Project 2
Bidding on an Oil lease
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Project 2- Description
Bidding on an Oil lease
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Business
Background
Class Project
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Business BackgroundAuctions
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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
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is being sold
Business BackgroundTypes of Auctions
• first-price sealed-bid auction
(We will use this type in Project 2)
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each bidder submits a sealed bid
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the highest bidder gets the item
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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
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Business BackgroundTypes 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
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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
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Simplistic Company Operating Statement
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Revenue
$150 million
Operating cost
( $125 million)
(cost to explore, extract,distribute)
Gross profit
General & Admin costs
Cost of lease
Net Profit
$ 25 million
$10million
$15 million
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Project 2. Description, Class
Business BackgroundOIL 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
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
(http://www.gomr.mms.gov/)
 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.
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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.
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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.
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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.
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Class Project- Geologists
Analysis
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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
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Class Project- Upcoming auction
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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
s1 = $264,900,000.
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s1 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.
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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.
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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.
Leases
Prior Signals
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Project Assumptions
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Assumption 1. The 19 companies will all bid in the auction,
and they will be the only bidders for the tracts.
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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, Sv, whose mean is the
actual value, v, of the lease.
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Assumption 3. Except for their means, the distributions
of the Sv’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.
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More Information
Does this sort of bidding really happen? Explore
http://www.dog.dnr.state.ak.us/oil
http://www.gomr.mms.gov
to see what is going on with government oil and gas
leases.
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Team Project
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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
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Team Project
The file for each team will list its own Company 1 signal, s1,
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.
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Preliminary Report
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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
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Preliminary Report- contd.
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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
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Preliminary Report-contd.
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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)
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