The oil and gas industry is highly competitive. Yet sometimes it is best to work with a competitor, rather than against them. Working together may mean that you can extract oil or gas that neither of you could do alone.
Companies use farmout agreements when one party who holds the rights to a particular piece of land wants to bring in another. They might do this when they do not have the resources available (perhaps because they are already stretched elsewhere) or do not have the particular skills or equipment needed for this particular job.
Farmouts are mutually beneficial
The company that currently holds the rights, (the farmor) assigns a percentage of interest to the other (the farmee) in exchange for an upfront fee, a promise to provide a particular service and a percentage of the profits made when performing that service.
It’s not always about size
Sometimes it is a small company bringing in a larger one and sometimes it is the other way around. It just depends on the particular needs of the first company. It might just be that a large company does not think a particular piece of land is worth the time to exploit themselves, but they do not want to sell their rights altogether just in case there turns out to be more oil or gas than they thought. A smaller company may be glad of the opportunity to carry out the extraction even though they will share the profits because they do not need to spend on a massive upfront fee to purchase rights.
Good contracts are crucial
Clearly, there can be a lot of money at stake in a farmout agreement. You need to be certain that the contract is clear to both parties and will stand up in court. Getting help to draft and review any farmout agreement is therefore wise.