A. Values change

The value of a natural resource deposit changes as conditions change. Sometimes the path of technological development can be forecast and so natural resource deposits can become valuable because new technology is anticipated to make them accessible or profitable, even if they are not accessible or profitable at the moment.Footnote ⁶ But the technology available for exploitation of a resource is just one of a host of relevant factors that change constantly: the costs of extraction and processing, the prices of substitutes, demand for the resource, and a host of other factors all affect the value of any particular mineral deposit. For example, the Alberta tar sands in Canada have been known for centuries, having provided caulk for Native American canoes, but it was not until innovations in processing technology cut the cost of recovering oil from them and external events drove the price of oil above the price point at which exploiting it became economically feasible that the tar sands became an economically viable resource.Footnote ⁷ Another example is the change in the oil refining industry from its focus on producing kerosene to its focus on producing gasoline: In the 1870s, when demand for kerosene was high, gasoline was treated as a waste product that was often simply dumped into streams. But in 1910, when faced with a shortage of gasoline and a surplus of kerosene, the refining industry invented technology that increased the proportion of gasoline and decreased the proportion of kerosene produced from a barrel of crude oil.Footnote ⁸ Today, crudes that yield higher proportions of gasoline command a price premium. A final example is the impact of environmental regulations in the United States and Europe that required reductions in sulfur contents of transportation fuels and thus affected the price of crude oil by increasing demand for low-sulfur crudes and decreasing demand for high-sulfur crudes.Footnote ⁹ These three examples illustrate changes in the value of a natural resource based on changes in technology, demand, and government policy.

Because technology, demand, and regulation all affect the market for natural resources, what constitutes a valuable resource changes over time. Fifty years ago, Alberta's tar sands had relatively little value; today they are worth billions. One hundred and fifty years ago, crude oil was a source of patent medicines and little else; today it is sufficiently valuable that billions of dollars are expended on locating new reserves. Gold mining debris from mining operations in the American West during the 1850s and 1860s is today used routinely as the raw material of processing operations, which recover a wide range of minerals from yesterday's wastes. In the opposite direction, high-sulfur coal reserves in the American Midwest have lost value as environmental concerns and regulations have shifted demand to low-sulfur deposits in the West.Footnote ¹⁰

The combination of property rights and government regulations that govern mineral rights (which I will call “mineral rights institutions”) needs to be capable of adapting to changes in regulations, changes in technologies, and changes in demand. In short, these institutions need to be adaptable in the face of incomplete knowledge about the state of the world both today and tomorrow. Without such adaptability, mineral rights institutions will fall victim to the problems that Friedrich Hayek identified as “the knowledge problem” in his classic 1945 essay “The Use of Knowledge in Society.”Footnote ¹¹ Hayek even used a natural resource illustration in that essay to make his point that dispersed knowledge about a resource's availability would be most effectively communicated by the price system:

Of course, adaptability does not mean everything is up for grabs—that produces only uncertainty. What is needed is the ability to apply principles to new situations. And Hayek's point is a general one, of course, not a point about mineral resources per se. But his argument is particularly important in the mineral context because much of the debate over mineral rights takes a static view of knowledge and places little emphasis on the need for flexible and adaptable institutions.

B. Knowledge matters

We know where some mineral deposits are. There is a great deal of coal in various parts of the United States, a lot of crude oil in the Middle East, and some of virtually everything in central Africa. What we do not know is where else there might be additional reserves of any of these mineral resources or how technology, regulation, or other factors will affect which reserves of which minerals end up in production at all, let alone when they might go into production. To use a particularly dramatic example, no one in 1847 had any notion that California would yield $550 million worth of gold over the next ten years (approximately 1.8 percent of total U.S. GDP during that period).Footnote ¹³ Today, we do not know where the deposits of natural resources that will be important in twenty years are or even how to exploit some deposits we can locate today. Most importantly, we do not know what we do not know about the location of mineral deposits.

Consider the case of crude oil, a valuable resource in high demand that has been the subject of intensive study for over a century. A 2007 U.S. Government Accountability Office examination of oil reserves looked at the impact of technological change on reserves and concluded:

As the report makes clear, despite over a century of study and intense interest, we still know very little about the source of oil resources we will use in the not too distant future.

It is tempting to think that these gaps in our understanding of natural resources are merely historical, that we have now reached the point where we understand the geology of the resource deposits, the technology of recovery, and all the rest of the factors influencing the use of particular resources well enough so that we at least already know what we do not know and have some idea when we will know it. This is incorrect. While our knowledge has improved over time, there are still major gaps in our knowledge about the types of resources that can be physically and economically exploited. This missing knowledge is inevitable because it is the result of two factors: the types of changes in markets that Hayek described in the excerpt previously quoted, and advances in science and technology. Such gaps in knowledge complicate natural-resource-related planning immensely and are an important reason why a system of private property rights is generally superior to a system based on politically determined central planning.

Central planning is superior to decentralized decision-making when the relevant information needed for the decision can be cheaply collected and transmitted to an expert decision-maker whose expertise allows superior decision-making. (We should also worry about whether the decision-maker in the central planning scheme is likely to be influenced by special interests, but that is a separate issue.) This is precisely the problem with respect to many mineral rights questions: Should we mine a particular site or should it be a ski resort? Is it worth a ten-year, $100 million investment to develop a new oil field, or will demand for this particular type of crude oil fall in the future? What will happen to demand for copper in the future as cell phones and voice-over-internet phones running on fiber optic cable increasingly take the place of landline phones that rely on copper wire networks? Answering such questions generally requires more information than any one individual can obtain, and thus relying on decentralized decision-making is preferable.

Central planning can even be problematic with respect to controlling environmental damage from the exploitation of natural resources. Central planners lack the detailed knowledge of local conditions and the incentives to tailor regulatory measures to local conditions. The growing environmental federalism literature has demonstrated the benefits to the environment of moving decisions closer to the sources of problems, and the free market environmentalism literature has documented how the combination of common-law causes of action and property rights can resolve a wide range of environmental problems.Footnote ¹⁵

The impact of the lack of knowledge can be seen clearly in historical accounts of natural resource development. For example, early California settlers were unaware of the state's mineral riches. Even once gold was discovered at Sutter's Mill, prospectors had a wide range of theories they used to guide their explorations—theories that now seem foolish. The lack of accurate science prompted one California miner to tell “Dame Shirley,” an early chronicler of the gold rush, that “science is the blindest guide that one could have on a gold-finding expedition. Those men, who judge by the appearance of the soil, and depend on geological calculations, are invariably disappointed, while the ignorant adventurer, who digs just for the sake of digging, is almost sure to be successful.”Footnote ¹⁶ One prominent theory in the early years of the California gold rush was that the gold found in streams had washed down there from a “big nugget” or “mountain of gold” somewhere further inland.Footnote ¹⁷ Although we now know this theory to be nonsense, the forty-niners engaged in exploration efforts and traded valuable property rights based on it. Of course, we know much more today about gold mining than we did in 1849, more about oil prospecting than we did in 1880, and more about virtually any aspect of locating almost every mineral resource than we did even twenty years ago. We do not know enough to do it particularly accurately, however. From 2006 to 2007, the U.S. Energy Information Administration raised its estimates of total world oil reserves by 24 billion barrels (about 2 percent), and estimates of crude reserves since 1980 have roughly doubled.Footnote ¹⁸ Planning based on estimates that regularly change by such margins in both the short and long term is inevitably fraught with difficulties.

When scarcity prompts efforts to discover additional reserves of a mineral, the results can be dramatic, overturning current thinking with new information. Energy analyst Daniel Yergin made this point in 2005 when discussing the recent concern that we are “running out” of oil. Looking at the historical record, Yergin noted:

In short, as elementary economic principles suggest, as the price of a resource increases people have an incentive to find more of it—and they may find more of the resource by locating entirely new deposits, by developing previously commercially unviable known deposits, or by creating new technology that makes a resource deposit viable. In some sense, therefore, mineral production can be viewed primarily as a problem of generating knowledge about the combination of the location of mineral resources and the technology necessary to commercially develop known deposits. Only someone who has both the knowledge of a mineral resource's physical location and the means to extract it at a cost that allows marketing of the mineral can develop a resource deposit.

The problem, then, is making sure that mineral rights institutions encourage, or at least do not hinder, the production of new knowledge about the location of resources and the technology needed to develop them. Indeed, in many respects, finding oil or platinum or any other mineral resource is much like finding a new pharmaceutical: it is expensive, based on theories that contain significant uncertainty, and involves large amounts of risk. Just to put the problem in perspective, the U.S. National Research Council estimates that known mineral deposits constitute less than 0.01 percent of the metal content of the upper kilometer of the continental crust.Footnote ²⁰ Finding deposits is difficult: locating a single viable hard rock mineral deposit in Canada required investigating more than a thousand sites in 1969, “and the odds have probably not improved” since.Footnote ²¹ As a result, the relatively small number of successful discoveries must cover not only their own costs but the exploration costs of large numbers of unsuccessful efforts as well.

Outside of the mineral context, we know how to provide people with incentives to create new knowledge. To encourage invention, governments offer patent rights that provide inventors of novel and useful innovations with exclusive use rights for a fixed period.Footnote ²² In some cases, both governments and private individuals have offered prizes for the first solution to a problem.Footnote ²³ In brief, rewarding the production of knowledge produces more of it.Footnote ²⁴ If we want mineral rights institutions to yield more minerals for human use, we need institutions that reward the production of knowledge.

C. Appropriate exploitation methods vary

How one exploits a natural resource deposit will vary with the type of resource and local conditions. Oil is obviously different from coal or gold, as mining coal or gold deposits on one parcel will not lead the minerals under an adjoining parcel to migrate to the first parcel, whereas pumping the oil under one parcel can lead to oil migrating in from neighboring parcels. It is therefore not surprising that we observe quite different institutions for “fugitive” resources (like oil and natural gas) and hard and soft rock mineral deposits. Yet not all differences are due to efficient institutional variations designed to maximize the value of overall production. Some are simply rent-seeking disguised as such variations.Footnote ²⁵ The pooling and unitization schemes in oil and gas fields thus respond (in part) to a desire to maximize technical efficiency in extracting the resource. Put simply, pumping rapidly from a large number of wells can reduce the pressure in the field and thus can reduce the total amount of crude extracted.Footnote ²⁶ Even with respect to hard rock mineral deposits, the appropriate means of extraction can vary considerably from location to location. For example, where the surface estate is more valuable, the need to maintain support for it by leaving some mineral deposits unmined will be greater. And recent developments in coal-bed methaneFootnote ²⁷ have produced numerous conflicts between surface and mineral estate owners over the costs to surface rights owners from mineral rights owners accessing their property—including disputes over water, environmental degradation, and access.Footnote ²⁸ There has even been conflict over who owns the voids left from the removal of hard rock minerals.Footnote ²⁹

Mining or drilling for oil or gas inevitably causes environmental impacts because these processes are extremely intrusive. A U.S. National Academy of Sciences review concluded:

In addition to differences in extraction methods, there may also be differences in appropriate restoration technologies and restoration goals.

Restoration and mitigation technology, like extraction technology, changes over time, and thus the incentives created for improvements here are often as important as changes in extraction and processing technology to determining the viability of natural resource deposits. As the U.S. National Academy of Sciences noted in its 2002 review of the mining industry,

Not just technology may vary; goals may also differ. Some land where natural resources have been extracted may be appropriate to restore to pre-extraction conditions, while other land may be more valuable on net without full restoration, with a change in condition from its pre-extraction condition, or without restoration at all. And some land may not be appropriate for resource extraction at all, even if it has significant deposits of a natural resource, because it is more valuable for other uses. Natural resource institutions that are flexible enough to allow for variation in all these dimensions are more likely to produce outcomes that advance human welfare than institutions that do not take such differences into account.

D. Resource extraction is capital intensive

The romantic image of the miner with his mule and pick and pan, or the oil wildcatter like James Dean's character Jett Rink from the 1956 film Giant, long ago stopped being an accurate image of the natural resource industry. Locating new mineral deposits is a lengthy and costly process and typically costs from $150,000 to $250,000, with another $500,000 to $1,000,000 necessary to determine whether to proceed with a site once a deposit is found.Footnote ³² The costs of drilling oil wells increased in real terms from $261,081 in 1960 to $1,526,293 in 2005 (in constant 2000 dollars).Footnote ³³ Searching for mineral deposits is now a data-intensive, expensive business requiring major investments over long periods of time before returns begin.Footnote ³⁴

This capital intensity of the natural resource business has grown in recent decades for several reasons. First, much exploration and production today involves looking for “unconventional” resource deposits, everywhere from inhospitable locales such as the deep sea bed, to politically unstable places like Equatorial Guinea or the Nigerian Delta region (which require not just investment in the actual exploration and production but also security infrastructure),Footnote ³⁵ to previously uneconomic sites, including reprocessing old mine tailings. As one mining expert put it: “The high-grade mines of yesterday have long since been mined and have given way to low-grade deposits of significantly inferior quality.”Footnote ³⁶

Second, these unconventional resource sources often include recovering thinly deposited amounts of multiple minerals from large quantities of raw material, rather than focusing on relatively dense deposits of just one mineral as was the case in the nineteenth and early twentieth centuries. This significantly increases the costs of operations. As a result, in the words of a report of a public-private partnership on new mining technology from 2000: “Mining is a highly complex and multidimensional industry made up of literally thousands of different processes.”Footnote ³⁷ That translates into a great deal of equipment needed to mine and process ore or other raw materials. And as recovery techniques make ever lower-grade resource deposits capable of exploitation, on-site processing becomes a key to saving the transportation costs of moving the larger quantities of ore.Footnote ³⁸ Similarly, processing and use technologies are increasingly specialized to particular resource streams. In the oil sector, refineries are increasingly customized to process oil from specific fields, making it harder to shift to alternative suppliers. In coal, since World War II, power plants have increasingly been built at the mine mouth, customized to the burning of a specific mine's coal production.Footnote ³⁹ Such customization makes the process more complex and capital intensive.

Third, environmental regulations have added significantly to costs (sometimes appropriately) of operation and remediation. The U.S. National Research Council concluded in 1999 that regulation of mining in the United States had reached the point where “it is only the larger, more established firms that can afford to make the investment in time, extensive data collection, complex analyses, and expensive environmental protection measures that the state and federal regulations currently require.”Footnote ⁴⁰

As natural resource industries have moved from Jett Rink to the supercomputer, the scale of capital investment necessary to bring mineral resources to market has grown ever larger. While some mineral resources remain available to anyone willing to pick up wealth from the ground (e.g., alluvial diamonds in Africa),Footnote ⁴¹ most mineral resources will be produced after the investment of tens of millions of dollars, or even billions, in fixed capital assets and site-specific expenditures on location. For example, “producing oil is not like producing shoes or bicycles. Oil projects are big and complex, and crude oil often does not start flowing until many years after a first discovery; a rise in prices takes a long time before it stimulates more exploration and a rise in supply.”Footnote ⁴²

E. Fixed investments are vulnerable

Natural resource industries' capital intensity and fixed locations make them vulnerable to expropriation. Once the capital investments have been made and are in place, they cannot be moved. Once the information about a resource deposit's location has been created, it cannot be repossessed. Once the technology to exploit a particular deposit has been developed, it is vulnerable to seizure. That natural resource investments were vulnerable became clear during the wave of nationalizations in developing countries in the 1960s and 1970s.Footnote ⁴³ (These expropriations led mining companies to withdraw from expropriating countries and concentrate their efforts in the United States and other countries with more secure property rights.)Footnote ⁴⁴

It is critical to recognize that expropriation can occur through a variety of forms beyond physical seizure of assets. While a separate essay (or perhaps a book) would be needed to catalogue the methods by which states can obtain larger shares of natural resource wealth once investments have been made, a few examples can illustrate the range of potential problems:

• • Between 1960 and 1974, fifty-six countries undertook 104 expropriations of assets of firms in the petroleum industry. The high degree of risk is made clear by petroleum's share of total expropriations worldwide during that period (18.5 percent).Footnote ⁴⁵

• • The nationalization of oil assets by North African nations in 1971 was repeated in “virtually every major oil producing [less developed country by 1977, producing] … a revolutionary transformation of the international petroleum industry” and changing “[t]he pattern of equity ownership of oil-producing concessions by international companies and global vertical integration, which had existed since the nineteenth century” in just “six short years,” a remarkably rapid transfer of investors' wealth to expropriators.Footnote ⁴⁶

• • Kazakhstan amended its Law on Subsoil and Subsoil Use in October 2007 to include a provision on renegotiations of contracts that specified that “if the actions of a mining company, while conducting mining operations in deposits/mines that have strategic importance, lead to a considerable change in the economic interests of the Republic of Kazakhstan, posing a threat to national security, the authorised body has the right to demand that conditions of contracts be changed and/or amended to restore the economic interests of the Republic of Kazakhstan.”Footnote ⁴⁷

• • Zambian politicians began demanding renegotiation of copper mining concessions granted when prices were low, and when Parliament opened in January 2008, the president “appeared to bow to public pressure and announced that a new fiscal and regulatory mining regime would be implemented this year, which would include hiking taxes for mining companies.”Footnote ⁴⁸

• • Venezuela “forced the renegotiation of contracts for four huge projects—worth, by some estimates, US$30 [billion]—in the country's heavy oil-producing Orinoco region. [Through the renegotiations, Petróleos de Venezuela] took control of all the projects, doubling its average stake over the four to 78%” in 2007.Footnote ⁴⁹

• • Venezuela is currently (December 2008) considering establishing an ecological damages tax on oil company operations.Footnote ⁵⁰

• • In 1974, “Jamaica suddenly broke its existing contracts with the mining companies and sharply increased the levy [tax] on all bauxite production.”Footnote ⁵¹ As a result, the country “frightened off foreign investment, and it encouraged the mining companies to develop new sources of supply in other countries.”Footnote ⁵²

• • In Equatorial Guinea, the president's brother “set up a company to provide security guards, and oil firms paid for his services. Relations of the ruling family set up employment agencies, which ensured that oil companies did not hire ‘enemies' in the oil sector, and which harvested large percentages of the oil company workers’ wages as ‘fees.’ … [The president] also had a cement import and construction monopoly, and he owned hotels, restaurants, and shares in the oil business itself…. Members of [his] inner circle teased out cash through unofficial import duties, port charges, monopolistic import and sales schemes, and hotel ownership….”Footnote ⁵³

• • Nigeria lost nearly 10 percent of its crude oil production to “illegal bunkering” (thefts from pipelines) in 2004 (and the problem continues). The losses amounted to almost 200,000 barrels a day, and the process was “lubricated by official complicity and petty bribery.”Footnote ⁵⁴ The oil company staff and allies outside the company simply stole 10 percent of output, a substantial loss to the Nigerian government and the oil companies involved.

• • As oil prices rose, Nigeria first “ramped up the price of its oil and raised tax rates, then increased audit requirements on the companies and even made them incorporate themselves locally so that they were subject to Nigerian jurisdiction.”Footnote ⁵⁵

These examples illustrate the wide range of possible margins on which a government can operate to increase its share of the wealth created from natural resource developments. As a result, while treaties can ban outright expropriation, they still leave natural resource owners vulnerable to demands to employ the president's brother's company, to “environmental taxes,” and to “renegotiations.” These margins of expropriation differ, of course, in the level of benefits they provide to interest groups in the government doing the expropriating. A tax gives the expropriator cash that it can spend as it likes, while substantive environmental protection mandates may yield benefits at a level below their cost to the expropriated. The crucial point is that the margins on which expropriation can take place are virtually infinite.Footnote ⁵⁶ If we measure whether an expropriation occurs by the change in position of the expropriated, it matters little whether the expropriation occurs through an outright seizure, a new tax on “environmental damage,” a contract “renegotiation,” or a requirement to hire local residents at high salaries. Governments can expropriate in an infinite variety of ways.

A classic example of the use of regulatory measures to expropriate in the United States was the deal between environmentalists and Eastern coal interests in 1977 when the Clean Air Act was amended. Eastern coal is high in sulfur content; Western coal tends to have much lower sulfur content. Burning Western coal thus produces a lower level of sulfur dioxide emissions. If the 1977 amendments to the Clean Air Act had been structured in terms of environmental impact, Western coal would have gained an advantage over Eastern coal since power plants burning low sulfur coal could avoid expensive pollution control equipment. To prevent this, the high sulfur coal interests (Eastern mine owners and coal miners' unions) joined forces with environmentalists to persuade Congress to mandate use of the pollution control equipment regardless of the sulfur content of the coal. Ultimately, this reduced environmental quality as it increased the use of higher sulfur coal relative to lower sulfur coal by eliminating the cost advantage for the latter.Footnote ⁵⁷ The environmental pressure groups went along because they opposed measures to allow pollution sources to choose how to comply with emissions reductions for ideological reasons; the Eastern coal groups increased demand for their product. The losers were Western coal interests, the environment, and utility rate payers, whose costs went up. The Eastern coal interests may have benefited only by a fraction of the losses incurred by the Western coal interests, but the transaction was a net gain for the Eastern coal interests even if it was a net social loss for Americans (or even coal resource interests) as a whole.

As the “clean coal/dirty air” example suggests, even investments in “safe” jurisdictions like the United States are vulnerable. For example, the Burlington Northern Railroad was almost bankrupted by the 1977 Clean Air Act amendments because it had invested $2 billion in new track premised on a move to cleaner Western coal.Footnote ⁵⁸ When the special-interest deal ended the cost advantage of clean Western coal, the company was left nearly prostrate. Although it is unlikely that a state or the federal government would seize mines or oil or gas wells outright, resource extraction in the United States remains vulnerable to “regulatory expropriation.” Real property owners can lose their property rights through the imposition of severe regulatory burdens as completely as they can from outright seizures. The same analysis applies to mineral rights owners, who are vulnerable to losing the value of their assets through the imposition of regulatory burdens; the more capital intensive an industry, the more valuable assets are at risk.

In the United States, this problem is more serious for natural resource extraction industries than for other capital-intensive industries because today much of the former are concentrated in just a few states. Most hard rock activity and claims are concentrated in Arizona, California, Montana, Nevada, and Wyoming (nearly 45 percent of claims at the end of fiscal year 2000 were in Nevada alone, and an additional 35 percent were in the other four states).Footnote ⁵⁹ Most domestic oil and gas development is concentrated in just four states (about 75 percent of production comes from Alaska, California, Louisiana, Texas, and federally controlled offshore areas; offshore production occurs almost entirely off of these same states.)Footnote ⁶⁰ Since most states have few natural resource industries within their borders, and since many mineral resources are largely on federal land, states without these interests form a majority coalition in favor of converting those resources into a form which potentially benefits their citizens at the expense of resource-rich states' citizens. (The protection provided to minority interests by the power that the structure of the U.S. Senate provides to individual senators and to relatively small minorities—the power of committee chairs, the unanimous consent rules for many steps in the legislative process, and the need for sixty votes to end debate, for example—has thus far prevented such a resource transfer by enabling resource-rich states to block efforts to change the General Mining Law of 1872.)Footnote ⁶¹

The United States is not the only place where regional tensions are exacerbated by the uneven distribution of natural resources. Angola, Iran, Iraq, Nigeria, Sierra Leone, and Russia are just some of the nations with serious problems related to political competition for control of unevenly distributed resources. Unfortunately, those countries' political infrastructures are less able to mediate these conflicts peacefully than are the political institutions of the United States, and, instead of heated speeches in the Senate, they have all experienced significant levels of violent conflict over control of natural resources. The vulnerability of natural resource investments is thus a serious problem for everyone in a country that has significant natural resource endowments. Natural resource firms (and foreign governments with strategic interests in natural resources outside their borders) have a great deal to lose when governments in resource-rich countries renege on regulatory bargains. It is no surprise that resource owners and those who control states with valuable mineral resources within their borders expend considerable financial resources in protecting their investments. In countries with poorly developed institutions, this combination of efforts to protect rights by those who own the resources and rent-seeking by corrupt politicians and bureaucrats can have tragic results.Footnote ⁶² As John Ghazvinian writes, in the context of his discussion of the impact of oil revenues on the small country of São Tomé and Principe (an island nation in the Gulf of Guinea, on the west coast of Africa): “Even good people tend to go a bit funny in the face of millions of dollars and there was no compelling evidence that São Tomé's politicians were ‘good people’. In a country with weak institutions, powerful neighbors, and a culture of dinner-table politics, there is every likelihood that a spectacular infusion of foreign exchange will act as a destructive and destabilizing force.”Footnote ⁶³ Even in countries with better developed institutions, the corrosive effect of rent-seeking can degrade the institutions significantly.

F. Summary

What are the consequences of a world endowed with natural resource riches when that world is one in which values change in unpredictable ways over time; knowledge about natural resource deposits matters a great deal; the appropriate technology for extracting and remediating varies from resource to resource, from time to time, and from location to location; natural resource industries are capital intensive; and natural resource investments are vulnerable to expropriation on numerous margins? In such a world, three problems dominate questions about the institutions governing natural resource issues: (1) the knowledge problem; (2) the prevalence of rent-seeking; and (3) the need to address the considerable uncertainty surrounding resource development.

First, the Hayekian knowledge problem is critical. The answer to natural resource questions—whether the question is “Where can we get more of a particular natural resource?” or “What do we do about the environmental damage caused by extractive activities at a particular site?”—is going to be “It depends.” And it depends on an astonishing variety of facts, as the description by Hayek of tin pricing quoted earlier suggests with its partial listing of the influences on the price.

Some people will reject this argument because they hold quasi-religious views concerning such issues. For example, some environmentalists believe that the “natural” state of the world is one essentially without human impact.Footnote ⁶⁴ Economist Robert Nelson argues that it is a religious form of environmentalism that explains why

The statement made by forswearing development of ANWR is a sacrifice of human needs—the energy available for man's use by drilling in ANWR—for the preservation of a place without utility for humans.Footnote ⁶⁶ Someone who holds such a view of environmental issues does not face a Hayekian knowledge problem, or at least faces a very different such problem. For example, environmental writer Thomas Berry has called for producing “a radical change in our mode of consciousness,” and “even a new sense of what it means to be human” as the task of the environmental movement.Footnote ⁶⁷ For the devotee of environmentalism as a religion, natural resource exploitation should be stopped because interfering with the earth is morally wrong. For most people, however, improving human welfare takes priority. When human welfare comes first, the challenge is to find ways to make use of natural resources while considering environmental protection as one of many components of human welfare.

Of course, Hayekian knowledge problems are pervasive. Local knowledge matters just as much for the production of iPods, cars, and wheat as it does for coal, oil, or diamonds. Indeed, it is the pervasiveness of the knowledge problem that is the central theme of Hayek's essay.Footnote ⁶⁸ In that sense, natural resources are no different from other goods and services. But even if it is true that local knowledge is always important, and so price mechanisms ought to be presumed superior to non-price measures absent compelling evidence to the contrary, there are reasons to think that the role of local knowledge is relatively more important in natural resource decisions than in many other contexts. Thus, the burden of someone advocating moving away from decentralized markets in natural resources should be even higher than it is in other areas. Since the modern presumption appears to be the opposite—that natural resource industries are particularly liable to generate terrible negative environmental externalities and thus require greater state involvement as a rule—this is not a trivial point.

Why might local knowledge be particularly important in the context of natural resource decisions? With respect to decisions about investment or production, it is easy to see that local knowledge about a resource deposit would be critical to making appropriate decisions. Just as important, however, is local knowledge about the alternative uses for land. Where mineral rights owners are also the owners of the surface rights, they have a powerful incentive to consider the impact of development of the resource on their surface rights' value.Footnote ⁶⁹ Local knowledge also plays an important role in dealing with the externalities that natural resource extraction may cause. How to harness that knowledge by giving resource owners the proper incentives may be an issue, but the operator of a mine or an oil well will have much better information on the operating procedures, waste streams, geology of the site, and other details than any central planner.Footnote ⁷⁰

Second, rent-seeking is particularly likely to occur where governments have power over natural resource allocations because of the combination of high-value assets to be distributed, large fixed investments, and multiple margins on which to expropriate. Indeed, the intensity of conflicts over resources around the world is a testament to the size of the stakes. Of course, rent-seeking is endemic in the modern resource-rich autocracies where there are few substantive constraints on the scope of rulers' power. My argument here is that rent-seeking concerning natural resource issues is likely to be worse than rent-seeking in many other areas because of the combination of capital intensity and multiple margins of expropriation. Rent-seeking is constrained in many areas by capital mobility. But in an industry where large investments must be in place for years, and sometimes decades, before a natural resource asset yields significant revenue, once an investment is in place it is virtually impossible for the investor to credibly threaten exit. Even worse, the creation of wealth by a nation's citizens can become irrelevant to the rent-seekers' competition to increase their share of the natural resource pie. As Nicholas Shaxson notes, in a natural resource boom, “[t]o get tax revenues, rulers no longer need to worry about improving the local business environment—and, by extension, the lives of their citizens,” since the rewards come from the natural resources.Footnote ⁷¹

Of course, an investor can threaten to place future resource investments elsewhere. But this threat is limited in two ways: (a) resource investment opportunities are sufficiently in demand that competition from other firms to replace an incumbent gives even a predatory state opportunities to find investment partners; and (b) the expertise of a resource firm is only valuable when there are opportunities to make use of it; if a firm cuts itself off from investment opportunities to retaliate, its human capital can be raided by rivals or by the predator state itself.

Third, the considerable uncertainties surrounding all aspects of natural resource extraction—from the future price of a resource for which production and investment decisions must be made years in advance, to the most basic scientific questions about the location of resource deposits—mean that the incentives for knowledge production provided by a set of institutions are critical to determining whether hypothetical resource wealth can be converted to real wealth.

In the next section, I turn to the problem of developing a framework for evaluating the institutions governing natural resources and choosing among potential institutions.

A. Mineral rights and other valuable property rights

Are natural resources different from other aspects that provide value to land? Consider two hypothetical parcels of land, Blackacre and Greenacre, before any exploration of the land for natural resource deposits has taken place. The prices of the total bundle of rights in these parcels are defined by the sum of all the characteristics of each that give each its value. These will include the potential for valuable mineral deposits but will also include the use value of the surface estate. That value, in turn, will be affected by the parcel's proximity to transportation routes, soil quality, natural beauty, proximity to other valuable uses, and countless other factors. Suppose that the owner of each parcel conducts an investigation and that the owner of Blackacre discovers valuable, commercially viable mineral deposits on his land and the owner of Greenacre does not. But while prospecting, the owner of Greenacre notices that if a stand of trees were removed, her property would have a stunning view of a local mountain range, yet is within easy commuting distance of an economically vibrant small city. As a result, Greenacre is an ideal location for high-end, large-lot home sites. Both parcels are now worth $1 million more than they were before the new information about each was discovered.

Should we treat mineral rights differently from these other value-affecting characteristics? If a share of mineral rights is to be reserved to the state on a theory that the public at large is entitled to benefit from the natural bounty of mineral resources, why is the same not true of the nonmineral characteristics that make Greenacre more valuable as well? Greenacre's scenic view makes it command a price premium over other parcels which lack the view. Is there a principled distinction between a view and a mineral deposit? Why should Blackacre's owner reap less of the reward for her investment in learning her land's value than Greenacre's owner gets for her identification of the entrepreneurial opportunity with respect to her parcel?

The same is true even if the investor in developing knowledge is an entrepreneur who is not the owner of either parcel. If an entrepreneur believes that Greenacre will make a fine site for homes or that Blackacre has the appropriate characteristics to hold mineral deposits, in both cases the entrepreneur is investing in the knowledge and skill to identify the opportunity. There is no principled basis for treating a portion of Blackacre's owner's gain as subject to confiscation if we do not treat Greenacre's owner's gain similarly. Reducing either owner's share by forcing her to disgorge a portion to the state simply reduces her incentive to seek knowledge about the land, and a standard neoclassical economic analysis would dictate subsidizing the data production, not weakening the property rights claim. (I am not suggesting a subsidy, for the rent-seeking reasons described elsewhere.) Confiscating a share of the value of either Greenacre or Blackacre seems unjust, but if there is a moral or utilitarian distinction then it is one that would support confiscating the value of both parcels. There is no justification for confiscating a share of only Blackacre's value.

B. The exceptionalist position

How then did mineral rights exceptionalism come to dominate thinking about mineral rights issues so completely? Why do anti-mining activists in the United States and elsewhere find such traction with arguments for public control of mining based on demands for a state share of the resources? There are three important strands to such arguments. None of the three can withstand close scrutiny.

C. Summary

This section has argued that natural resources are no different from any other resources, so there is no justification for treating them systematically differently from other resources. The arguments for mineral rights exceptionalism are ultimately based on inadequately theorized historical claims that turn out not to support the distinction, or on utilitarian arguments for which the evidence is, at best, contested and is generally unexamined. To the extent that the rules and institutions governing natural resources are going to differ from the base set of laws prohibiting force and fraud, establishing a framework for voluntary transactions through establishing corporate law, and so forth, those differences require finding a connection to the nature of a particular resource or class of resources.

A. Natural resources on privately held land

The bundle of potential property rights attached to a piece of land includes rights to use and transfer the surface estate and rights to use and transfer the natural resources on the land. If we define the maximum bundle as the post–California Gold Rush American common law fee simple absolute,Footnote ⁹¹ we include in it virtually unlimited use of both surface and subsurface resources. The only limits are the traditional ones imposed by nuisance law (not making use of your property in a way that injures your neighbors' property) and by voluntary unbundling of rights from the maximum fee simple absolute bundle through covenants, servitudes, and easements or contractual means.

The polar opposite bundle of rights would be to include in the surface estate the maximum fee simple absolute surface rights (subject to nuisance, covenants, etc.) in the landowner's bundle, allocate the natural resource rights to the government, and then subtract from the landowner's bundle of rights those affecting the surface estate which are necessary for the exploitation of the natural resources and add them to the government's natural resource bundle.

The final case that needs to be considered is where the surface estate is privately owned and the government and the surface estate owner share the mineral rights bundle. All cases of intermediate government ownership shares should collapse analytically into a single case of joint ownership, since a different government share in the natural resource bundle merely diminishes or increases any incentive effects from reducing the landowner's bundle of rights relative to any shared bundle. For convenience, we will make the bundles of mineral rights equal in size. The problem of shared ownership does not resolve, in principle, any of the problems of complete public ownership of the natural resource estate, and it adds a problem of reconciling the interests of the landowner and the government in making resource management decisions. Let us consider these three alternatives as they would appear arrayed along a continuum from pure state ownership to pure private ownership.

B. Natural resources on publicly held land

When the state owns the surface estate, the question is how to transfer the associated natural resource rights to private hands. One possibility is production through a state-owned entity, but I will not consider state-owned enterprises here, as their defects are well known (e.g., the problems of the Mexican state oil company, Pemex, which has suffered from steadily declining production due, in part, to interest groups' ability to use it as a vehicle for rent-seeking).Footnote ¹⁰² The alternatives are free access to the resources, in which the finder takes title to the resource upon location, and a sale (auctioning of leases, etc.).