10 - Farm-Out Agreement...The Escape Door
Updated: Aug 22, 2018
Farming-Out is an old approach that farmers used to take in order to use their land and grow their crops when they don't have the capability to do so.
Nowadays; Farm-out agreements are one of the most popular agreements in the Oil & Gas industry. It follows the same concept as the old days except for the commodity type and rendered services.
What Is A Farm-Out Agreement?
It is a contract signed between two parties:
the Farmor; who is the owner of the mineral lease
the Farmee; who wishes to obtain a percentage of the mineral lease
The contract stipulates that the Farmor (owner of the mineral lease) will assign a percentage of the lease to the Farmee in return of a service. This service can be in the form of:
acquisition of seismic data,
drilling of an Oil or Gas well(s), or
Perform well testing, as well as many other services.
The take is that the rendered services should result in commercial and viable Oil or Gas production. Therefore, the assigned lease percentage is usually awarded after reaching a defined milestone, which could be:
reaching certain production rate,
drilling a well to a certain depth or to a specific formation
What Drives The Signing Of A Farm-Out Agreement?
The Farm-Out agreement is commonly observed in activities involving emerging and junior Oil & Gas companies who wish to partner with third parties to meet their work obligation.
Some of the many drivers to sign a Farm-Out agreement could be:
Lack of capital, where the Farmor doesn't have the neccessary funds to meet its work obligation,
Restructuring asset portfolio, as the Farmor has a limited amount of funds, he wishes to optimize the use of his capital by allocating his funds among his assets. This might result in the disposition or acquisition of some assets,
Excess of acreage, which might results in poor return on capital from a Farmor's financial perspective,
Desire to acquire knowledge, where the Farmor doesn't necessary have or wish to develop expertise,
Approaching the time-limit of the exploration lease, which makes partnerships an expedited way to meet the work obligation
Consolidation of assets, as either the Farmor or the Farmee wishes to dispose or acquire certain acreage in a manner that facilitates managing their asset-portfolio.
Risk Sharing, as the Farmor wishes to share the risk with another party as a result of a change in risk appetite
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