The Influence of Private Contractual Failure on Regulation: The Case of Oil Field Unitization

A case study is presented of the breakdown of private contracting and the regulatory response to efforts to unitize oil fields. The focus is oil field unitization regulation in Wyoming (federal lands), Oklahoma, and Texas during the years 1948-1975. Despite large potential gains from unitization, private unit negotiations typically fail because of lease heterogeneities and associated information problems concerning estimates of lease values and holdout strategies. In response, the federal and state governments have instituted strikingly different policies to promote unitization, with different results. The regulatory policies on federal lands surmount the informational problems by encouraging unitization prior to development. In Texas and Oklahoma, however, unitization can occur only when oil fields are completely developed. Oklahoma's compulsory unit law leads to more unitized production than in Texas. The federal lands case is of general interest because federal policies are effective and, apparently, independent of the political influence of small firms in Texas and Oklahoma that benefit from nonunitized production.