The Strategic Importance of Farm Outs – Part 2

Farm out agreements are amongst the most common and strategically important agreements in oil and gas.  For the explorer they can represent an opportunity to create value from a promising prospect, for others they may play a critical role in portfolio optimisation.

There are many different types of farm out agreement but perhaps the most common covers the exchange of an interest in a licence or contract for the assumption of an obligation.  This almost always happens at the exploration stage and the obligation assumed is usually a commitment to the government to shoot seismic or to drill a well.

In my last article I considered some of the strategic reasons for entering into a farm out agreement.  In this article I consider some more examples and take a look at some common farm out agreement terms.

The recent Africa Oil Corporation farm out agreement with Marathon Oil Corporation in onshore Kenya provides a good example.  In this agreement Marathon will gain a position in two onshore exploration blocks covering over 11 million gross acres in northwest Kenya.  The transaction will include a 50 per cent working interest in Block 9 and a 15 per cent working interest in Block 12A.

Marathon will pay Africa Oil a $35 million entry payment which will almost certainly reflect past expenditures by Africa Oil and a premium.  Marathon will also fund Africa Oil’s working interest share of expenditures in these blocks over the next three years up to a maximum of $43.5 million.  These exploration expenditures will cover work commitments given to the Kenyan government by Africa Oil.

For Marathon the attraction will be gaining entry into an emerging onshore play that offers potential across a vast acreage position.

The Marathon – Africa Oil example provides a good illustration of some of the common commercial terms to be found in a typical farm out agreement.  These include:

(i)  The parties to the agreement and the licence or contract area under consideration.

(ii)  The assignment of the working interest, including a list of owners before and after the transaction and the effective date.

(iii)  Any conditions precedent that must be fulfilled.  This is a contractual mechanism that lists those things the parties agree have to be in place for the agreement to proceed, for example government permissions.

(iv)  The consideration to be made by the farmee in return for gaining a working interest in the licence.  This could be cash, or paying for a work programme commitment such as seismic (“shoot to earn”), or a well (“drill to earn”) or a certain level of production (“produce to earn”).

(v)  Undertakings are notifications made by both parties to each other that indicate the current state of affairs and any changes.  For example, the farmor will notify the farmee if there are any problems within the joint venture, such as default, claims, suits, losses or damages.

(vi)  Representations and warranties are stronger commitments than undertakings and will usually be accompanied by an indemnification.  Examples of farmor representations include that there are no liens on its working interest and that it has provided correct and complete copies of all documents.  Examples of farmee representations include that it has sufficient technical and financial capacity to fulfil its obligations.

(vii)  And lastly there are a series of further terms covering areas such as tax, law and dispute resolution, default and force majeur.

Earlier this year Falklands Oil and Gas (FOGL) executed of a farm out agreement with Noble Energy.  The deal included a licence position consisting of 40,000 square kilometres in offshore Falklands.

Noble will gain a 35% working interest in the Northern Area Licences, except for two excluded areas.  FOGL will continue as operator of the entire Northern Area Licences until early 2013, when operatorship of the farmed in area will be transferred to Noble.

The two excluded areas within the Northern Area Licences will be delineated both geographically and stratigraphically between FOGL, Edison and Noble along different horizons.

Noble will also gain a 35% working interest in the Southern Area Licences.  FOGL will continue as operator of these licences until no later than early 2014, when operatorship will transfer to Noble.

Noble’s financial consideration for the farm out deal includes 60% of the Scotia exploration well costs and a $25 million contribution to past costs.  Noble will also contribute 60% of the costs of the Southern Area Licences commitment well, and 45% of a discretionary exploration well, should Noble decide to participate in the well.

And lastly I should also mention the recently announced farm out deal between Rockhopper and Premier Oil.  Although widely reported in the media as a farm out in truth it is a very large deal that has more in common with a major merger or acquisition.

Rockhopper has entered into a farm out agreement with Premier Oil which covers its interests in licences in the North Falkland Basin.  Premier will acquire 60 per cent of all Rockhopper’s interests for a upfront cash payment of US$231 million and a Sea Lion development carry of US$722 net to Rockhopper.  Rockhopper will receive a US$48 million exploration carry and an option to receive development financing from Premier.

Furthermore, the two companies will enter into an Area of Mutual Interest agreement for future co-operation in the North Falkland Basin and analogous plays in South Africa, Namibia and Southern Mozambique, with Rockhopper taking the lead in sub-surface exploration activities.

Clearly, farm out agreements come in all shapes and sizes!

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