Posted in Finance, Accounting and Economics Terms, Total Reads: 453
Farmout are very popular agreement in oil and gas industry. It is an agreement between a person (Farmor) with a underlying working interest who enters into an agreement with the Farmee for exchange of services and creating some underlying interest for the faremee.
For eg. A works for XYZ Co. and has an area of land which he believes is oil rich. A takes a lease on the land and hires a geologist for drilling purpose. In this case the driller is ready to drill after estimating that there is oil to be explored and money to be made. Thus A takes care of 100 % of the expenses and in return gain 100% of the profit.
Now lets assume A has found out about a similar piece of land which is supposedly oil rich. But unfortunately A is not rich enough to hire a driller. Another Company B was late in doing business and missed out on the opportunity to lease on the land. In this case B is assumed to be very rich and proficient in drilling services. Thus before the lease of A expires, B comes and offers to A to “farm in” to working interest . B agrees to do the drilling and pay the expense of drilling cost in exchange of A sharing a apart of the oil profit with B.
Generally if A is a company then they will enter a farmout agreement with another company if A is not wealthy enough of if A decides to diversify the risk by agreeing to work with a superior technology partner like B.