THE EXPLOITATION OF NON-RENEWABLE NATURAL RESOURCES IN INFORMATION ASYMMETRY

We analyze the exploration and extraction of a nonrenewable resource under asymmetric information. The principal delegates the exploitation of a resource to an agent (a mining firm) who possesses private information about the cost of exploration; the agent learns further information on extraction costs once reserves have been established and constrain extraction. The principal can only commit to current-period royalty contracts: one discovery-transfer menu and one extraction-royalty menu that is conditional on reserves discovered. Compared with the symmetric information first best, avoiding adverse selection in extraction requires the optimum mechanism to increase discoveries by the lowest cost type and possibly others. This is tempered by a countervailing effect stemming from information asymmetry in exploration that tends to reduce discoveries, especially by higher cost types. We further detail implications on the forms taken by the inefficiencies associated with asymmetric information: abandoned reserves, excessive use of low-cost exploration prospects, and inefficient levels of technological sophistication in the exploration and extraction sectors.