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

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Project 2

Bidding on an Oil lease

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Project 2- DescriptionBidding on an Oil lease Business

Background Class Project

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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

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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

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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

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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 Equilibrium1994 Nobel Prize in Economics. John C. Harsanyi John F Nash Reinhard Selten

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Simplistic Company Operating Statement

Revenue $150 millionOperating cost ( $125 million) (cost to explore, extract,distribute) Gross profit $ 25 million

Net Profit $15 million

General & Admin costs $10millionCost 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

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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 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

s1 = $264,900,000.

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 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, Sv, whose mean is the actual value, v, of the lease.

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

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 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.

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. 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)