NATIONAL BUREAU OF ECONOMIC RESEARCH
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The Economics of Time-Limited Development Options: The Case of Oil and Gas Leases

Evan M. Herrnstadt, Ryan Kellogg, Eric Lewis

NBER Working Paper No. 27165
Issued in May 2020
NBER Program(s):Environment and Energy Economics, Industrial Organization, Public Economics

Oil and gas leases between mineral owners and extraction firms ubiquitously include royalty and primary term clauses. The royalty denotes the share of revenue that is paid to the mineral owner, and the primary term specifies the date by which the firm must complete a well, lest it lose the lease. Using data from the Louisiana shale boom, we first show that wells' drilling timing is substantially bunched just before lease expiration, raising the question of why leases include development deadlines that distort drilling decisions. We then develop a contracting model in which mineral owners face firms with private information and have the ability to contract on both realized revenue and drilling timing. We show that primary terms can increase both the owner's expected revenue and total surplus because they counteract the delay incentives imposed by the royalty.

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Document Object Identifier (DOI): 10.3386/w27165

 
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