It is a one-stop solution the government seems to have found to preclude allegations of corruption in the allocation of natural resources - hold an auction. From oil and gas blocks to coal blocks to spectrum bandwidth, auctions have become the preferred mode of sale to both ensure transparency and generate substantial revenue. The civil aviation ministry even considered auctioning unused and future bilateral rights (rights to fly to foreign destinations negotiated with destination countries), though the proposal was eventually stalled due to internal differences over its advisability. The reverse auction, where the government is the buyer of goods or services, has also become an effective means of driving down prices, especially in the case of solar tariffs.
Last year alone, a total of 55 coal mines were auctioned over three rounds, of which 28 went to private companies and 27 to Central and state PSUs. 3G and broadband wireless spectrum was auctioned too, earning the government over Rs 1.1 lakh crore. This year, there are expectations of another Rs 70,000 crore from the auction of 67 small oil and gas fields, which began in late May. (So far, under the New Exploration Licensing Policy or NELP, formulated in 1998, over 250 hydrocarbon blocks have been auctioned across nine rounds.)
Two Supreme Court judgements have also contributed greatly to making auctions the norm across government departments. The first, in February 2012, cancelled 122 Unified Access Services (UAS) licences for 2G spectrum, awarded four years earlier, thereby bringing closure to a scam that had rocked the previous United Progressive Alliance (UPA) government. The second, in August-September 2014, cancelled 204 coal block allocations made since 1993. In both cases, the court found fault with the process of allocation, which it maintained favoured particular entities and deprived the exchequer of considerable revenue. In both cases, auctions have since been held to arrive at a fair price, and ensure transparency.
Auctions are indeed an excellent means of price discovery of a product or resource - the most effective recourse when there are a number of potential buyers and revenue maximisation is the key objective. It reduces the discretionary powers of those entrusted with the sale, thus reducing the potential for corruption. Auctions can be of many kinds - the type chosen depending on objectives other than revenue maximisation, such as efficiency, or various technical considerations of the market in question. Auction rules can also be suitably framed to target specific objectives, or even to guard against market dominance. Rules can also impose service obligations on the winners, such as a 'use it or lose it' provision that necessitates starting the auctioned service within a time limit.The Devil is in the Details
But auctions are not always a fool-proof means of fair exchange. The design matters, and a poorly designed auction can lead to bad or perverse outcomes. For one, bidders have to satisfy technical standards to qualify; and the discretionary power of the assessing authority - usually a procurement committee - can never be entirely done away with. This power can be used to exclude certain players or promote some at the expense of others, even unintentionally.
For another, there is always the possibility of rigging through collusion, unless rules have been very carefully devised. A blatant instance of misuse, for instance, was a 1994 telecom spectrum licence auction in New Zealand, where the government made the mistake of not fixing a reserve price. While the winning bid was for NZ$ 7 million ($4.9 million at current rates), the second highest was a mere NZ$ 5,000. Since this was a second-price sealed bid auction, the winner got the spectrum at the drastically lower price offered by the second highest bidder, suggesting collusion between the two.
There is also the phenomenon of the 'winner's curse' - a participant bidding so aggressively that the asset is no longer worth the amount paid for it. This can happen when the value of the asset is relatively unknown before the auction. A fourth pitfall is the possibility of an unexpected, post-auction deterioration in the quality of the asset, which could leave the winner facing losses. The global commodity prices crash in the last two years, especially the fall in the price of crude, is a prime example, and has affected the use of exploration licenses.
Auctions 101
The third kind is the first-price sealed bid auction, which is essentially the same as the Dutch auction - here each potential buyer submits a sealed bid independently. On opening the bids, the one who bid the highest wins at the price he suggested. The fourth kind is the second-price sealed bid, akin to the English auction, where, once more sealed bids are submitted, but the highest bidder pays the price proposed by the second-highest bidder.
There is also the reverse auction, in which the objective is price minimisation. In such auctions, the government is the buyer, while there are several potential sellers - the winner is the one who offers the product or service at the lowest price, subject to satisfying technical requirements. Again, this is similar to inviting sealed bids by floating a tender. The reverse auction has lately been widely used to award infrastructure and other projects. One of its major successes, coupled with a global fall in the price of solar panels, has been in driving down the tariff for solar power.
In practice, we see combinations and variations of the different auction methods. These include online auctions, the use of rounds, the setting of reserve prices, and the imposition of time limits per round or bid. There is the Simultaneous Ascending Auction, where sealed bids are invited and several rounds of bidding held, with the highest bid of each round being made public before going into the next. There is the Simultaneous Clock Auction, where the auctioneer declares the prices of different items on sale and bidders respond with the quantity they want, which leads to the price of the items in excess demand being progressively raised.
There are combinatorial auctions, where bids are placed on combinations of the different items being auctioned rather than each one separately. Telecom spectrum allotment, in particular, which has a long history of auctions dating from 1994, has used all kinds of formats, from the second price sealed bid to the combinatorial auction.
The Indian Experience
In India, the NELP, under which oil and gas blocks are auctioned, was initially considered a very good auction mechanism. But its impact on supply has been muted. Participation too has been low. Few international majors have taken part in the bidding. Investment commitments made by successful bidders have often not been fulfilled. There have also been inordinate delays in bringing discoveries into production. The natural gas in the Krishna Godavari basin, discovered in 2004, could be brought into production only in 2009. It is now argued that the failure to increase supply, and lack of ex-post enforcement, can be traced to the NELP design itself.
Telecom auctions have also had their share of teething problems. The first one, in 1994/95, fared poorly. The country was divided into 23 circles and spectrum for each auctioned, along with the licence to offer 2G services. But rules were changed in the middle of the auction process, leading to much confusion. The government announced a cap on the number of circles a participant could bid for only after the first round of bidding had been held. It also decided to set reserve prices - using the bids for each round to gauge the reserve price for the next - after auctions had already begun. Eventual winners were asked to match the licence fee quoted by the highest bidder (whose bid may have been rejected for technical reasons). With some declining to do so, claiming the price was too high, rebidding had to follow.
Still, the subsequent telecom auctions have seen many changes and improvements, and have garnered considerable revenue for the government. Partly due to advances in technology, telecom policy has also undergone changes (including a phase of allocation instead of auction in 2008 which resulted in the 2G spectrum scam), with unified licences becoming the norm and obtainable for a fixed sum, delinking them from spectrum allocation through auctions.
The lack of clarity in policy has also affected coal auctions. The first round, in February 2014, received less than expected participation. Of the three blocks put up for auction, one received two bids while the other two were totally ignored. Later auctions, though, have done better.
Keep Calm and Carry On
So what can be done to improve the outcome of government auctions? Auction design must include a consideration of the main objective of the auction, market design, complementarities in the market or the objects of bidders, the presence of information asymmetry between participants, and so on.
Collusion and cartel behaviour pose the biggest risk to an auction. While there is no one clear mitigation strategy, the incentives of market participants need to be well understood. Complementary goods should be sold together wherever possible, and bids should be tested statistically before winners are announced. There are several theoretical prescriptions available for doing so.
It has also been observed in some cases that bidders effectively parcel out the resources among themselves, by not bidding for the same resources, and thus lowering the price that each winner pays. The post-auction cancellation of the coal licenses of Jindal Power occurred because the government suspected collusion to keep bids low. Even at the risk of occasionally getting it wrong, the government should continue to ruthlessly act against suspected collusion.
Market design is also very important, to prevent underutilisation, which happens when bidders buy up blocks simply to deny access to other participants. This can be achieved through high reserve prices, and by imposing penalties or upfront payments for speculative bidding.
Information asymmetry can be a problem too. A consortium of BHP Billiton and GVK Industries, for example, placed bids for seven deep-water blocks during NELP VII in 2008, and won all of them. But later it could not meet its investment commitments, leading to delays in exploration. Analysts have suggested that this was because it was only after the auction that the consortium realised it was the sole bidder, and might therefore have submitted a bid higher than the actual value of the blocks. There is the possibility that it was not properly informed about the true value of the blocks. Information asymmetry could have been mitigated by publishing geological databases relating to the blocks, or through the use of reserve prices, which would improve a bidder's estimate of the true value.
Setting reserve prices also has other advantages: it mitigates the problem of collusion. But while reserve prices help, the auction designer must also take care not to set these too high, or there might be little or no participation.
Most of all, the government needs to adapt to changing markets, and increased use of technology. In telecom and IT, especially, advances are taking place so fast that the products being auctioned can become obsolete by the time of the auction. A willingness to consult experts, to hire the best designers, and to experiment with improvements, will also help.
"Crony capitalism, where the rich and the influential are alleged to have received land, natural resources and spectrum in return for payoffs to venal politicians? is harmful to free enterprise, opportunity, and economic growth," Reserve Bank of India Governor, Raghuram Rajan, said in a speech in 2014. India has a long way to go before its business environment can completely escape the crony capitalist tag. But the increased use of transparent, well designed auctions is a step in the right direction. If the momentum continues, perhaps the next RBI governor will have reason to sound more upbeat.
The author is a Delhi-based freelance journalist.