Volumetric Production Payment Agreement

In the oil and gas industry, Chesapeake Energy is the most visible user of VPP, raising about $5 billion in working capital since 2008 without creating debt on its books or diluting shareholders by issuing more shares. Under a VPP, a bank or hedge fund purchases and obtains ownership of a portion of the mineral reserves in an oil and gas concession or group of leases. This raises legal issues when the VPP seller (usually the operator of the leases and subject to a joint operating agreement with its co-tenants) sells and transfers a portion of the existing mineral reserves in which it has an undivided interest, and then retains the entire VPP cash payment for itself without sharing it with its roommates (other working interest owners). While Pioneer believes that its previous treatment of field fuel was acceptable, the Company intends to amend its field fuel reports, no longer account for them as revenues or expenses, and not include them in production. Pioneer believes this presentation is more common in the industry and will provide a better basis for comparing Pioneer to other oil and gas companies. Some volumetric production payments for oil or gas relate to the production of a single well and carry a significant risk in terms of obtaining the full amount specified in the contract. However, in recent years, some contracts have essentially eliminated this risk by linking deliveries under volumetric production payments to the production of a group of production wells or a small volume related to the expected production of a single production well, thereby reliably determining the quantity of goods delivered. The typical transaction consists of three basic documents – a purchase and sale agreement, a transfer of the duration of the license best interest, and a production and supply agreement. The purchase and sale agreement is the first agreement signed by the parties and governs the process by which the investor performs his due diligence as well as the closing process. In the case of the conclusion of the VPP, the producer transfers the relevant interest to the investor by performing and delivering the transfer of the predominant licence right, and the parties also conclude the production and supply contract, among other ancillary documents. The production and supply contract is the key agreement that governs the relationship between the parties after closing, specifying, among other things, the details of how and when the production in question will be delivered to the investor (whether in kind or marketed and sold by the manufacturer on behalf of the investor) and determines what constitutes a delay, and provides for the investor`s remedies. A volumetric production payment (PPV) is a type of structured investment in which the owner of an oil or gas interest sells or borrows money for a certain volume of production associated with that field or land.

The investor or lender receives a specified monthly quota – often in gross production, which is then marketed by the VPP buyer – or a certain percentage of the monthly production made in the particular property. The terms of a volumetric production payment transaction are governed by the purchase and sale as well as by production and marketing agreements. The transfer of the predominant royalties is also governed by the company`s terms. In addition to the above methods to guarantee the investor`s rights to maintain the specified output, investors are also exposed to price risk and savvy investors will implement a hedging strategy in the derivatives market to protect themselves from falling prices of the energy commodity in question. The VPP agreement entitles the holder of the VPP to a fraction of the production under certain leases. An unexpected drop in production from associated reserves can also affect the licensee`s performance. The VPP is compiled from the working interests in one or more properties. A labor interest is the right to exploit a property and receive all the proceeds of production after the payment of royalties. In most cases, the owner of the labour share leases the mining rights to another party with the promise to pay royalties and assumes the full cost of development and exploitation. A non-operational interest, in turn, may be conveyed by the employer of the labor interest to investors in a volumetric production payment agreement.

Pioneer has always recognized the value of field fuel as an operating expense equal to that of oil and gas revenues, with no net profit effect. Pioneer also reflected the quantities associated with field fuel in gas production. This practice has been regularly discussed by the company, particularly with regard to the increasing value of fuel used in the field and its contribution to the increase in operating costs in the field. In 2004, mining entrepreneur Ian Telfer founded Silver Wheaton, which aimed to apply volumetric production payment transactions to the mining sector. [4] The business model became known as metal streams and structures VPP transactions in such a way that an initial payment is exchanged for a percentage of metal production, with a fixed payment made for each ounce of metal delivered. The model proved to be extremely successful, as Silver Wheaton became a multi-billion dollar company in a few years of operation. [5] Franco Nevada Corp., Royal Gold Inc. and Sandstorm Gold Ltd. are other companies that have used the metal streaming business model. A VPP transaction usually involves two parties – the producer and the investor. In short, the producer agrees to transfer a term that outweighs the predominant license right, and the investor accepts the purchase, which gives him the right to receive a certain amount of oil and/or gas production over a certain period of time – usually three to five years or if the specified amount of production has been delivered. In return for such production, the investor pays the producer a negotiated sum, the sum of which can be used immediately by the producer – and often demanded by the investor – in exploration and drilling activities in order to improve the production of the energy facilities in question.

The amount an investor is willing to pay in a particular VPP transaction depends on the production history and future prospects of the oil and gas facilities in question, the maturity at which that production will be delivered, and current and expected market conditions. For reporting purposes, Pioneer`s production and reserves are reduced by the volumes of oil and gas sold through PPVs, and revenue is recognized as deferred revenue on the balance sheet. Over the life of PPVs, the balance of deferred revenues is amortized and recorded as non-cash oil and gas revenues, resulting in an increase in oil and gas revenues per barrel of oil equivalent because VPP volumes are not reflected in production. Since Pioneer retains all operating costs and depreciation, depletion and depreciation costs associated with the production of oil and gas sold, when calculated on an oil equivalent per barrel basis, these costs will also increase since VPP volumes are not included in proven production or reserves. Interest charges are reduced by the savings associated with the proceeds used on the outstanding debt. If the quantity of goods delivered under a volumetric production payment agreement cannot be reliably determined, it is assumed that the commodity futures contracts incorporated in those volumetric production payment agreements do not contain a notional amount, as that term is used in statement 133. Such a circumstance may occur if the volumetric production payments for oil or gas relate to the production of a single well (or relatively unproven properties) and the volume of the contract is relatively large and therefore carries a significant reserve risk compared to the receipt of the entire quantity specified in the contract. If the date of the goods incorporated is not subject to the requirements of Declaration 133, the total payment of the associated volumetric production will be included in Declaration 19. The holder can reduce this risk by reviewing the reserves before the transaction. An ideal scenario is when 50% to 60% of the expected production can cover the return to the owner. Entering into VPP contracts with diversified leases rather than in a single area can also help mitigate reserve risk. Fasb Statement No.

19, Financial Accounting and Reporting of Oil and Gas Producing Companies, discusses the accounting of production payments. The term payments on production includes different types of contracts that justify different accounting. Declaration 19 distinguishes between production payments that contractually relate only to cash flows recognised as bonds (as defined in paragraph 43(b) of this declaration) and those involving the delivery of goods (so-called volumetric production payments) which are recognised as a transfer of mining interests. Paragraph 47(a) of Declaration 19 explicitly deals with the latter as follows: the purchaser of VPP does not have to contribute time or capital to the actual production of the final product. However, many investors in this type of interest will hedge their expected claims (the volumes indicated in the contract) through the derivatives market to protect themselves from commodity risks or otherwise hedge expected profits. A volumetric production payment (VPP) is a means of financing mainly used in the oil and gas industryThe oil and gas industry, also known as the energy sector, refers to the process of exploration, development and refining of crude oil and natural gas. This is the owner of an oil or gas property who sells a percentage of the total hydrocarbon production in cash for an upfront payment. The VPP agreement involves a global licence fee, i.e.

a predetermined share of the total production (or proceeds from the sale of the goods produced) over the specified period paid by the gas field owner to the VPP buyer. .