Upstream Oil and Gas Exploration JOA and Farmouts
In this lesson, we will discuss Joint Operating Agreements JOA and Farmouts, two common types of agreements E&P companies use to gain access to reserves and diversify their portfolios.
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Joint Operating Agreements (JOA)
First, let’s discuss Joint Operating Agreements, or JOAs. JOAs are a common form of agreement that often used in both US and international operations. In general, JOA’s, have four elements:
Operator Designation. For operational practicality, an “Operator” is designated who will control day-to-day activities. The Operator’s powers, duties, compensation and replacement are specified.
Method of Conduct. The agreement sets out a method for the conduct of the joint operations. I.E., who has the authority to make what decisions, and under which circumstances.
Formulas for Participation. The agreement contains the formulas for participation in costs, production and/or revenues, as well as ownership of property and materials.
Pooling. If different companies own interests in different, segregated leases, the agreement will need to specify the formulas for pooling.
International JOA’s take into account the special concession or contracting arrangements involved in the host country. The international JOA is always subordinate to the host government contract, not vice versa.
Model form domestic and international JOA contracts have been developed by oil and gas industry associations.
Farmouts
Farmouts are a fundamental and essential vehicle for the exploration and development of oil and gas.
Farmouts are agreements under which the owner of a working interest in an oil or gas lease assigns the working interest, or a portion of the working interest, to another party who desires to drill on the leased acreage. Generally, the assignee is required to drill one or more wells in order to earn its interest in the acreage.
The assignor usually retains a royalty or reversionary interest in the lease. The interest received by an assignee is a “farm-in” while the interest transferred by the assignor is a “farm-out.”
In general, farmouts occur in the exploratory stage, when the commercial risks of the project failing to recover its costs are considerably greater to the operator than at the later development stages.
Let’s discuss two examples of farming out and farming in:
“Farming out” would make sense if an operator is unable to develop expiring acreage due to budgetary constraints. The operator could also wish to reduce risk and would be willing to accept a lower return associated with a reduced acreage position.
“Farming in” makes sense if another operator’s budget can stand the costs of drilling. Thus the operator would be willing to accept greater costs and risk by increasing acreage position, and thus increase potential return.
Model form farmout contracts have been developed by the American Association of Petroleum Landmen.
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Related Resources:
What is the difference between Upstream and Downstream?
Drilling Wells for Oil and Gas and Offshore Drilling