ALLOCATING OIL LEASES - OVERCAPITALIZATION IN LICENSING SYSTEMS BASEDON SIZE OF WORK PROGRAM

Discretionary systems of awarding exploration and production licences, such as that on the UK continental shelf, often use the size of propo sed work programmes as an important criterion. This paper models the e ffect of strategic considerations on the choice of work programme in s uch licensing systems. The model incorporates uncertainty about resour ce size and about the work programmes proposed by competing companies. It is found that competition between bidders results in a level of ca pital investment which exceeds the profit maximizing allocation. It is concluded that licensing systems which emphasize size of work program me can result in strategic but wasteful overcapitalization.