The Transaction Costs of Oil and Gas Lease Auctions: the Brazilian Local Content Policy
Abstract: Local content policy has been widely used by countries rich in natural resources as a mechanism to promote national industries. Nonetheless, the design of the institutional arrangements required to put in place this kind of policy is often controversial. To shed light on this topic, we study the case of the Brazilian oil sector. In it, the mechanism that decides which firm has the right to explore a region (block) is a scoring auction. Such auction combines bids in several dimensions besides a price bid according to a pre-defined rule to define the winner. One of those dimensions is the amount of local content that they are willing to implement. In that context, we study the question: is the auction the best mechanism to decide on local content programs? Literature on scoring auctions have proved that they perform better than other mechanisms when all criteria are measurable and contractable upon. However, local content programs are subject to significant uncertainty and complexity. In the case contract clauses are not fulfilled, penalties or renegotiation create significant mal-adaptation costs. We develop and empirical study to analyze both the bids and the ex-post mal-adaptation problems associated with the local content clause that have been already observed. As predicted by the theory, we observe high transaction costs associated with rigid long-term contracts in presence of uncertainty and complexity. The results of the Brazilian local content case are in agreement with public procurement literature. They also point at some of the key challenges to define efficient arrangements to implement local content policies.
