Government vs. Resourceship (Bureaucrat vs. Entrepreneur in the quest for mineral wealth)

By John Brätland -- April 6, 2011

[Editor note: The original title of the post of Dr. Brätland (bio at end) was “Institutions and Policies that Impede Capital Maintenance for Extractive Firms.” Resourceship is a term used by the late economist Stephen McDonald (1924–2006) to describe entrepreneurship applied to mineral resources.

Dr. Brätland’s post below complements a series of entries at MasterResource under the terms resourceship, peak oil (fixity-depletion), and ultimate resource, as well as subsoil privatization.]

Although capital maintenance by extractive firms refutes the exhaustion myth of minerals, this refutation hinges on access to lands, entrepreneurial latitude in managing resources, and secure private-property rights.

In particular, certain institutions of governmental control and jurisprudence hinder entrepreneurial actions of extractive firms striving to maintain capital (defined as the asset value of to-be-extracted minerals).

These hindrances include:

(a) Foreclosure of land access by government ownership of mineral lands;

(b) Foreclosure of entrepreneurial latitude by court imposed covenants enforcing obligations to surface owners; and

(c) In the case of petroleum, the extractive firm’s inability to acquire full control and ownership of reservoirs it has discovered.

The first of these impediments bears on access to land; the latter two impede extractive firms’ ability to manage resource deposits as capital assets.

Foreclosed Land Access via Government Ownership

Maintenance of entrepreneurial income requires the replacement of the capital goods critical to continued operation in the same industry. This entrepreneurial process requires that the firm have access to new resources that may be extractible at lower cost. Resource replacement usually depends on leasing arrangements between surface owners and entrepreneurial firms that seek to find and develop new deposits.

Through an unhampered market process, resources tend to gravitate to their highest valued use. The one obstacle facing the entrepreneurial extractive firm in its efforts to maintain capital is that some properties are controlled by landowners who can totally foreclose access rights to extractive firms.

These owners are invariably governments that have merely nationalized lands through acts of political power without any actions establishing legitimate ownership. Once these lands are under governments’ control, access is established through a political process. In modern democracies, this conflict is manifested in political struggles to marshal the power of legislatures to assure certain politically popular uses of lands and to foreclose less-popular uses.

This political selection of popular uses of nationalized lands is one of the more pernicious features of democratic processes. Once lands are nationalized, alternative uses of them are chosen with the intent of appeasing “stakeholders.”

For the purposes of this inquiry, the important question is: Who is a stakeholder with respect to the use of public lands? Unfortunately, political self-selection is the only criterion used to establish who has a legitimate stake in decisions about the alternative uses of government lands. Stakeholders are voters with diverse and subjective views about what constitutes an environmental amenity for them and how its presence or absence affects them.

This political process takes the focus off legitimate environmental issues and instead motivates allocative decisions on the basis of the placation of certain self selected political constituencies (Brätland 2004, 528–32). This participatory process has little to do with rational environmental policy or with the commitment of resources to their highest-valued use.

Political advocates of policies that foreclose access are unencumbered by the opportunity costs of such sanctions. In this sense, forsaking the value of the next most highly valued opportunity never impinges on the actions of non-owning bureaucrats, politicians, or environmentalists who seek to foreclose certain uses of government lands. Problems of resource exhaustion and firms’ failure to replace resource deposits can arise because the weighing of opportunity costs plays virtually no role in foreclosing lands to exploration and development.

In bearing little of the opportunity costs of political foreclosure of access, self-selected stakeholders have incentives to become extremists in exaggerating preferences and overstating claims. Whatever the benefits of foreclosing exploration and development may be, these benefits are provided as a free good through the process of political control.

Foreclosure of Entrepreneurial Latitude by Obligations to Surface Owners

As argued earlier, the extractive firm must have ample timing latitude if its efforts to replace resources are to succeed. However, an early juridical declaration of surface owner rights has tended to preclude this speculative latitude in maintaining capital.

The British jurist William Blackstone first enunciated an interpretation of the land surface owner’s rights to subsurface minerals:

“land hath also, in its legal specification, an indefinite extent, upwards as well as downwards . . . downwards, whatever is in direct line between the surface of any land and the center of the earth . . . if a man grants all his lands, he thereby grants all mines of metal and other fossils. This is incorporated in the fundamental law of the land” ([1766] 1983, 18).

The modern-day implication of this interpretation of the surface owner’s rights is that the surface owner is entitled to a fixed percentage royalty on the gross proceeds from the sale of the extracted mineral. (1)

Under this entitlement, the surface owner and the extractive enterprise that has acquired a lease have mutually and fundamentally incompatible objectives. Because of uncertainty and economic change, speculative latitude is always critical in managing capital goods, including mineral leases.

The management of mineral leases as capital goods requires that lease activities be scheduled so that the capital value of entrepreneurial income is maximized. However, given the fixed-percentage royalty on gross proceeds to which the surface owner is entitled, speculative timing decisions by lessees almost always diminish the present value of royalty income. The surface owner prefers that the extraction operation be managed so that royalty revenue is captured as quickly as possible (Brätland 2001, 694–95). (2)

In sum, speculative timing of production by the royalty-paying lessee is critical to the maintenance of capital but anathema to the surface owner’s interests. Moreover, the surface owner’s financial rights are protected by court-imposed implied covenants that foreclose any action or lack of action that delays or diminishes the surface owner’s receipt of royalties. By curtailing speculative latitude in the timing of production, the covenants reduce the net present value of mineral resources and impede the extractive enterprise’s ability to maintain capital.

Special Circumstances of Petroleum and the Issue of Owning Discoveries

Blackstone’s declaration of surface-ownership rights presents difficulties in its application to in situ petroleum, given the unusual characteristics of petroleum deposits. Because of petroleum’s migratory nature, the resource can often be extracted from the reservoir beneath the land of several different surface owners. Hence, a rule of capture has evolved such that a discovered reservoir never becomes a capital good to be managed by the entrepreneurial firm. The rule of capture applies even though the petroleum being extracted may have migrated from beneath another surface owner’s property.

Application of Blackstonian principles has not specified that the owner of the surface also necessarily owns subsurface petroleum, but that owner is always entitled to a percentage share of gross production or a percentage share of the gross sales proceeds of production.

Again, to this end, the courts have imposed the covenants mentioned previously to protect the surface owners’ financial interests. The consequence of the covenants is that the royalty-owning surface owner essentially precludes the management of petroleum leases as capital assets. In so doing, the implied covenants dissipate entrepreneurial income by compelling exploration, development, and production on expedited schedules that may be inconsistent with the efficient management of extractive operations.

Moreover, mandates to undertake these activities at an earlier time entails that in almost all cases the opportunity cost associated with these activities will be increased (Mead et al. 1985, 110–12). In circumstances unimpeded by the covenants, a decision to expedite exploration or development would be made only if doing so was expected to increase the project’s capital value. Attempts to impose artificial schedules on decision makers can only create confusion, chaos, and impediments to the maintenance of capital.

The conflict, ethical breeches, and implied covenants associated with current property law would not exist if the discovered petroleum deposit were to become the sole, exclusive property of the extractive enterprise making the discovery. In this case, ethically and functionally legitimate ownership would be achieved by applying the principle of original appropriation and by discarding the Blackstonian strictures on the scope of the surface owner’s property rights. (3)

Of course, in this situation, some consent to surface access would still be required from a surface owner to make exploration possible. (4) Court-imposed covenants would no longer impinge on the discovering firm’s ability to engage in speculative timing in the scheduling of investments in the project. In this case, the surface owner would have no contingent claim on production. This situation would represent the normative ideal from both an allocative and an ethical perspective.

FOOTNOTES

[1] The surface owner is usually also the owner of royalties; however, situations exist in which royalty streams are sold as investment assets. In other instances, the surface owner’s property rights may not include mineral rights, in which case presumptive royalty obligations are owed to the owner of those rights

[2] In the context of the petroleum lease, the surface owner’s economic interests are defined by the attainment of a rate of revenue recovery that maximizes the present value of the royalty-receivables revenue stream. Delay only diminishes this present value. Hence, expedited recovery of royalty revenue is always optimal for the surface owner as a lessor.

[3] This proposal was first put forward by Murray Rothbard ([1982] 1998, 71–72). Robert Bradley has advanced a version of the Rothbard proposal (1996, 69–74).

[4] In most cases, a single surface owner would not be able to extort a royalty concession from an exploring entrepreneur who is establishing ownership of a subsurface discovery. Directional drilling would be permitted so that a particular subsurface structure could be accessed from a multiplicity of surface locations. Competition between surface owners would weaken any single surface owner’s bargaining power.

REFERENCES

Blackstone, William. [1766] 1983. Commentaries on the Laws of England. Vol. 2. Special ed. New York: Legal Classics Library.

Bradley, Robert L. 1996. Oil, Gas, and Government: The U.S. Experience. Lanham, Md.: Rowan and Littlefield.

Brätland, John.. 2001. Economic Exchange as the Requisite Basis for Royalty Ownership of Value Added in Natural Gas Sales. Natural Resources Journal 41, no. 3: 685–711.

———. 2004. Externalities, Conflict, and Offshore Lands: Resolution Through the Institutions of Private Property. The Independent Review 8, no. 4 (spring): 527–48.

Mead, Walter, Asbjorn Moseidjord, Dennis Muroaka, and Phillip Sorensen. 1985. Offshore Land: Oil and Gas Leasing and Conservation on the Outer Continental Shelf. San Francisco: Pacific Institute for Public Policy Research.

Rothbard, Murray N. [1982] 1998. The Ethics of Liberty. New York: New York University Press.

———. [1973] 2006. For a New Liberty: The Libertarian Manifesto. Auburn, Ala.: Ludwig von Mises Institute.

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John Brätland is an economist with the U.S. Department of the Interior in Washington, D.C. A specialist in Austrian School economics, Dr. Brätland is the author of “Capital Concepts as Insights into the Maintenance and Neglect of Infrastructure, (Summer 2010); Resource Exhaustibility: A Myth Refuted by Entrepreneurial Capital Maintenance (Winter 2008); and Externalities, Conflict, and Offshore Lands: Resolution Through the Institutions of Private Property (Spring 2004).