil lease Sites developed and their proven values are now known The amount paid by the winning company may not be equal to the actual proven value These are given in the Excel file Auction Data.xls. LeasesPrior Signals

17 Project Assumptions Assumption 1. The 19 companies will all bid in the auction, and they will be the only bidders for the tracts. Assumption 2. The geologists employed by each of the bidding companies are all equally expert and, on average, they can estimate the correct values of leases. Specifically, each signal for the value of an undeveloped lease is an observation of a continuous random variable, S v, whose mean is the actual value, v, of the lease. Assumption 3. Except for their means, the distributions of the S v ’s are all identical. Assumption 4. All of the companies act in their own best interests, have the same profit margins, and have the same needs for business. Thus, the fair value of a lease is the same for all 19 companies.

18 More Information Does this sort of bidding really happen? Explore to see what is going on with government oil and gas leases.

19 Team Project Each team will receive an Excel file Number of companies will be given The Proven values of the 20 tracts will be same as class project( These leases have been already developed) Assume that you represent company 1 show team 1-data file

20 Team Project The file for each team will list its own Company 1 signal, s 1, for the next auction. Teams have three assignments.  Determine what would be expected to happen if each company bid the same amount as its signal.  Determine the Company 1 bid under several uniform bidding strategies, and explore the expected values of these plans.  Find a stable uniform bidding strategy that could be followed by all companies, without any chance for improvement.

21 Preliminary Report Teams & Data for Project 2 on Class website 3-5 minutes PowerPoint presentation You will be asked 1-2 questions about the presentation You need to give me a copy of the PPT presentation (size 6X4) Dress Code- Business Casual

22 Preliminary Report- contd. Should start the presentation by introducing the team A Discussion of the problem Definitions Project Assumptions Study of Historical Data Evaluation Form for the Presentation is posted on the class website

23 Preliminary Report-contd. Give a name and description for your company ( Show example team 1 excel file) Tentative decision Must decide how much to bid for the undeveloped tracts (based on problem data/common sense/ business considerations)