Introduction to Project 2 – Bidding on an Oil Lease

1. Introduction to Project 2 – Bidding on an Oil Lease Fall 2003, Math 115B

2. Basic Idea • You work for an oil company • Want to buy the rights to a patch of sea bottom in the Gulf of Mexico • The government owns it now • Decide how much to bid on the land • Hire a geologist to look at the land and decide how much it is worth • This number includes a fair profit • The number he gives you is called the signal

3. Basic Idea (continued) • To preclude companies from getting together with a $10 bid and sharing the resulting enormous profit, the government sets a reserve price • If you get the bid, you won’t know for years what the lease’s proven value is. • http://www.gomr.mms.gov and http://www.dog.dnr.state.ak.us/oil

4. Auctions • 4 common ways • English (open outcry): Starts at a starting price and bidders raise their hands to indicate bids. Item goes to bidder who made last bid and is sold at that price. • Dutch: Starts at a high price and goes down. The first bidder to stop the clock, wins the item and pays the price indicated at the time s/he stopped the bid. • First-price sealed bid: Each bidder submits a sealed bid. The highest bidder gets the item and pays what s/he bid. • Second-price sealed bid: Each bidder submits a sealed bid. The highest bidder gets the item and pays the amount of the second highest bid.

5. Class Auction • What happened when we ran our own auction? • Who won? • How much was paid? • Was a loss or a profit incurred by the winning bid?

6. Project 2: Oil Lease Bid • Want to bid on the right to extract oil from off shore patch of ocean bottom. • To aid us, we have results of 22 prior leases very similar to ours • Sites have been developed and their proven values are known. • Auction Data.xls

7. Assumptions for Project 2 • The same number of companies will each bid on future similar leases, and they will be the only bidders for the tracts. • The geologists employed by each company are all equally expert and, on average, they can estimate the correct value of the leases.

8. Assumptions continued • We have a continuous random variable, SV. • Observations of this R.V are signals for the value of undeveloped tracts. • The mean of this R.V. is the actual value, v, of the lease. Assumption 3 • Except for their means, the distributions of the SV’s are identical

9. One more assumption • Every company will act in their own best interest and have the same need for business and profit margin. Thus, the fair value of a lease is the same for all companies.

10. Project • On-line: Each team’s data • Includes your team’s signal, s1, for the next auction • A list of companies that will be bidding on leases that are similar to those in historical data plus the companies geologists’ prior signals for the 22 proven tracts

11. Goal(s) of Project (from page 132 in student handbook) • Determine what would be expected to happen if each company bid the same amount as its signal • Determine the Company 1 bid under several uniform bidding strategies, and explore the expected values of these plans • Find a stable uniform bidding strategy that could be followed by all companies, without any chance for improvement

12. Preliminary Presentations • Your team should develop a 5-minute presentation which includes the following: • The name of an oil company • Your roles in the company • Appropriate definitions • State goals (in your own words) • Show and explain your data • Talk about the assumptions (in your own words) • Give initial guess for company’s bid and justify your bid