Legal Definitions - production payment

A production payment is a financial arrangement, most commonly found in the oil and gas industry, where a party receives a specified share of the oil and gas produced from a particular property. This right continues until a predetermined total sum of money has been collected. A key characteristic is that the recipient of a production payment does not have to pay for any of the operational costs associated with extracting or processing the oil and gas.

Here are some examples to illustrate how production payments work:

• Financing a New Drilling Project: Imagine a small independent oil company, "Prairie Drills Inc.," needs to raise capital to drill a new well in a promising field. Instead of taking out a traditional bank loan or selling equity in the company, Prairie Drills Inc. might offer an investment firm a production payment. The firm provides the upfront cash, and in return, receives a percentage of all oil and gas extracted from that new well, free of any drilling or operating expenses, until they have recovered their initial investment plus an agreed-upon return. Once that total sum is reached, the production payment ends, and Prairie Drills Inc. retains 100% of the future production.

  This illustrates a production payment because the investment firm receives a share of future production from a specific property (the new well) without incurring production costs, and this right terminates once a defined financial target is met.

• Monetizing Existing Reserves: Consider "Desert Sands Energy," a large oil producer that owns several mature oil fields. Desert Sands Energy wants to generate a significant amount of immediate cash for a new acquisition without selling off an entire field or taking on more debt that would appear on their balance sheet. They could sell a production payment to a pension fund. The pension fund pays Desert Sands Energy a lump sum today, and in exchange, receives a fixed percentage of the oil and gas produced from one of Desert Sands' existing fields. The pension fund does not pay for the ongoing operational costs of the field. This arrangement continues until the pension fund has received a specific, agreed-upon total amount of revenue from the production.

  This demonstrates a production payment as the pension fund acquires a temporary, cost-free right to a portion of the oil and gas output from an existing property, ceasing once a specific financial threshold is achieved.

• Estate Planning for Mineral Rights: A landowner, Ms. Eleanor Vance, owns mineral rights beneath her ranch, which are currently producing oil and gas. She wants to ensure her granddaughter, Clara, receives a specific amount of income from these mineral rights over time, but without burdening Clara with the complexities of managing the operations or paying for expenses. Ms. Vance could establish a production payment in her will, granting Clara a right to a certain percentage of the oil and gas produced from the ranch, free of all production costs, until Clara has received a total of $500,000. After that sum is paid out, the production payment to Clara would cease.

  This example highlights a production payment because Clara receives a share of production from a specific property, free from any associated costs, and this right is finite, ending once a predetermined sum has been paid.