Oil & Gas: What Is A Farm-out?

When a landowner, sometimes called a freeholder, assigns all or part of an oil, natural gas, or mineral interest to a third-party, it is referred to as a “farm-out.” Think of it like this: a triple-a baseball team relinquishes their rights to a player to a major league team when the major league team promotes him. Easy enough?

Farmer/Farmee Relationships

The third-party in a farm-out agreement is known as the “farmee,” and pays the “farmer” an upfront sum for the interest and also commits to spending an agreed amount of money to perform specified activities related to the interest, such as drilling and shipping costs, exploration, testing, and other costs associated with the agreement. Income generated by the farmee is divided between the two parties; typically a percentage is worked out beforehand.

When To Enter A Farm-out Agreement

A person or company may decide to engage in a farm-out agreement with a third-party if he/it/they want to maintain an interest, but either at a reduced risk or because drilling and activities associated with the oil business become too expensive to take on. Farm-out agreements provide farmees with profit opportunities that they might not have otherwise. In some cases, government approval may be necessary.
One benefit to farm-out agreements, insofar as farmers are concerned, is the farmee generally assumes all legal liability in the event of a lawsuit. For instance, if a worker is injured on the job and decides to file a worker’s comp claim, the liability generally falls on the third-party. The freeholder cannot be held liable for damages, in this scenario.
Another major benefit: Farmers do not generally invest anything more than their land. They speculate the land’s value and contract the actual work to someone else. Hence, splitting a percentage of the profits could mean nothing but profits for the farmer(s).

Why Would A Third-Party Want To Do This?

Money. The farmee doesn’t need to buy land in order to speculate. They essentially lease the right to speculate, which is much cheaper than buying parcels and taking on the risk of finding nothing.
Here’s the bottom line: if you’re sitting on a piece of land and are approached by a third-party who wants to speculate for oil, seek legal help right away. Farm-outs are complex agreements; and if you’re not careful, you could end up giving up what you would otherwise deserve. Contact Robert Robles today to get legal advice on your Farm-out.