This map illustrates the coal lands of the United States, west of the 100° meridian, which were patented to the Burlington Northern, Union Pacific, and Santa Fe railroads under the Douglas Act of 1850, and subsequent land grant Acts. These Acts generally provided for grants of certain sections to either side of the rail line beyond the western-most existing tracks, to encourage completion of a transcontinental rail system. Originally, the railroads were patented the evennumbered sections to either side of the tracks for a distance of usually six to eight miles. Later, the grants were changed to the odd-numbered sections. In some areas, settlers had already squatted on the lands granted to the railroads, in anticipation of the commerce and other activity to be generated by the railroad. To compensate the railroads for lands lost in this manner, the primary grants were supplemented by indemnities, granting the railroads land beyond the primary grants, up to a limit which varied from railroad to railroad.

Some of the lands patented to the railroads were rich in coal. This map provides a basis for estimation of the value of the coal obtained by the Burlington Northern, Union Pacific, and Santa Fe railroads, by indicating the estimated total amount of coal lands which each of them received under the land grant Acts.

Mrs. MINK. It would seem to me logical for this committee to assume that since we have had long dissertations about the checkerboard system and the interspersed Federal holdings in these areas, that along with an analysis of whatever our resources might be on the Federal portion, we would be apprised of what the mineral resources and deposits are on the adjoining sections of lands. This kind of estimate and calculation could be reasonably expected to be made by the numerous geologists that are in the Department without having to depend solely upon the private records of the railroad companies. Mr. TURCOTT. All right. We can do that.

Mrs. MINK. We do have railroad estimates. I am interested in knowing the Government's analysis of this information.

Mr. TURCOTT. We will do the best we can from data from the railroads; if not that, then our best estimate by geologic inference on the mineral resources, especially coal.

There is one thing about it, I don't know about getting it done by the first of January. If there is any reluctance by any one railroad to give acreage holdings that they still retain of land grant in the first instance, we will have to go to the county assessor's records.

Mrs. MINK. In order that we may know for the purpose of these hearings, we should have what you have available as of the end of the year together with whatever other information you can supply. Mr. TURCOTT. Can I limit information to the hundredth meridian west rather than the whole United States?

Mrs. MINK. Yes, these are the lands that we are specifically interested in.

Mr. TURCOTT. Thank you.

Mrs. MINK. The question is, and response is, that Dr. Ross has made available to the subcommittee are, I think most helpful in understanding this checkerboard pattern and its impact on development of coal.

Without objection, I would like to request that that except for the first question which was propounded and responded to, that the other questions and responses be inserted into the record at this point as though they were asked and responded to at the hearing by Dr. Heather Ross.

[Material referred to follows:]

Question. What is the objective of the contract study mentioned in Mr. Turcott's testimony?

Answer. The Department has contracted with Science Applications, Inc. of McLean, Va., to study ways the Department might best structure its proposed new coal leasing program so as to achieve the objective of receiving fair market value for the leased coal. The principal investigators for the study are Profs. Robert Lind, and Robert Smiley of the Graduate School of Business and Public Administration at Cornell University. The objective of the research is to identify mechanisms for facilitating the greatest possible competitive interest in Federal coal and thereby obtain revenues from the coal which most closely approximate its true value. The work so far has indicated that a major impediment to the Department obtaining a fair market value for its coal is the complex pattern of Western land and mineral rights holdings which prevents the Government in many cases from leasing tracts which are themselves complete logical mining units. The principle example of this problem is the railroad-Federal checkerboard. However, the research, and the Department's concern, are not directed at the railroads or at the checkerboard lands only, but are broadly oriented toward the overall leasing objective of receiving fair market value for publicly-owned minerals. Question. Why does the pattern of Federal-railroad checkerboarding pose a problem currently for the Department in obtaining fair market value for Federal coal?

Answer. We can see from past lease sales that the government gets more for its coal when it leases large, contiguous tracts which are themselves suitable to form logical mining units, than when it leases isolated blocks which must be combined with other non-Federal land to be economically mined. Bidders on the latter type of tracts must negotiate with the holder of the adjacent coal-either to lease it from him or to enter into a joint venture with him—before an economic unit can be formed and mining begin. Those bidders may not, in general, know the terms under which a deal with the adjacent coal holder can be struck. They face costs in the form of costs of conducting the negotiation, costs of delay while the negotiation goes on, and risk that they will not be able to reach agreement or that they will have to settle on unfavorable terms. Consequently, they will bid less for the Federal lease because of these costs they face before a mine can be started. Bidders may in some cases know, through advance bargaining, what deal they can strike with the adjacent coal holder, but this will not result in their bidding fair market value to the Government if they find that the adjacent coal holder's terms are so stiff that they cannot meet them and pay the Government fair value as well. The checkerboard, by and large, is a prime instance of the general situation where Federal and non-Federal coal must be developed together, and in this case, the adjacent coal holder is the railroad.

Question. What effect would repeal of Section 2(c) have on the Department of the Interior's ability to capture fair market value for its coal leases?

Answer. As noted in the answer to another question, the Department faces impediments to obtaining fair market value for Federal coal on checkerboard lands now. This is simply a function of the pattern of landholding and is not related to the identity of the adjacent land holder-the railroad-nor confined to the checkerboard lands. But considering the checkerboard lands, the Department's ability to capture fair market value is protected to some degree by section 2(c) which prevents railroads from bidding directly for Federal leases. If this section is effective in confining bidding on Federal leases to companies whose economic interests are independent of those of the railroads, then every bidder for Federal coal should be on a roughly equal footing in dealing with the railroad if he wins the Federal lease, and thus some competition for Federal coal leases can likely be maintained, even though the bids will be reduced because of the costs and risks present in negotiating a logical mining unit after winning the lease. However, if a railroad can enter the competition for Federal leases, it has a clear cut advantage over other bidders, since it faces no costs and risks of negotiation with itself, and it may drive other bidders out leaving the field open for itself to obtain the Federal lease at a low bid. If some other bidder anticipating a low bid from the railroad enters the competition and wins the Federal lease, the railroad could refuse to form a logical mining unit with him, or agree to form one only on very unfavorable terms to him. This would signal potential bidders in other Federal lease sales of checkerboard tracts not to expect any gain if they win a Federal lease away from the railroad. Those bidders would then most likely stay out of future competitions. There is no way of saying with certainty that this is what rail

roads would do when allowed to bid on Federal coal. But it is one strategy they could follow, and given the major values at stake in coal leasing, a strategy they could prove very rewarding to them.

Question. What alternatives to the current situation or to the repeal of section 2(c) is the Department studying in its effort to structure a leasing program which captures fair market value?

Answer. The Department is considering several broad approaches to improving its ability to capture fair market value on the checkerboard and other mixed ownership lands. One is exchanges a trade of ownership rights so that the non-Federal owner, (the railroad in the case of the checkerboard) and the Federal Government would end up with the same value of coal holdings as they had before, but the holdings would be consolidated into large contiguous blocks suitable for leasing as one or more logical mining units. These consolidated holdings would mean both a gain in efficiency of coal development and a gain in ability to capture fair market value since the uncertainty and potential gaming behavior involved in negotiating logical mining units on a case by case basis would be eliminated. The challenge is to work out a feasible way of carrying out these exchanges which does not defeat the purposes for which they are undertaken. If the exchange takes a long time to arrange, is very costly in terms of resource information which must be collected, or results in the Government giving away considerably more value than it receives, then the objectives of timely development and capturing the full market value of publicly owned minerals will both be lost.

Question. Won't tract evaluations by the Department which set minimum acceptable bids ensure receipt of fair market value for Federal coal?

Answer. Tract evaluations are a very important part of the Department's efforts to receive fair market value. However, it is difficult for the Department, as for anyone else, to consistently predict with accuracy the value of a mineral deposit. Consequently, it is always in the interest of the Government to be helped as much as possible by market forces of competition in establishing and obtaining a best estimate of fair market value. The use of tract evaluations is complicated in cases, such as the checkerboard, where Federal coal is significantly more valuable when mined in conjunction with adjacent coal than when mined in isolation. There is not at present any readily available mechanism for obtaining information about the adjacent non-Federal coal on which the value of the Federal coal depends. Furthermore, if that information were fully available and the value of the joint deposit could be determined, a minimum acceptable bid which was the Department's judgment of the share of the value of the joint mine due the Government might be challenged as too high, since it would be higher than the value of the Federal tract in isolation.

The Government would have a standard set of terms which would share the value fairly, and would require agreement to those terms by the adjacent coal owner before a Federal lease sale could be held. This approach would permit receipt of fair market value by both parties. It would avoid the substantial front-end costs of gathering resource information, and the possibility of making major mistakes, which characterize large exchanges of ownership rights. The challenge would be to devise terms and procedures which would be fair and workable over the range of Federal coal holdings, and on which early agreement with adjacent coal holders could be reached.

Other possible approaches include charging higher royalties on land where capture of fair market value at the lease stage is difficult, or structuring the leasing program so as to foster intertract competition in ways which tend to neutralize the advantage any particular bidder has on any particular tract.

[Note: the subcommittee was later supplied a copy of the study, referred to above, conducted by Science Application, Inc., for the Department of the Interior's Office of Policy Analysis. Included was the following discussion of the effect of Section 2(c) on competitionwhich represents the opinions and recommendations of Science Application, Inc., and not of the Department of the Interior:]

COMPETITION AND SECTION 2(c) OF THE FEDERAL MINERAL LEASING ACT OF 1920

Congress is currently considering the repeal of Section 2(c) of the Federal Minerals Leasing Act of 1920 which prohibits railroads from obtaining federal coal leases. This is significant because there are numerous coal fields where a railroad is

the major private owner in a checkerboard pattern, e.g., the Powder River Basin in Wyoming. In fact checkerboard patterns of ownership were created by federal land grants to the railroads of alternate sections of land at the time they were built. While some of this land has been sold over the years, the railroads retain large land holdings within checkerboard patterns in rich Western coal fields. This creates the bilateral monopoly situation described in the previous chapter with the railroad being the private owner. Whether the railroad can enter the competition for federal leases will therefore affect competition for federal coal leases. The previous analysis can be used to analyze whether Section 2(c) should be repealed or whether it should be strengthened to preclude railroads that own coal deposits adjacent to federal deposits in a checkerboard pattern from competing for the adjacent federal leases.

Before turning to the analysis of Section 2(c) we should point out that there is some question as to whether, as it now stands and as it has been interpreted in the courts, Section 2(c) does effectively preclude railroads from obtaining federal coal leases. A recent Department of Justice interpretation of Section 2(c) in light of recent court decisions suggests that railroads can effectively circumvent it by establishing coal company subsidiaries that then can compete for federal leases. If this is true, then the important issue is not whether 2(c) is repealed, but rather whether it is strengthened and made fully effective.

It was argued in the previous chapter that where one private owner held all or most of the non-federal land in a checkerboard pattern and where logical mining units were comprised of both private and federally owned deposits, the private owner, in many cases a railroad, will have a significant advantage in bidding for the leases. One reason for this advantage is the railroad's superior access to information regarding the value of the entire logical mining unit. The value of the unit clearly depends on the amount of coal on each of the tracts in the checkerboard. While all firms are likely to have access to information regarding the amount of coal on the government parcels, only the railroad will have information on the parcels it owns. This information assymetry, we have argued, may lead to the railroad's dominating the bidding for non-unitized tracts.

The other factor leading to railroad domination of lease bidding on these tracts concerns the transactions which may take place after the lease auction-leading to the assembly of a logical mining unit. The railroad will have a significant advantage in this post lease bargaining due to its vast ownership of coal reserves and the possibility that it will merely refuse to negotiate with any winner of a government lease. A potential bidder for a federal coal lease thus faces the unpleasant prospect of dealing with the railroad, that it just defeated in the auction, in attempting to assemble an efficiently sized logical mining unit. The possibility that the railroad will simply refuse to bargain with firms that defeat it in auctions, in order to discourage such future bidding, is too significant to ignore. The bargaining advantage held by the railroad may lead to the absence of any real competition for these tracts and railroad domination of much of the Upper Great Plains Coal industry by default. Government leasing revenues would clearly suffer from the lack of any real competition.

For these reasons, we would favor strengthening Section 2(c) of the 1920 Minerals Leasing Act. However, if prior unitization were requitrd, the railroad's advantage would disappear. All potential bidders would have access to information about coal deposits on all portions of a unitized logical mining unit. Furthermore, since the unit would be unitized prior to sale, there would be no post-sale bargaining. We would support the repeal of Section 2(c) if the unitization concept were implemented and endorsed by the railroads. The acceptance of prior unitization by the railroads should be the "price" for the repeal of Section 2(c).

If the Department of the Interior cannot extract this "price", we feel it should support the strengthening of Section 2(c) to preclude railroads or coal companies owned by them from competition in those areas where checkerboarding exists. If unitization is not adopted, the government's only protection against the loss of much of the rents attributable to the coal it owns is the establishment of a reasonable bid rejection price. The very least the Department of Interior should accept in exchange for the repeal of 2(c) is exploratory access to railroad coal lands for use in establishing a minimum bid rejection price. Even with this access, the establishment of a reasonable bid rejection price is a very difficult task.

The Justice Department has suggested an alternative policy that would create efficiently sized logical mining units where checkerboarding patterns now exist. The policy would involve trades of mineral rights between the government and the railroads. Thus, if the government and a railroad each owned half of two logical

mining units, each would emerge from the trade with complete ownership of one unitized tract. One problem with this proposal is that due to the huge holdings of checkerboarded mineral rights by the railroads, they would own a substantial portion of the unitized tracts. If they choose to mine these units themselves, a concentrated oligopoly would be created overnight. The less obvious problem with this proposal is the determination of which government parcels would be traded for which parcels owned by the railroads. All the problems discussed (in the unitization section) in setting reasonable bid rejection levels and in establishing fair sharing rules pose difficulties here.

Mrs. MINK. Before the subcommittee must recess because of the convening of the House, I would like to go back to your chart for a moment and ask you, ask the Department whether the 60,000-acre logical mining unit map which we have before us is the typical situation of logical mining units as they have been developed by the Department or is this an extraordinary situation?

Mr. BAILEY. I would say this is one of the extraordinary ones. You would have others like it, but they wouldn't be as large as this one. Mrs. MINK. This is ordinary, this is typical?

Mr. BAILEY. No, it is not typical.

Mrs. MINK. Extraordinary. OK. Extraordinary in what respect? Mr. BAILEY. In the way the coal deposits lay, topography, how it can be mined and things like that.

You have a thick coal seam which you could mine over the whole lease, the whole unit, then it wouldn't take near as large of a unit. Mrs. MINK. The typical logical mining units are much smaller though?

Mr. BAILEY. Oh, yes, most of them would be much smaller.

Mrs. MINK. Does this logical mining unit characterization on the chart fall in line with the Department's guidelines and regulations, or was it made purely for illustrative purposes for the use of this committee today in this hearing?

Mr. BAILEY. This is a logical mining unit that will be developed some day, we expect.

Mrs. MINK. None of this has yet been leased?

Mr. BAILEY. It has not been leased. They are under prospecting permits and there are applications for preference right leases. Apparently from talking with the company they have other lands tied up where they can mine.

Mrs. MINK. When you say logical mining unit, do you necessarily mean that the entire unit will be leased as one unit or that the intention is that it should be developed as a unit?

Mr. BAILEY. It should be developed as a unit.

Mrs. MINK. But not necessarily issued as one single lease?

Mr. BAILEY. That is right. Because you run into problems sometimes with smaller acreage limitation contained earlier in the Mineral Leasing Act. This is one of the reasons you have five different lease applications because of prior acreage limitations that could be included in one lease.

Mrs. MINK. So as we have tried to provide in our legislation for the concept of a logical mining unit, it is purely and simply a method by which we are allowing the Department and the coal operators to avoid the severe requirements of continued operation and due diligent development. In other words, instead of requiring them to begin operations within the 15-year period, we would allow under our