Optimal Resource Extraction Contracts under Threat of Expropriation

33 Pages Posted: 14 Jan 2008

See all articles by Eduardo M. R. A. Engel

Eduardo M. R. A. Engel

Yale University - Department of Economics; National Bureau of Economic Research (NBER)

Ronald D. Fischer

University of Chile - Center of Applied Economics (CEA)

Multiple version iconThere are 2 versions of this paper

Date Written: January 2, 2008

Abstract

The government contracts with a foreign firm to extract a natural resource that requires an upfront investment and which faces price uncertainty. In states where profits are high, there is a likelihood of expropriation, which generates a social cost that increases with the expropriated value. In this environment, the planner's optimal contract avoids states with high probability of expropriation. The contract can be implemented via a competitive auction with reasonable informational requirements. The bidding variable is a cap on the present value of discounted revenues, and the firm with the lowest bid wins the contract. The basic framework is extended to incorporate government subsidies, unenforceable investment effort and political moral hazard, and the general thrust of the results described above is preserved.

Keywords: Taxation, Mining, Rent extraction, Royalty, Non-renewable natural resource, Present-value-of-revenue auction

JEL Classification: Q33, Q34, Q38, H21, H25

Suggested Citation

Engel, Eduardo M. and Fischer, Ronald D., Optimal Resource Extraction Contracts under Threat of Expropriation (January 2, 2008). Cowles Foundation Discussion Paper No. 1636, Yale Economics Department Working Paper No. 34, Yale University Economic Growth Center Discussion Paper No. 960, Available at SSRN: https://ssrn.com/abstract=1083651

Eduardo M. Engel (Contact Author)

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Ronald D. Fischer

University of Chile - Center of Applied Economics (CEA) ( email )

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