Volumetric Production Payment (VPP) in Oil Industry


Key Takeaway:

  • Volumetric Production Payment (VPP) is a type of financing in the oil industry, where a buyer provides upfront capital to an oil producer in exchange for a percentage of the future oil production, usually for a fixed term.
  • For oil producers, VPPs provide a way to raise capital without taking on debt or selling equity, while VPP buyers can enjoy a steady stream of revenue from the oil production.
  • However, VPPs also come with risks, such as market volatility, operational issues, and legal complications. It is important for both parties to carefully consider these risks before entering into a VPP agreement.

Do you need a secure and reliable payment system for oil production? Volumetric Production Payment (VPP) is the answer you are looking for. It offers a safe, fast, and cost-effective way to make and receive payments for oil production. Learn more about VPP in this article.

Definition of Volumetric Production Payment (VPP)

Volumetric Production Payment (VPP) refers to an oil and gas financing agreement whereby the investor, i.e. the buyer, acquires a fixed volume of future oil and gas production from the seller in exchange for the upfront payment made. This strategy transfers production risks to the buyer while allowing the seller to access capital and reduce debt. VPPs are typically used in mature fields where production levels are predictable. These agreements are highly structured and include detailed provisions on the amount, timing, quality, and delivery of the purchased oil and gas. A wise Pro Tip would be to engage experienced legal and financial advisors for a well-structured VPP agreement.

How VPP works in the Oil Industry

One of the ways in which the Oil Industry employs Volumetric Production Payment (VPP) is by selling a production-based interest to investors in exchange for upfront cash. This allows the company to generate cash without losing full ownership of the property. Below is a table showcasing the working aspects of VPP in the Oil Industry -

Column 1 Column 2 Column 3 The asset - often an oil or natural gas field The Pre-Payment The Reserve Production Percentages

It is important to note that VPP agreements vary greatly from one another. They are based on factors such as reserve size, pricing, the current market, and production targets.

VPPs have unique capital structures that allow investors to invest on a non-recourse basis. Non-recourse financing means that the investors are not liable beyond their initial payment. This makes it safer for both the buyer and seller.

In a similar tone, it is worth noting that during the financial crisis of 2008, the oil reserves hedged with VPP remained more valuable than the shares of the same companies. This provides an idea of the honest value of the VPP as a financial instrument in the Oil Industry.

Risks Associated with VPP

VPP Risk Factors: Mitigating Financial Losses

Identifying the potential risks associated with VPP is crucial for investors and companies pursuing this option. Commercial risks like price volatility, production output, and production-demand alignment can result in substantial financial losses during the term of an agreement. Mitigating these risks requires identifying the need for careful due diligence and a comprehensive evaluation of the upstream production asset.

Negotiation and analysis of VPP contracts can be challenging as they involve complex financial structures. In such contracts, the non-recourse nature of payback to investors can also increase risks, particularly in situations involving bankruptcy or default. Hence, due diligence, and designing a comprehensive hedging strategy are crucial to reduce risks that can be unplanned or foreseeable.

Besides these commercial risks, operational and environmental risks such as mechanical failure, natural disasters, and government regulations may negatively impact production output. Mitigating these risks entails designing and implementing an effective disaster management plan, which involves an efficient and competent management team with extensive knowledge of the sector, and with experience in managing or mitigating scenarios of similar calamities.

According to a Forbes report in 2010, Delta Petroleum, an independent oil and gas producer, faced risks when its VPP deal with Inergy LP fell apart due to operation-related issues. The VPP agreement worked on 22.5% of Delta's revenue from a Colorado-based mineral property for USD 360 million. However, Inergy's inability to sustain operations led to a decline in production output, which impacted Delta's revenue and led to a sharp decrease in stock price. Delta had to seek bankruptcy protection and subsequently settled with investors. The case shows the need for careful evaluation of all potential risks before undertaking VPP.

Five Facts About Volumetric Production Payment (VPP) - Oil:

  • ✅ VPP is a financing tool used by oil and gas companies to raise capital. (Source: Investopedia)
  • ✅ In a VPP, an investor provides financing in exchange for a portion of the production revenues from a specific oil or gas reserve. (Source: Oil and Gas Investor)
  • ✅ VPPs are typically used by companies to fund development and exploration projects. (Source: Geology for Investors)
  • ✅ VPP investors have the right to receive a predetermined volume of production, regardless of the prevailing market prices. (Source: EnergyNet)
  • ✅ VPPs have been criticized for their complex structures and high transaction costs. (Source: OilPrice.com)

FAQs about Volumetric Production Payment (Vpp) - Oil

What is a Volumetric Production Payment (VPP) in the Oil Industry?

A Volumetric Production Payment (VPP) is a financial instrument used in the oil and gas industry. It is basically an agreement where an investor gives money to an oil company in exchange for a certain amount of the oil or gas produced from a specific field or production unit.

How does a Volumetric Production Payment (VPP) work?

A VPP investor gives money to an oil company in exchange for a set amount of the oil or gas produced from a specific field or production unit. The investor typically receives the rights to a certain percentage of the production of the field (usually around 80% to 90%) for a specific period of time (typically 5 to 10 years). The investor receives the production payments, and the oil company continues to operate the field and sell the remaining oil or gas to other buyers.

What are the benefits of a Volumetric Production Payment (VPP) for the investor?

The benefits of a VPP for the investor are that it provides a stable income stream over a certain period of time, typically 5 to 10 years. As the investor is entitled to a set percentage of the production volume, they are not affected by fluctuations in the oil or gas price. Additionally, VPPs are typically structured as low-risk investments, as they are secured by the underlying oil or gas production.

What are the benefits of a Volumetric Production Payment (VPP) for the oil company?

The benefits of a VPP for the oil company are that it allows them to raise capital without having to sell equity in the company or take on debt. This can help them to finance new projects or expand their existing operations. It also provides them with a guaranteed revenue stream for a certain period of time, which can help them to plan their operations more effectively.

What are the risks associated with investing in Volumetric Production Payments (VPP) in the oil industry?

The main risk associated with investing in VPPs in the oil industry is the possibility that the production volume may be lower than expected, which could lead to lower revenue for the investor. Additionally, there is always the risk associated with commodity prices, though the investor is typically insulated from these fluctuations. Finally, there is the risk of a default by the oil company, though VPPs are typically structured as low-risk investments to minimize this risk.

How are Volumetric Production Payments (VPPs) different from royalty trusts?

While both VPPs and royalty trusts are financial instruments used in the oil and gas industry, there are some key differences between the two. A royalty trust is essentially a publicly traded company that owns the rights to a certain percentage of the oil or gas produced from a specific set of wells. The investor in a royalty trust typically receives a dividend based on the production volume. In contrast, VPP investors are entitled to a set percentage of the production volume from a specific field or production unit. Additionally, VPPs are typically structured as private transactions, while royalty trusts are publicly traded companies.