Estimating strategic interactions in petroleum exploration

When individual petroleum-producing firms make their exploration decisions, information externalities and extraction externalities may lead them to interact strategically with their neighbors. If they do occur, strategic interactions in exploration would lead to a loss in both firm profit and government royalty revenue. Since these strategic interactions would be inefficient, changes in the government offshore leasing policy would need to be considered. The possibility of strategic interactions thus poses a concern to policy-makers and affects the optimal government policy. This paper examines whether these inefficient strategic interactions take place in U.S. federal lands in the Gulf of Mexico. In particular, it analyzes whether a firm’s exploration decisions depend on the decisions of firms owning neighboring tracts of land. A discrete response model of a firm’s exploration timing decision that uses variables based on the timing of a neighbor’s lease term as instruments for the neighbor’s decision is employed. The results suggest that strategic interactions do not actually take place, at least not in exploration, and therefore that the current parameters of the government offshore leasing policy do not lead to inefficient petroleum exploration. JEL Classification: C21, C25, L71