Farmout
What Is a Farmout?
A farmout is the assignment of part or the entirety of an oil, natural gas, or mineral interest to a third party for development. The interest might be in any settled upon form, for example, exploration blocks or drilling land. The third-party, called the "farmee," pays the "farmor" a sum of money upfront for the interest and furthermore commits to spending money to perform a specific activity connected with the interest, for example, operating oil exploration blocks, funding expenditures, testing or drilling.
Income created from the farmee's activities will go partly to the farmor as a royalty payment and partly to the farmee not set in stone by the agreement.
All the more conventionally, a farmout may likewise allude to whatever other example where a few activities are [outsourced](/reevaluating, for example, cultivating out investment strategies by a portfolio manager to a sub-manager.
Figuring out Farmouts
A company might choose to go into a farmout agreement with a third party if it has any desire to keep up with its interest in an exploration block or drilling land however needs to reduce its risk or doesn't have the money to embrace the operations that are attractive for that interest. Farmout agreements give farmees a potential profit opportunity that they wouldn't in any case approach. Government endorsement might be vital before a farmout deal can be settled.
The farmor as a rule gets a royalty payment once the field is developed and creating oil or gas, with the option to change over the royalty back into a predefined working interest in the block subsequent to paying for drilling and creation expenses that were incurred by the farmee. This type of option is commonly known as a back-in after payout (BIAPO) arrangement.
Farmout agreements are effective risk management devices for more modest oil companies. Without them, an oil fields would just stay undeveloped due to the high risks facing any single operator.
Illustration of a Farmout
Farmout agreements are extremely well known with more modest oil and gas producers who own or have rights to oil fields that are costly or hard to create. One company that utilizes this type of arrangement is Kosmos Energy (NYSE: KOS). Kosmos has rights to grounds off the shoreline of Ghana, yet the cost and risks to foster these resources are high since they are underwater.
To assist with lessening these risks, Kosmos "ranches out" its land to third parties like Hess (HES), Tullow Oil, and British Petroleum (BP). Doing so permits these offshore blocks to be developed and produce cash flow for every one of the parties in question. A farmee like Hess assumes the obligation to foster the field and, in return, has the option to sell oil that is created there. Kosmos, as the farmor, procures a royalty payment from Hess for providing the land and the natural resource.
Highlights
- A farmout is the point at which a resource-creating property is re-appropriated for development to a third party or farmee.
- The farmee pays the owner (farmor) eminences on income produced from the re-appropriated activities.
- Farmouts are most common in natural resources exploration and extraction, for example, with oil, gas, or minerals mining.
