total number of bidders would be increased, there would be a corresponding

overall increase in competition.

B. Incentive to rapid exploration and development

The cash bonus bidding system provides maximum incentive for the operator to explore and develop the lease since the operator is anxious to get an early return on his investment, to amortize his investment over the maximum amount of production, or to decide to abandon the lease and recover part of his investment through tax deductions.

The deferred bonus bidding system similarly is conducive to rapid exploration and development. This system has the added incentive of the opportunity to prove reserves or abandon the lease before subsequent segments of the bonus payment are due. Early exploration and development also may be encouraged because of the reduced initial capital outlay which frees capital for exploration and development. However, there are some that feel this system could provide less incentive than the full cash bonus system to fully explore the lease as the operator has less "sunk" cost and he may elect to relinquish the lease without further exploration before subsequent bonus installment payments are due.

A royalty bidding system could make available large sums of capital for exploration and development that otherwise would be committed to bonus payments. However, there also is the probability that the low initial capital requirement would be conducive to leasing by operators at very little financial risk on a speculative basis with little or no incentive

or intention of exploring and developing the tract. This potential disadvantage could be minimized by use of fixed threshhold bonus payments and diligence provisions but there still might be less incentive for early exploration and development than would exist under the bonus alternatives.

However, at the present time due to the critical need to develop oil and gas reserves and because of productive conditions, incentives to oil and gas exploration and development would be essentially the same under any bonus-royalty system. There are strong indications that industry's needs are such that rapid exploration could be expected for all leases having significant resource potential.

C.

Conservation of energy resources for future use

Conservation of energy resource for future use primarily depends upon the scheduling of OCS lease sales over an appropriate period of time rather than the bidding method used. However, there could be some difference in the rate of exploration, development and depletion. As previously indicated, the bonus bid system is conducive to rapid exploration and production. The subsequent fixed royalty is conducive to production at the maximum efficiency rate and to the greatest amount of total production to amortize the bonus investment over the largest possible economic recovery volume subject to the relatively low fixed royalty rate.

Accordingly, the cash bonus system could

be conducive to earlier production and/or greater and longer total production.

Development might occur nearly as rapidly under royalty bidding

where the firm needs the additional production, however, the much higher

royalty payment could be conducive to earlier abandonment of leases

due to the direct marginal production costs involved. Accordingly, production could stop at an earlier date and a greater amount of oil could be lost in terms of future and total production. This potential loss could

be mitigated by use of a declining royalty system which would permit

continued production by virtue of reduced royalty payments.

Depending

upon the relative overall unit production costs under either system,

total production and length of production could be more or less depending upon the individual lease circumstances involved.

D. Total amount of resources ultimately recovered under the lease

Cash bonus bidding systems provide the maximum incentive for maximum resource recovery since the bonus represents a "sunk" cost which can be best recovered over the greatest amount of production possible within the economic limits afforded by minimal fixed royalty charges. Under the deferred bonus system there could be less overall production since the firm could elect to relinquish a lease before production and subsequent bonus installments. In such instances there probably would be no production under the existing lease and there could be little or no incentive for subsequent releasing and development of the same tract which could result in potential losses of resources that otherwise might have been developed through additional initial exploration effort.

A royalty bidding system could result in less resource being recovered than would result under the bonus systems because of the premature abandonment of leases due to the much higher royalty unit cost product

threshhold. This could result in the loss of a considerable amount of

otherwise recoverable reserves.

In any producing field the combination

of declining production and increased operating expenses result in conditions which ultimately result in costs exceeding income from the product. When this point is reached, production ceases, the well is abandoned, and the remaining resource is considered as being lost since there is little probability of subsequent reentry and production. However, as indicated in the previous section, this potential loss could be mitigated, or possibly even eliminated, if it were possible to operate under a system of declining royalty payments scheduled against economic production

threshholds.

The nominal initial cash requirement could be conducive

to more intensive exploration as a result of capital availability.

could result in more discoveries.

This

E. Efficiency of Allocation

The cash bonus bidding system tends to limit leasing to technically proficient and financially strong operators. A deferred bonus system probably would have similar results since there still would be a substantial initial investment requirement. While the barrier threshhold would be lower, bidding still would be limited to technically proficient and financially strong operators.

Royalty bidding could be conducive to leasing to less proficient and less financially capable operators. There also could be considerable potential for speculators having little or no intention of exploration and development. The potential adverse consequences of such bidders could be

mitigated by use of a fixed bonus of sufficient size to limit bidding to legitimate operators and by performance or diligence provisions

that require timely exploration and development. Royalty bidding also

could result in marginal operators getting in beyond their capabilities

F. Possible bias toward any one class of lessees (Ease of entry, etc.) As previously indicated, cash bonus bidding tends to limit participation to the financially strong and more technically proficient operators. Deferred bonus bidding would permit the entry of somewhat smaller operators but they still would have to have substantial capabilities. As leasing moves to smaller operators, there is greater risk in their not having the total financial resources required to fully explore and develop the leased areas.

By contrast, royalty bidding is not biased toward any one class of operator, particularly if there is not a substantial fixed bonus requirement associated with the bidding. Removal of the high initial capital, requirement could permit development and production by firms having less financial resources. Entry of small companies or consortia of independents would be stimulated. It could result in leasing to firms that do not have the financial and/or technical capabilities to explore and develop the leased areas. There also is the potential for entry by speculators having no intention of resource development or production.