Legal Definitions - farmout agreement

A farmout agreement is a common contract in the oil and gas industry. It occurs when a company that holds an oil and gas lease (known as the farmoutor or farmor) agrees to transfer a portion of its interest in that lease to another company (the farmoutee or farmee).

In exchange for this interest, the farmoutee commits to performing drilling and testing operations on the leased land at their own expense. This arrangement benefits both parties:

• For the farmoutor, it allows them to develop their lease, potentially discover new reserves, or fulfill lease obligations (like drilling commitments) without incurring the significant costs and risks associated with drilling. They typically retain a royalty interest or a share in future production.
• For the farmoutee, it provides an opportunity to gain access to promising acreage for exploration and development that might otherwise be unavailable or too expensive to acquire directly.

Here are some examples illustrating how a farmout agreement works:

• Scenario: A Small Company with Extensive Leases but Limited Capital

  Imagine Prairie Exploration Co., a small independent company, holds numerous oil and gas leases across a promising geological basin. While they believe in the potential of these leases, they have limited capital and personnel to drill on all of them simultaneously. One particular lease is nearing its expiration date, requiring drilling activity to maintain it. Prairie Exploration enters into a farmout agreement with Deep Rock Drilling Inc., a larger company with readily available drilling rigs and financial resources. Deep Rock agrees to drill an exploratory well on the specified acreage within the lease's timeframe. If the well successfully finds oil or gas, Deep Rock earns a percentage interest in the producing well and the surrounding area, while Prairie Exploration retains a royalty interest in the production without having to bear the upfront drilling costs, thus preserving their lease and potentially discovering new reserves.

  This example illustrates how a farmout agreement allows a farmoutor (Prairie Exploration) to develop its lease and meet its obligations without expending its own limited capital, while the farmee (Deep Rock Drilling) gains access to a potentially lucrative drilling opportunity.

• Scenario: A Major Company Streamlining its Portfolio

  Consider Global Energy Corp., a large multinational oil company that owns a vast portfolio of leases, including some in frontier areas that are not central to its current strategic focus. Global Energy wants to concentrate its capital on developing its most productive, established fields. To avoid letting a promising but non-core lease expire due to inactivity, and to explore its potential without diverting significant resources, Global Energy offers a farmout to Frontier Ventures LLC, a smaller, specialized exploration company. Frontier Ventures, eager to expand its footprint in new territories, agrees to drill a high-risk, high-reward exploratory well on a specific block of Global Energy's lease. If the well is successful, Frontier Ventures earns a working interest in the discovery, and Global Energy benefits from the exploration and potential future production without having invested its own capital in the initial risky drilling phase.

  This example demonstrates how a farmout agreement enables a farmoutor (Global Energy Corp.) to manage its lease portfolio efficiently and explore non-core assets without direct investment, while the farmee (Frontier Ventures LLC) gains an opportunity to explore new acreage.