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Wednesday, 15 May 1985
Page: 1950

Senator GARETH EVANS (Minister for Resources and Energy)(10.25) —in reply-Nothing that the Government has heard in this debate or during the long course of consultation which has preceded it has dissuaded us from giving our support for this measure. I think it ought to be appreciated that that consultative process has been a long one. It dates all the way back to January 1984, with the issue then of a discussion paper, and it has continued with accelerating momentum ever since. In the course of that consultation it has been apparent that there has been some opposition to the measure from some, but by no means all, of the States. But that opposition has disappeared since I undertook a few weeks ago to delay the application of cash bidding legislation to State adjacent waters for a period of two years to enable the practical operation of the legislation in its initially proposed area of application in the Ashmore and Cartier Islands to be closely monitored. Certainly, Premier Brian Burke, despite his perhaps rather extravagant speech in Perth on one occasion, has indicated to me that he no longer has the objections which have been attributed to him in this debate by Senator Durack and that he is very happy to consider the application of cash bidding to Western Australia adjacent waters in two years time and to do so with a completely open mind.

There has also in that process of consultation been opposition expressed, I am well aware, from industry, particularly through its lobbying agency, APEA-the Australian Petroleum Exploration Association-but there always is on occasions of this kind, as Senator Sir John Carrick, I think, will well remember from his occupancy of this portfolio. I believe that overall the dialogue with the industry has been calm, rational and constructive. Industry is well aware that cash bidding is not some extravagant antipodean invention of the Labor Government, but does work very well elsewhere in off-shore exploration in several other countries. Industry is well aware that the cash bidding proposal in its present form is thoroughly consistent with free enterprise business principles, and generally it is well aware that it is nothing like the ogre that has from time to time been painted.

I think the best demonstration of this comes from a speech which was given only last week, on 8 May, by Mr Alec Gorrie, the Managing Director of BP Australia Ltd and the outgoing Chairman of the Australian Institute of Petroleum to that Institute's annual general meeting in Sydney. What he said was this:

There has been much discussion lately about the proposed introduction of cash bidding for exploration licences. I believe that the industry as a whole, and certainly the majors have in the past submitted tenders on both a cash bidding and work program basis, and therefore, conclude that under the appropriate circumstances the industry is not opposed to either form of license bidding. The success of either method, however, is very much dependent on the degree of exploration data available and the prospectivity of the area concerned and hence is very much 'horses for courses' rather than one system being superior to the other.

I readily acknowledge that there are qualifications in that statement and there is a difference of opinion about the prospectivity of the area, as to whether it is sufficiently high to justify this, but it is, albeit with those qualifications, a very firm and explicit statement that cash bidding has attractions and advantages and really is not something which justifies the opprobrium that has been heaped upon it as a system by so many contributors to this debate.

If I have not budged, as Senator Jack Evans said in the course of his contribution, one inch from the position where I started, it is not because I have been, I believe, pig-headed or closed minded about the issue-in fact, I approached it when I inherited it with a completely open mind-rather, it has simply been because neither I nor the Government have been persuaded by any of the arguments that have been put. I believe that there is a rational and persuasive answer to be made to every one of the criticisms that have been advanced of the cash bidding proposal. Perhaps the briskest way of putting those criticisms and answers on the record is to seek the leave of the Senate to incorporate, if I may, in Hansard the relevant sections of my speech to the Australian Petroleum Exploration Association's annual conference in Perth on 26 March 1985.

Leave granted.

The speech read as follows-

Cash Bidding

For some time now the Government has been concerned about the equity and efficiency of our system of awarding offshore exploration permits. We have difficulty in continuing to support a system which, in competitive situations, produces numerous more or less identical offers of work commitments which are almost impossible for Governments to pick and choose between, and which may then subsequently not in fact be met by the successful bidder because the work program proves not to be commercially viable.

The inherent weakness of a work program bidding system (at least one whose integrity is maintained) is its inflexibility: it requires resources to be committed not on the basis of current assessments of prospectivity and commercial reality, but those of up to six years ago. To allow exemptions from a work program once commenced undermines the credibility of the system and is inequitable to unsuccessful bidders; but if pursued to its logical conclusion, the work program system requires the Government to force permittees to complete uneconomic work programs, which is a clear waste of national resources.

It is overwhelmingly for these reasons-our desire to improve upon the economic efficiency, equity and administrative workability of the allocation of exploration permits in competitive situations-that we have moved to introduce legislation enabling the use of a cash bidding system in areas considered to be highly prospective.

While there is a secondary revenue objective-viz. to ensure, by the combination of cash bidding and RRT, that the community receives its appropriate share of economic rent-the primary objective is to enable the free play of market forces to substitute for Government regulation in the interests of allocational efficiency: an objective which one might reasonably expect to be vigorously supported in an industry gather such as this.

Cash bidding systems of one kind or another are used extensively in the U.S., U.K. and Canada, so quite apart from their inherent economic rationality, the Government's proposals do not even have the quality of untested novelty (which, I am well aware, can provoke shivers of apprehension in the business community for even the most worthwhile proposal!)

The elements in the Government's cash bidding proposal are well enough known by now not to require repetition to this audience. It is the case that in the long process of evolution of this legislation, very careful consideration has been given to the extensive comments received from industry, the States and the Northern Territory, and the legislation when shortly introduced will contain some minor modifications to the original proposal to address particular concerns. But the basic elements in the proposal remain as they have been communicated to you, and I believe the most useful way in which I can spend the remaining time available to me is to specifically address the main criticisms which APEA has put forward.

(1) ''Cash bidding will reduce the funds available for exploration''

The assumption underlying this argument is that the funds available for exploration are fixed-that the Australian exploration industry is a ''closed shop'' within which a given amount of funds circulate, without either escaping or being topped up.

But there is no reason at all, either in principle or as a matter of practical experience, to suppose that this is so. While it may be that the payment of a cash bid to acquire good acreage will require some companies temporarily to divert funds from other exploration activity (rather than arranging new funds or diverting funds from some other company activity), it is not likely that other petroleum prospects with attractive profit potential will be neglected for very long. It is simply a matter of the companies' priorities being rearranged in a normal commercial decision-making manner.

Whatever might be the case in the very short term, in the medium term exploration funds are not fixed; there is nothing wrong-from the point of view of the national interest or anything else-with exploration being channelled into the more prospective areas first.

So far from cash bidding operating to irrecoverably divert a given quantum of funds from Australian exploration activity, information which has come to my Department from overseas sources in the last week suggests to me that the net effect of the introduction of cash bidding may be to add substantially to the pool of investment funds available for exploration in the medium term. It appears that a number of overseas companies with no previous experience in Australia, who have been very reluctant hitherto to compete against those with local knowledge and experience in work program bidding, have now expressed an inclination to participate in cash bidding auctions, where they see their lack of on the ground experience as no hindrance.

If the objection is that, within a particular highly prospective and high priority cash bidding area, there will be a shortage of available capital for subsequent exploration, the answer again is straight forward. In deciding to bid for a particular permit, a company will both design an exploration program that enables it to properly assess its petroleum potential, and estimate the expected return from that program. The extent to which the estimated return will exceed the company's required return will determine the size of its bid. The bid may be large or small depending on the particular circumstances but, if rationally calculated, will not reduce the amount of exploration expenditure identified as appropriate for that particular permit.

Generally speaking, I continue to believe that the farm-in analogy is an apt one when assessing the implications of cash bidding for funds availability. In the 100 or so offshore permit areas released in the last five years, there have been at least 50 occasions where parties have paid up front premiums to farm in to a permit, sums of an order of magnitude that could be expected to result from cash bidding. The decision to acquire a farm-in right is a normal commercial one based on the commercial realities of the day, and often made very quickly: in one recent farm-in proposal an Australian company was able to decide within 30 days to pay tens of millions of dollars to a foreign company for the latter's interest in an attractive permit, which action appears hardly consistent with the notion of a fixed corporate exploration budget.

If the point is made that at least in the case of farm-ins the funds remain within the industry rather than being drained off into the public purse, the short answer is that not only will it make no difference in practice to the decision of a farming-in company what happens to the premium it has paid, but it simply cannot be assumed that the recipient of farm-in funds will in fact reinvest them in petroleum exploration in Australia.

(2) ''Cash bidding, involving an upfront payment, is inconsistent with the spirit of the RRT concept, which requires a threshold rate of return''

The Government does not acknowledge any inconsistency between cash bidding and RRT. They are complementary measures which will operate together to collect for the community a share of the economic rent, or super profits, which results from the exploitation of Australia's petroleum reserves.

Because of the lack of complete knowledge about a prospect before it is fully explored, the amount of any particular cash bid is likely to prove either too high (disadvantaging the bidder) or too low (disadvantaging the community). The co-existence of cash bidding with RRT evens out these risks. The existence of RRT (and the non-deductibility of cash bids against it) means that companies will be deterred from overbidding; at the same time the existence of an RRT regime of certain dimensions, in place alongside the cash bidding system, means that companies will not face the risk that, in the event of a cash bid proving too low in the light of subsequent discoveries, some additional form of tax will be imposed to increase the community's take.

Putting it in summary form, by combining cash bidding with RRT, companies can bid with certainty as to the return the community expects, and because of the RRT, will be deterred from over-bidding.

Revenue the Main Motive? This is a convenient point to deal with a further objection to cash bidding which, although not put explicitly by APEA in these terms, underlies much of the negative industry response: this is the assertion that the Government's main motive in introducing cash bidding is revenue.

There is, to put it brusquely, no foundation whatever for this assertion. The primary objective is to enhance the economic efficiency and equity with which highly sought after permits are allocated, and to overcome deficiencies in these and other respects in the present work program bidding system. (I shall return below to the question of the relative merits of cash and work program bidding). While there is, as I have already said, a secondary revenue objective (viz. to ensure, by the combination of cash bidding and RRT, that the community receives its appropriate share of economic rent), it should be clear from any examination of our proposed cash bidding legislation that the Government is not seeking to maximise revenue from this source.

If revenue was the key concern then the Government would be offering large permits with unlimited renewal options; it would be encouraging speculators; and it would be allowing deductibility of cash bids against RRT and company tax. I might add that the argument that cash bidding only works overseas because of higher petroleum potential, and will not work in Australia, is not an argument against cash bidding as such but merely an argument for lower cash bids.

(3) ''Cash bidding will be a disincentive to offshore exploration because of the extra financial risk involved''

The short answer here is that companies will take into account the expected risks and costs involved in exploring a permit when they are considering bidding for the permit, and the size of the cash bid will reflect that calculation.

The cash bid in no way changes the risks or the costs involved (other than the up front cost of the cash bid itself); rather it is the risks and costs-the expected return weighed against the required return-which influence the size of the cash bid.

Compared with the work program system, the cash bidding system will actually reduce the risks faced by companies. Under the cash bidding system, companies will be free to undertake the most commercially viable exploration program consistent with changing economic conditions and prospective assessments. Under the work program system, by contrast, companies are committed to an exploration program designed up to six years in advance, and must face the considerable risk that changing circumstances will make that exploration program uneconomic.

(4) ''Cash bidding is an inferior system to work program bidding in the Australian context''

In answer to this objection, I can only repeat and expand upon the points I have already made in outline. We believe that in economic terms, cash bidding systems are the most efficient means of allocating exploration rights when competition is high; and that cash bidding has in addition significant advantages in terms of equity and administrative workability over the work program bidding system.

To be more precise, the work program system:

first, encourages companies to propose substantial exploration programs that may later prove to be uneconomic either because of changes in economic conditions or a downgrading in prospectivity following initial exploration;

secondly, forces the Government, where a work program becomes uneconomic, to either agree to exemptions from parts of the work program, which undermines the credibility of the system and is inequitable to unsuccessful bidders, or require the permittee to undertake the uneconomic exploration under threat of cancellation of the permit: neither course is in the long term interest of the exploration industry;

thirdly, requires a subjective selection of the winning bid where competition is high, as no amount of technical advice can differentiate between work programs of a similar size; nor can that advice predict whether the work program will actually be completed by the applicant; and

fourthly, is costly and complex to administer, as work programs must be verified throughout the life of the permit in order to maintain the credibility of the system.

Recent experience in the Gippsland Basin illustrates these difficulties. Applications were invited in 1980 for three permits for highly prospective areas, attracting 29 bidders overall with more than 8 for each permit. Most bidders proposed large work programs, but a whole variety of different exploration philosophies were involved, and acute difficulties were experienced in choosing administratively between them. In the result, after all this effort, there is no evidence that the Government got it right: one permit was surrendered after only four wells were drilled from a commitment of twelve; in another, only six wells have been completed from an original program of nineteen and there is doubt about the future program; and the third permittee has deferred some commitments and applied for a reduced program.

Various modifications to the work program system have been suggested from time to time, but none of them address the problems I have outlined. Performance bonds could force uneconomic work to be completed; don't address the problem of differentiation between bids; and, because of the problems of verifying the cost of work completed, would add significantly to administrative complexity and cost. Dry hole bidding would overcome some of the problems associated with over-bidding, but would exacerbate the problem of differentiation in that it is likely that a number of applicants would specify the same number of wells. Even more stringent administration of the present work program system, as urged by APEA, would not make the problem of differentiation any easier to solve, and would only reinforce the problem of inflexibility which lies at the heart of the present system.

What cash bidding will do is give explorers the opportunity to adopt the optimum and most economically efficient exploration philosophy based on progressive acquisition of information about the permit area. Commercial judgments can be made about the appropriate level of exploration at any given time, without the heavy (albeit well intentioned!) hand of government regulation intruding. In that happy state of innocence which prevailed until I took on this portfolio, I had thought that this is what private enterprise was all about.

(5) ''Cash bidding will discriminate against most Australian companies, which do not have access to large amount of exploration capital from production cash flows''

It has to be squarely acknowledged that there are and always will be difficulties in local explorers taking offshore leases, because of the very high capital outlays involved. In keeping with the high costs, the high risks and the high level of technical skills necessary, it is only the stronger companies that will be able to participate-but this has been as true of work program bidding as it will be for cash bidding. Under either system, the applicant who values the permit highest will be the one prepared to bid the most.

As has been the case in the past, it is very likely that consortia including Australian companies will be formed to bid for permits under the new system. Although there are no Australian equity requirements at the exploration stage, many foreign companies seek to include Australian companies in their consortia because of the 50 per cent local equity requirement should petroleum be found and developed. Under cash bidding, there is no reason whatever to anticipate a change to this practice.

Senator GARETH EVANS —I will summarise the answers there made very briefly and put it this way. In the first place, cash bidding will not reduce the total funds available for exploration in this country. It is not, as I have said on numerous occasions, to be regarded as some kind of closed shop for funds available for exploration expenditure or a zero sum gain whereby money directed to up-front cash bids is necessarily to be regarded as money thus unavailable for expenditure elsewhere.

Senator Durack himself acknowledged in the course of his speech that foreign investment, in terms of the supply of funds from overseas, is likely, in fact, to increase under this regime. He seems to have accepted the statements that I have made on several occasions that the cash bidding auction system has been perceived by a number of exploration companies overseas that have not hitherto ventured into Australian waters as being an admirable opportunity to do so that does not demand the same kind of knowledge of local conditions and government behaviour that is so much an indispensable prerequisite for living with a work program system. It is also a point in relation to this criticism that farm-ins have operated on a massive scale in recent years in relation to off-shore acreages after their release and that farm-ins are analogous in a number of crucially irrelevant ways to the cash bidding system. A lot of money has been spent other than from companies' exploration budgets to take advantage of buy-in opportunities of this kind. When money has been spent in this way, a lot of it has left the country rather than being redirected into further exploration expenditure by the recipients of it.

The second answer which I made and which I repeat now is that cash bidding is not inconsistent with resource rent taxation. Its primary motive is, of course, not to secure more government revenue. Revenue is, as I have always publicly acknowledged, a secondary objective in this exercise. It is certainly not and never has been the primary objective and the scheme would have been constructed on a very different basis had it been a primary objective. I will come back to that point later.

The third point that I would make by way of answer to the critics is that cash bidding will not be a disincentive to off-shore exploration because of the extra financial risk that is involved. The amount of the bids that is forthcoming will, of course, be contingent on the assessments by bidding companies of the likely returns from the exploration in question. There will be, as a result of this system, a complete flexibility of operation with no need on the part of the participating companies to pursue uneconomic prospects in the way that they are obliged to do under the letter of the present work program system. In other words, all sorts of financial disabilities are attached to the present system which will not flow through to the cash bidding regime.

The final point I make in answer to an oft repeated criticism is that cash bidding will not discriminate against Australian companies, especially small Australian companies, any more than the present system does. The reality is that off-shore exploration is a very expensive business which is beyond the resources and capacity of all but the most substantial companies unless, now, under the work program system, they can band together in consortia of one kind or another. Similarly, there will be all sorts of incentives for that to occur in the context of cash bidding and I and the Government cannot believe that the result there will be any different.

Of course, the positive case for cash bidding depends not just on answering the criticisms that are specifically directed at the Government's legislative model but rather by establishing that this model is superior to any other system now available or that might reasonably be created for allocating exploration acreages at least for highly prospective areas for which there is a great deal of competition. In the course of discussions and negotiations with the industry and, it must be said, with the Australian Democrats, that have taken place in recent months, three basic alternatives to our cash bidding proposal have been canvassed: First, the maintenance of the existing work program system; secondly, the supplementation of that existing work program system with some arrangement for performance bonds, perhaps further backed by bank guarantees; and, thirdly, a replacement of the present work program system with a system of dry hole bidding.

Let me quickly advert to each of these suggested alternatives. First, as to the existing work program system the difficulty is that, while it works well enough for non-competitive acreages where there is not much competition to get into some particular area, it simply does not work well-this has been the proven Australian experience-for the kinds of highly prospective and highly competitive acreages that we are talking about, and only talking about, as appropriate candidates for the application of cash bidding. There is a fundamental logical problem about the application of the present work program system that I have been trying-I think ultimately with some success-to explain to the Australian Democrats and to others, which I summarise as follows: Either one enforces a successful work program bid with absolute rigour, which may then well result in forcing the company after an initial run of unsuccessful drilling to engage in further activity which is obviously uneconomic and a waste of resources; or, on the other hand, one enforces the successful work program bid with discretion, not requiring a company to go on drilling uneconomically when it is clear that a prospect has been thoroughly worked over and found to be, in effect, dry, in which case one loses the capacity of the system to deliver for the purposes of initial selection.

Let me put the point another way by saying that once it becomes apparent that any work program bidding system is not to be followed up by absolutely rigorous requirements that the full successful bid is worked through, there is no disincentive on the bidders to strike a bid which is artificially high and which they never have any intention of honouring. Once that happens and one loses the credibility and integrity of the bidding system, one loses the capacity, when one is at the government end of the process of trying to pick and choose between bids, of doing so on rational grounds. One simply knows the bids one is getting are inflated bids-inflated by the knowledge on the part of the bidders that they will not have to honour the particular bid they are putting in. That is the basic difficulty.

Associated with that are all sorts of difficulty in picking and choosing between competing work program bids when one is talking about highly competitive and highly prospective areas. The example I have used in the past, and I use again because it is still very present to the Government's recollection, is the applications that had to be dealt with in 1980 for three Bass Strait permits for highly prospective areas, P17, P18 and P19, which attracted 29 bidders overall and more than eight for each permit. As I said in the speech to the Australian Petroleum Exploration Association, a copy of which has already been incorporated, most bidders proposed large work programs with a whole variety of different exploration philosophies, and it was enormously difficult to pick and choose between them. In the end, after a great deal of effort was put into that process there is no evidence that the Government actually got it right in the sense of the subsequent experience. One of the permits was surrendered after only four wells were drilled from a commitment of 12; in another only six wells were completed from an original program of 19, with doubt now about the future of the whole program. In the third the permittees deferred some commitments and applied for a reduced program. There are all sorts of difficulties about the operation of the work program system even with the great skill, dedication and competence of my Department, and even with the best will in the world in trying to make it work.

Senator Jack Evans —Are you suggesting that cash bidding would have got it right in Bass Strait?

Senator GARETH EVANS —Cash bidding to the extent that it is a straight auction system necessarily resolves the problem in terms of initial selection. It is a necessary incident of cash bidding that the companies be given the flexibility in the five-year period of their permit to operate the program in the way they see fit. One expects that they would have engaged in a substantial exploration program. If they had, one would not have confronted the sort of problem of generating expectations which are unsatisfied, to which I am referring.

The performance bond system has been advanced as an alternative to this. It was originally urged by the Australian Democrats and flirted with the industry for as long as it seemed a useful vehicle for knocking off cash bidding, but not once it seemed as though it might actually come into force because, obviously, it is not the answer. I think that is not generally acknowledged. The difficulty with the performance bond system, which is designed to put acute financial incentives on companies to make sure that they do work out the full extent of their original work program commitment, is that while it might in that sense help to preserve the integrity or credibility of the initial bids it nonetheless accentuates the irrationality from an economic perspective that is involved in forcing people to drill uneconomic holes. I think it is not necessary to go into that in any more detail.

The third option that has emerged as the preferred position of the industry-again with the Democrats tagging along in support-is the option of dry hole bidding or what in less suggestive terminology might be referred to as guaranteed activity permit systems. The essence of that is that companies bid on the basis of not the full program they might anticipate but a minimum program in which they identify the number of holes they are prepared to drill and find dry before, in effect, abandoning the prospect. There are advantages in this system as compared with the basic work program system because it is readily and easily enforced to the extent of that minimum commitment and it does not force uneconomic, irrational exploration to occur.

The difficulty with dry hole bidding is that it does not help with the problem of initial selection. One loses one's capacity to discriminate between bids simply because, given the very nature of this bidding system, the bids will come in almost identically, with almost everyone nominating exactly the same minimum drilling program. The only way one can then move to distinguish and pick and choose between the bids is by adding a series of additional criteria. A number of those additional criteria that can be added in order to enable one to make the selection after the initial dry hole bids have come in identically are technical and objective. Some of them have been mentioned by Senator Evans in the debate. But the extent that they are technical and objective criteria-for example, the amount of Australian content in the drilling packages companies are prepared to offer-one will still have problems of discrimination because most bidders will satisfy readily enough those hurdle requirements.

What one is left with ultimately-this has been the experience in the United Kingdom, where this system has tended to operate for North Sea acreage allocation-is the necessity to have some very broad discretionary criteria up the Government's sleeve in order to make the final decision between company A, company B and company C which are bidding the same number of holes, the same minimum work program, and which are satisfying to the same extent the objective technical criteria. In the United Kingdom that residual discretionary criterion is extraordinarily open-ended. It is in terms of the contribution the bidders are thought likely to make to the overall economy of the United Kingdom.

I simply make the point-I have made it with quite a lot of vigour to the Democrats and the industry-that it is simply not appropriate in the Australian system, and with the way in which parliaments have reacted to governments, for governments to be given extraordinarily wide discretions to pick and choose between applicants for potentially very lucrative returns. It is at odds with the very kinds of principles the Australian Democrats have constantly espoused through Senator Haines and others in the Senate Standing Committee for the Scrutiny of Bills. It is just at odds with the notion that legislation should not vest in government open-ended discretions to make decisions of this kind. I can make that point only so often. I think perhaps the best way of getting it on the record again without going on too long and occupying the time of the Senate is to seek leave to incorporate in Hansard the letter of the Australian Petroleum Exploration Association of 29 April which was sent to me and which I think may have already been incorporated in Senator Jack Evans's speech. More particularly, I seek leave to incorporate my reply of 7 May which sets out in some considerable detail the Government's reaction not only to the performance bonds system and other proposals that are made but particularly to the dry hole bidding proposal.

Leave granted.

The documents read as follows-

Dear Mr Ives


Following the discussions between the Department and the Association on 21 April as well as our subsequent contact by telephone and telex, APEA Council has again discussed the offshore administration issue in detail.

The Council wishes to re-iterate at the outset its belief that an effective, rigorously enforced form of work programme bidding is in the best interests of petroleum exploration in Australia.

The Government has emphasized that it sees the key issue in 'highly prospective' permit areas as being the selection of a successful applicant in a highly competitive situation. The other political view is that enforcement of commitments made by operators to win permits is the major issue. The Association believes that latter point has more validity than the selection issue which, APEA asserts again, is capable of being handled adequately under the existing legislation.

The Association wishes to draw to the attention of all parties that the Petroleum (Submerged Lands) Act was amended last year to significantly strengthen administration and an insufficient period has elapsed to evaluate its effect on the award or administration of permits.

However, given that the Government appears to be determined not to use the existing P(SL)A system in the Ashmore and Cartier Island Adjacent Territory, the Association suggests the following approach be considered:

1. The present cash bidding Bill be withdrawn and the Government pursue the necessary amendments to existing legislation to permit it to-

(a) Declare 'guaranteed activity permits' where successful applicants will be required to guarantee their initial work programmes for the first two or three years of the life of a permit on a dry-hole, trouble-free basis;

(b) Institute a review system as practised in the North Sea by the UK Government to short-list applicants for these specially-designated permits and subject them to a detailed technical review on a range of criteria which will establish the optimum application.

2. Under the 'guaranteed activity' system the successful applicant to be penalized for non-compliance with programme commitment by having to pay to the Government a sum equivalent to the difference between work carried out and work committed on award of the acreage. Capacity to meet such a financial commitment should be one criterion of consideration of a company or joint venture for short-listing for application review.

3. The System could be structured to allow further for subsequent years' work to be similarly committed on a year-by-year basis.

4. It is necessary for some Government discretionary power to be applicable as to timing where force majeure, unavailability of contractors or equipment, or exploration disasters interfere with timely fulfilment of a commitment.

5. The successful work programme and the financial commitment should be matters of public record.

6. Except for the 'guaranteed activity permits' the Act should remain in force in its present form.

The Association wishes to make clear its continuing firm opposition to the Government's cash bidding proposals.

APEA Council requests an early opportunity to discuss further the suggestions contained in this letter with the Government.

Yours sincerely


Executive director

Dear Mr Fitzgerald,


I appreciate the opportunities we have had to discuss your Association's objections to the Government's cash bidding proposal.

As I indicated in my speech to Parliament introducing the cash bidding Bill and at our meeting on the matter, the Government's objectives in introducing cash bidding are:

(i) to allow explorers to determine and carry out the most economically efficient exploration strategy in the light of the commercial realities of the day, free from unnecessary Government regulation;

(ii) to avoid the significant shortcomings of the work program system as a selection mechanism which arise when competition for permits is high; and

(iii) to collect for the community a rent associated with award of the exclusive rights to explore, the amount of which is determined by the applicants.

The Government has not set out to introduce this system of awarding exploration permits with a view to progressively applying it to all offshore areas: our intention is to apply it only to those areas which would be generally acknowledged as highly prospective.

Nor has raising revenue been a significant consideration. As I pointed out in my speech to the APEA Conference earlier this year, if revenue was of prime importance the Government would have chosen a very different formulation of the cash bidding system.

During discussions with myself and my Department, and in subsequent correspondence, you have identified possible alternative arrangements which address only some of the objectives outlined above. You will recall this was my principal difficulty with the proposed work performance bond system and I am afraid that it remains my difficulty with the guaranteed activity system you propose in your letter of 29 April.

Difficulties with Performance Bonds

Further refinement of the work performance bond proposal has made it clear that, once steps are taken in order to meet the Government's first objective stated above (i.e. to allow the work program to be governed by considerations of economic rationality), the system's inherent integrity and credibility-and its utility as a selection mechanism-will inevitably be compromised.

The difficulty in administering such a system arises once the obvious prospects in a permit area prove to be unsuccessful. A performance bond system requiring, say, bank guarantees of around 15 per cent of the value of the work program commitment to be lodged against satisfactory completion of 75 per cent of the work program in fact concedes that a substantial part of the original work program will not be undertaken. In highly competitive areas, the remaining 25 per cent of the work program could involve several wells and many millions of dollars. Clearly, such a system invites applicants to inflate their work program bids.

Other difficulties with the work performance bond system were also noted by some of the smaller exploration companies with limited assets or cash flow in Australia. They included difficulties in raising and maintaining large bank guarantees that would clearly tie up vital capital. Unlike a cash bid, which is a sunk cost and which does not affect the future cost of exploration, a bank guarantee involves interest payments which are ongoing and will influence future decisions on exploration.

We note further that performance bonds have been seen by smaller companies as conferring advantages on the large exploration companies, who-unlike their smaller brethren-would not be likely to be required to actually lodge funds to obtain a bank guarantee.

I can well understand, in the light of considerations such as these, that your Association should now have moved away from its earlier tentatively expressed support for a work performance bond system.

Difficulties with a ''Guaranteed Activity'' Permit System

The system of awarding permits which you now propose in your letter of 19 April would undoubtedly be more rational, in the sense that it would be based on a dry-hole work program for the first two or three permit years, followed presumably by negotiated work commitments on a year-by-year basis. Since the initial commitment is in effect the absolute minimum needed to explore the area in question, it is unlikely that many bona fide permittees would fail to comply with the work requirements.

I acknowledge, generally, that this approach certainly avoids the dilemma of trying to maintain the credibility of a permit award system without requiring uneconomic activity to be carried out in order to maintain title over the area.

But there are, nonetheless, a number of difficulties with the proposed system which make it ultimately much less attractive than the cash bidding system proposed by the Government. The most fundamental arise from the fact that any dry-hole bidding system, such as that proposed, is unlikely in itself to constitute an effective selection mechanism-since bids of this kind are likely to be almost identical in character-unless accompanied by unacceptably wide discretions vested in Government decision- makers.

You acknowledge the need for a supplementary discretionary procedure by proposing that the Government should ''institute a review system as practised in the North Sea by the UK Government''.

But on the basis of our enquiries, I do not believe that application of the UK practices in the Australian context are as straight forward (or would be as acceptable to the Parliament) as you infer.

I am advised that under the UK system, work program commitments only represent an agreed, achievable, program of work which excludes unrealistic proposals designed simply to attempt to win the licence. They are by no means the most important consideration in the selection of a successful bidder. In each UK North Sea licencing round, a range of extraordinarily diverse selection criteria apply, and the UK Minister exercises almost open-ended discretion in awarding permits based on these criteria (see, for example the most recent set of selection criteria at Attachment A).

While the discretionary criteria involved may have some superficial attractions, there are at least four serious practical difficulties in their application in Australia:

(i) There would be obvious difficulties for the Commonwealth and the States/NT in reaching agreement on the criteria to apply in relation to each area and in the relative weighting to be given to each of the criteria.

(ii) Administrative law in Australia has developed considerably from that applying in the UK, particularly in relation to review of discretionary decisions. The rigidities imposed by the Administrative Decision (Judicial Review) Act and the Administrative Appeals Tribunal Act-accepted as desirable in confining otherwise free-ranging official discretions-do not encourage the adoption of a highly discretionary system along the lines of the UK system.

(iii) The adoption of such a system in Australia will be at odds with the view taken by the Commonwealth Parliament on the inclusion of highly discretionary provisions in legislation. As you will be aware, the Senate Standing Committees on both Regulations and Ordinances and the Scrutiny of Bills report adversely on legislation or regulations which makes rights, liberties and/or obligations unduly dependent upon insufficiently defined administrative powers or dependent upon non-reviewable administrative decisions. I do not believe it would be possible to justify the adoption of such a highly discretionary system in a way which would be acceptable to the Parliament.

(iv) A highly discretionary system would seem to be a disincentive to those potential investors, not presently involved in Australian petroleum exploration, who have indicated a willingness to participate in a cash bidding round, where familiarity with the local political and administrative systems is not a practical prerequisite. Discussions with companies not presently exploring in Australia suggests that they are attracted by the prospect of a system where there are few advantages to be gained by ''knowing-the-ropes''.

In the absence of such a discretionary system for awarding exploration permits in highly competitive areas, I do not believe a ''guaranteed activity'' permit system could work any more efficiently than the existing working program bidding system. In fact, it is likely to involve considerably more administrative work than the current system and is likely to add to the complexity of that work.

Difficulties with Proposals to Strengthen the Administration of the Work Program Bidding System

A recurring theme in the discussions that have taken place on the cash bidding system is that there is room for improvement in the particular administration of the present work program bidding system. But quite apart from the difficulties, from the point of view of economic rationality, that flow from a work program system that is too rigorously and insensitively enforced, it should be said that in recent years a more stringent approach to administration of the existing provisions of the legislation has in fact been undertaken. This has involved tougher criteria for work program variations, early cancellation of permits where commitments have not been met and tougher negotiation on proposed work program commitments. Over the past two years, 13 exploration permits were cancelled for non-compliance with work conditions and a further 25 permits surrendered by permittees not willing to carry out further work in the areas. I believe an even more stringent approach to permit administration would not be conducive to the maintenance of ongoing exploration in Australia's offshore areas, nor would it be consistent with the economically rational approach industry is suggesting we pursue.

Your Association has also suggested that the Petroleum (Submerged Lands) Act was amended last year to significantly strengthen administration and that an insufficient period has elapsed to evaluate its effect on the award or administration of permits. I have difficulty in understanding the significance of this proposal as the only amendments which are relevant to our current discussions are of a purely drafting nature and have no bearing on the stringency of permit administration.

To sum up, I believe that neither the work performance bond system, nor the ''guaranteed activity'' system, not any other variation on the present system of work program bidding, satisfies the Government's objectives in introducing the cash bidding legislation. The Government has closely, carefully and in an open-minded way examined all the alternatives to cash bidding, and the views expressed both publicly and privately about cash bidding.

We are convinced that cash bidding is the most efficient means of awarding exploration rights in the circumstances identified by the Government and is the only system which allows companies to pursue the most commercially attractive exploration strategies free from unnecessary regulation.

Yours sincerely,


Senator GARETH EVANS —I draw towards the end of my remarks by saying that the Government's clear preference remains for cash bidding because we believe, first, that it will avoid the significant shortcomings of the work program system as a selection mechanism which arise when competition for permits is high and, secondly, that it will allow explorers to determine and carry out the most economically efficient exploration strategy in the light of the commercial realities of the day free from unnecessary government regulation. In the event that this Bill is defeated, as has been clearly enough foreshadowed by the Opposition and the Australian Democrats together, it will be a matter of the Government setting up, or shoring up, the selection system as best it can. In that respect, as I have said to the Democrats and the industry, I will certainly give consideration to at least some of the alternative mechanisms that have been floated during the debate and the consultative process. There is something to be said for the dry hole bidding system, but how on earth we make it work consistently with the opposition that this Parliament has traditionally had to open-ended discretionary criteria remains to be seen, I suppose, on another occasion.

It will also be a matter of the Government having a closer look not only at the selection mechanism but also at the financial implications of a decision not to support this legislation. The proposals to introduce cash bidding in highly prospective areas have been misrepresented on a number of occasions as an attempt to obtain additional revenue for the Government. Throughout the debate, as I said earlier in the Parliament and in the public arena, I have made it clear that additional revenue was not our primary objective. Had it been our primary objective, we would have proposed a quite different formulation of the cash bidding model. For example, we may have included provision for reserve prices, which is a feature of the United States model, and allowed certainly deductibility of cash bids for resources rent tax purposes which would have had the effect of inflating them beyond that which will be the case where they are, as now, non-deductible.

We would also no doubt have made permits for larger areas than they are at the moment. We would perhaps have made unlimited renewal rights part of the package. We would have done nothing to discourage speculators bidding for these areas. We would not have been talking in terms of the bidders having to satisfy threshold, hurdle requirements of technical competence and capacity actually to get out there and drill. Had we gone down any of these tracks, that could have been expected to very substantially increase the Commonwealth's revenue from cash bidding and would have been demonstrative of the claim that we were in fact in this for the business of revenue raising.

It is, however, the case that, even though cash bidding has never had revenue as a primary objective, some revenue, it has been acknowledged always, would accrue from the cash bidding proposals, and that revenue has been taken into account in the Government's deliberations on the 1985-86 Budget. If the cash bidding legislation is rejected the Government will be forced to look to alternative measures to make up the expected revenue shortfall. Two possible measures in this respect to which the Government is giving consideration are retention lease premiums and signature bonuses for bidders in highly prospective areas. A requirement for companies to pay a premium of, say, $10m for the award of a retention lease would recognise that companies awarded a lease will retain title over a valuable community asset for an extended period. Under the draft legislation currently before the House of Representatives retention leases may be granted over currently non-commercial discoveries which are likely to be commercially viable within 15 years. The requirement for the payment of a premium would ensure that the community receives part of its share of economic rent from the resource at an early stage. Furthermore, introduction of a premium would discourage permittees from tying up extensive amounts of prospective acreage without ongoing exploration programs. Permittees not wishing to take up a retention lease could retain title over a discovery provided a meaningful exploration work program were undertaken during each term of the permit.

The introduction of a system of fixed signature bonuses such as used overseas in some United Kingdom North Sea licensing rounds and in the China off-shore area could also be considered. The combination of a fixed signature bonus of, say, $1m for each applicant for a highly prospective area combined with a rigorous work program bidding system would help to eliminate excessive work program bids. Such an approach had the support last year of the Broken Hill Proprietary Co. Ltd as one possible alternative to cash bidding.

Clearly these measures do not represent our preferred position. However, one or other or both of them would meet some of our revenue objectives which, I repeat, are and always have been very much secondary objectives in the context of this measure. Our clear preference remains to proceed with the cash bidding amendments as set out in the draft Bill without going down any of those other tracks. I hope that in the final analysis, notwithstanding what has been said in the course of the second reading debate, there may be some last minute reconsideration of the position adopted by the Opposition and the Australian Democrats and that this legislation, which has been acknowledged to be perfectly rational and perfectly consistent with good petroleum industry exploration practice in many other parts of the world-answers to such criticisms as there have been systematically placed on the record-will command the support of the Senate.

Question put:

That the Bill be now read a second time.