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proven that it is possible and realistic to have consistent rules and regulations governing those areas with the same or similar environment conditions.
SUBMISSION OF THE MASSACHUSETTS INSTITUTE OF TECHNOLOGY
Senator HENRY M. JACKSON,
MASSACHUSETTS INSTITUTE OF TECHNOLOGY,
DEPARTMENT OF ECONOMICS,
DEAR SENATOR JACKSON: This reply to your letter of June 1 is somewhat hasty because I have just returned from an extended trip abroad. My comments are largely confined to Attachment B, number 46. I believe that the present system of competitive bidding for oil and gas leases should be retained. It awards mineral rights to those who are able to make the best and therefore, most profitable use of a given lease. Thereby it rewards efficiency and risk taking. Unlike a royalty, it does not serve as a discouragement to production, and therefore does not tend to premature abandonment of wells when they are less productive but still worth operating.
The answer to question 46 a must be "no." The funds available for exploration are not a fixed amount. Whatever is worth spending because it promises a sufficient return will get spent whether the money is from retained earnings or borrowing or selling or trading of equity shares. The chance to explore in good areas does certainly cut down on spending in poor areas which is as it should be.
The answer to 46 b is not as clear cut but must again be negative. There is nothing to prevent independent operators from pooling their interests to present a single bid. There has never been a dirth of serious contenders for leases such that competition threatened to be diminished and the price paid less than would exist in a free market.
The answer to question 46 c is affirmative because the best test of who is a qualified operator is in how much he is willing and able to pay for the permission to operate.
Question 46 d is based on a confusion. The payment of a high cash bonus is not an incentive nor a disincentive. Once the bonus is paid, by-gones are by-gones and the decisions of the operator on the rate of exploration and production depend on his estimates of the investment and rate of return thereon. But where a royalty is a disincentive, a previously paid cash bonus is not.
An examination of the leasing methods used by the British government for granting licenses in the North Sea shows their criteria to be a set of ready justifications for picking anybody they happen to prefer. These vague standards of "public interest" have debeviled much public regulation in both countries and should by all means be avoided.
MORRIS A. ADELMAN.
MASSACHUSETTS INSTITUTE OF TECHNOLOGY,
Hon. HENRY JACKSON,
Chairman, Committee on Interior and Insular Affairs,
DEAR SENATOR JACKSON: In reply to your letter of July 26, I enclose the article on Long Run Cost Trends, which I hope may be incorporated in the record as an appendix, and the following summary, to serve as response to Part C of Attachment B, questions 18-23.
Since 1950 for oil and since 1957 for gas, there has been a dramatic shrinkage in large new-field discoveries. There are no acceptable estimates of finding cost per barrel, but it must have increased very much.
A failure of discovery is reflected in rising cost, of development of oil and gas fields by drilling, equipping, and connecting wells. But this tendency may be off set for a considerable time though not forever.
In crude oil, the failure to find new fields has been largely compensated by finding new pools in and around old fields, and by more intensive development. Over the last fifteen years, the great bulk of the new oil reserves have been developed in old fields. Since the average recovery factor is only about 30 per cent, there is a big cushion of undeveloped oil-in-place, some of which can be developed into new reserves albeit at increasing cost.
Natural gas is different from crude oil because it does not cling to rocks and needs little or no force to move it to the well-bore. The bulk of it is produced without leaving much for additional development. Therefore, there must be discovery to maintain the needed stock of gas reserves.
Up to the middle 50's, the new gas fields found were capable of supplying, and did later supply, a larger amount of reserves than were created up to that time to support production. Since then, discoveries have created insufficient gas-inplace. More reserves had to be developed in old fields, but for reasons stated above, this was a rapidly vanishing resource.
Analysis of development cost confirms these two pictures. The investment needed to develop an additional daily barrel of crude oil capacity, in constant dollars, was about the same in 1968-70 as in 1960-63. In view of the fact that 1964-67 was lower, and the many deficiencies of the data, it would be wrong to extrapolate this, but the change will probably not be dramatic.
In nonassociated natural gas (and liquids), the shrinkage of resources and reserves led to an increase in investment needed per unit of new capacity of gas plus liquids 180 percent from 1960-63 to 1968-70. The data are no more satisfactory than for crude oil, but the analysis does not depend on the reserves of gas, whose accuracy has been debated.
In order to calculate cost per barrel of oil and per mcf of gas, two more items are needed. One is the rate of return to be applied to the investment, adjusted by the current decline rate. If we assume a level 12 percent rate of return in 1960 and 15 percent today (anyone may supply his own estimate) adjusted for decline then the needed return for oil was 22 percent in 1960 and 29 percent in 1970; for gas, 18 and 26 percent. Perhaps the trend is more important than the exact numbers: a 30 percent increase in oil, 44 percent in gas.
The other piece of information needed is the current cost of operating oil and gas leases: labor, fuel and power, repairs and maintenance, etc. Here, unfortunately, we have almost no information. I have made some estimates for the year 1962 (in a forthcoming book, The World Petroleum Market, Chapter II Appendix) but so many special adjustments are needed that they are not worth reproducing here, having served the limited purpose of a base from which to estimate costs outside the United States, which are much lower and hence with much less margin for error. However, operating costs tend to follow development investment costs, and they are a minor though substantial fraction.
However insufficient the basic data, I doubt that any improvement could greatly change the picture. The economic concept of scarcity is clear cut: a rise in the value of inputs needed to create a new unit of output. By this criterion, crude oil is growing gradually more scarce, and the pace may quicken if improved regulation, the departure of market-demand-prorationing, is a one-time benefit. Natural gas is growing acutely more scarce, and not much can be done to stretch out the resource in the ground: only large new discoveries will help; in new provinces, or at greater depths, or in tight formations by nuclear fracturing. There is one basic qualification which is as important as the findings. The estimates here are all averages (except for the postscript on North Slope Alaska). Hence they are not necessarily good estimates of the cost of new supplies from the more promising new provinces like the Continental Shelf and Alaska. And within these areas, we need division of basic data by oil and gas, which as indicated here are different in their economics. More knowledge might allow more optimism than can now be justified.
This information has become much more desirable in the past 18 months. For reasons stated earlier this year to your Committee, I believe security of supply has been much impaired by the unwise action of the United States Government in supporting and encouraging the cartel of the oil producing nations. But once established, the cartel will not soon disappear even if we withdraw support, and in order to formulate sound policies on imports of oil and gas relative to domestic production we need better information on domestic oil and gas costs.
MORRIS A. ADELMAN.
SUBMISSION OF JAMES T. JENSEN
Arthur D. Little, Inc. ACORN PARK CAMBRIDGE MASSACHUSETTS 02140 (617) 864-5770
September 15, 1972
Mr. William J. Van Ness
Committee on Interior and Insular Affairs
Room 3204 N50B
United States Senate
As a result of losing two key energy economics staff members to clients, ADL has had me spending the better part of the summer fire fighting with a substantial part of my time outside the country. I had hoped to be able to get my comments on the leasing issue in to you before your midJuly deadline. On the outside chance that the record may still be open,
I am sending my comments along now. If it is not, you may do with them what you will. I'll try to do better another time.
James T. Jensen
ATHENS BRUSSELS CARACAS LONDON MEXICO CITY NEW YORK PARIS RIO DE JANEIRO SAN FRANCISCO TORONTO WASHINGTON
STATEMENT OF JAMES T. JENSEN,
SUBMITTED TO THE
U.S. SENATE COMMITTEE ON INTERIOR AND INSULAR AFFAIRS
FEDERAL LEASING AND DISPOSAL POLICIES
I appreciate the opportunity to comment on a number of items in your hearing outline concerning questions and policy issues in energy resource leasing. Rather than discussing specific points in the detailed outline, I would like to address my comments to two broad policy areas. They are 1) the implications of the concept of fair market value as a guide to successful leasing policy and 2) relative merits of various alternatives to the traditional cash bonus fixed royalty bidding system.
Fair Market Value as a Guide to Federal Leasing Policy
Throughout the outline the concept of fair market value for
mineral leases appears. For example, item A-3, Attachment B, explores some of the factors in determining fair market value for the leasing of any resource. Clearly the idea that there is a fair market value for any given mineral lease has great appeal. It implies that the administration of the Federal leasing program can be conducted in such a way that the public gets its fair share of the value of the mineral properties while at the same time, the exploration process can go forward expeditiously. Fair and simple though the concept may seem, however, it can be a hindrance to an effective leasing program if it is misunderstood and, therefore, misapplied. The problems are:
That it is of limited usefulness in judging the value of
That if there is a danger that it will be used retrospectively
a good job, it is unworkable and may inhibit the effective
Since one of the most critical needs of the Federal leasing program at the present time is to enhance our natural energy resources by promoting more exploration and by stepping up activity in new energy technology areas such as shale, it is critical that the fair market value concept not be misused to impede these national goals.
Arthur D Little Inc.