Anh Nguyen, associate professor of economics, argues that not showing losing bids creates stronger competition in ocean oil and gas auctions, and generates more revenue for the government.
The U.S. government is tasked with getting the maximum value for public oil and gas reserves, but what if the very system designed to sell these resources is structurally flawed and costing taxpayers billions? Historically, the system has faced criticism for failing to secure fair market value due to perceived structural flaws and outdated policies. However, the key to improving government revenue lies with the degree of transparency applied to auction results.
Outer continental shelf auctions operate under a fundamental condition of common value—all competing firms generally agree on the eventual production value of a tract, yet that value remains uncertain until costly exploratory drilling is performed. This process is complicated by a central post-auction risk, often termed a moral hazard: the winning bidder holds the right to explore but is not obligated to do so. If the tract remains unexplored, the government receives no royalty revenue, which is significant, as the royalty payment accounts for approximately 85 percent of the total expected revenue.
Before bidding, oil companies invest heavily in seismic surveys to generate private signals about the tract’s resource potential. Under the current system, typically characterized by full disclosure, all losing bids are revealed to the winner after the auction. The winning firm then uses its rivals’ bid values to update its confidence in its initial assessment of the tract’s profitability. Empirical analysis documents a strong and positive correlation between a winning bidder’s likelihood of exploratory drilling and the value of the losing bids. High losing bids validate the winner’s optimism, increasing the probability of exploration; conversely, low losing bids act as a discouraging signal, often leading the winner to forgo drilling, thus preventing any royalty payment. By allowing the winning firm to reduce its post-auction uncertainty via this clue, the government effectively lowers the true risk perceived by the bidder, thereby suppressing the highest possible initial offer and consequently reducing bid revenue.
This dynamic highlights the power of information design, or the auctioneer’s capacity to commit strategically to how post-auction information is handled. The central economic trade-off in considering a policy shift toward non-disclosure is the balance between potentially lower upfront bid revenue and potentially higher subsequent royalty revenue. Moving toward a non-disclosure policy, where losing bids are kept secret, inherently increases the winner’s uncertainty. Anticipating this higher risk, bidders must depress their initial bids, leading to a theoretical reduction in bid revenue.
However, this policy of strategic secrecy offers a significant counterbalancing gain. By withholding the full spectrum of auction results, the government strategically pools “bad” information (low losing bids) with “good” information (high losing bids). This prevents the winner from receiving the discouraging signal of low bids, compelling the firm to rely more heavily on its own initial, usually optimistic, signal. Consequently, the expected probability of drilling increases. For deep tracts, analysis suggests that a non-disclosure policy reduces bid revenue by 4.23 percent but yields a 2.37 percent increase in royalty revenue. This results in a substantial net increase in overall revenue, estimated at up to $0.81 million per tract for deep tracts. This revenue increase is primarily driven by the fact that the rise in drilling probability is concentrated in the more productive tracts.
Implementing a non-disclosure policy also affects competition by disrupting firms’ incentives to form joint bids. Firms frequently form joint ventures to pool capital and to reduce competition, particularly for deeper, riskier tracts. The increased post-auction risk, fostered by a non-disclosure policy that lacks the rivals’ bids as a risk-reducing clue, makes solo bidding comparatively more attractive than engaging in a costly joint venture, thereby discouraging joint ventures and lessening competition in the auction.
Furthermore, the policy adjustment can generate welfare gains. The government’s positive royalty rate functions as a tax on production, which inherently distorts the winning bidder’s incentive, leading to a downward distortion in the probability of exploratory drilling compared to the socially optimal level. The strategic withholding of information under non-disclosure often counteracts this royalty-induced distortion, reducing the negative impact of the royalty rate for approximately 80 percent of tracts.
This subtle policy adjustment regarding bid transparency provides a specific, evidence-based solution for policymakers tasked with reforming the outer continental shelf program and ensuring receipt of fair market value. The effectiveness of resource management and the maximization of taxpayer returns hinge on the technical decision about whether to reveal the losing bid numbers. The government, acting as auction designer, must selectively manage informational risks post-auction to encourage the exploratory drilling that unlocks the highest possible revenue stream.
This article is based on Anh Nguyen’s research in “Information Design in Common Value Auction with Moral Hazard: Application to OCS Leasing Auctions,” conditionally accepted at Econometrica.
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