SO-CALLED “farm-in” agreements have been recently making headlines in Guyana, mostly in relation to the Kaieteur and Canje blocks offshore. These agreements can be difficult to understand, but they’re a commonplace arrangement throughout the global energy industry and it is vitally important that Guyanese understand their meaning.
A farm-in agreement creates a partnership between two companies – one that already holds a lease granted by the government and one that wants to participate in developing that lease. For example, a small company might be granted an offshore lease from a government years ago, but after recent discoveries in a nearby block, a bigger company now wants to acquire a stake in that lease and develop it. The bigger company can “farm into” the block which the smaller one “farms out” to them. To do this, the bigger one takes on a portion of the smaller company’s stake in the block and agrees to pay part or all of the development costs in exchange, in addition to other fees.
In simple terms, these agreements allow smaller companies that want to invest in oil but may not have the capital to fully develop a block to outsource the financially intensive exploration and development stages to companies that have more access to capital and expertise. Many contracts contain a provision to allow later farming-in if a company eventually decides to do so.
This type of agreement is mutually beneficial. Small companies are often willing to take bigger risks than larger ones and bet on oil blocks that are much more speculative, which larger companies can be reluctant to bid on initially. However, if the acreage does turn out to contain oil or gas resources or is in an area that is technically difficult or expensive to extract, a smaller company may not have the resources or technical wherewithal to spend billions of dollars developing it.
Because of this, farm-in/farm-out agreements are a common practice in the energy industry used by small companies around the world. Many small companies can be as simple as a handful of geologists who buy cheap lease acreage in new or emerging areas where they think there might be oil – in the same way that many real estate speculators buy land near cities that they think developers may be interested in years from now.
Then if an oil find is made nearby, they can farm-out to bigger companies that are interested now that risks are lower to develop it and keep some of the eventual production revenues.
Guyanese will likely know some of the names of companies that have used this practice offshore, like JHI and Eco Atlantic. It is also commonly used by medium sized operators like Tullow and Kosmos all over the world. Even larger state-owned companies like Petronas, Malaysia’s national oil company, commonly farm-out blocks. Petronas farmed out a block in Suriname to ExxonMobil earlier this year.
Guyana normally requires government approval for new farm-in agreements, which it has traditionally granted – most recently for a deal between CGX Energy and Frontera Energy Corporation in May 2019. Although this is a common step for governments to take, it is important to note that a farm-in agreement doesn’t change the terms of the original lease or alter the government’s cut of revenues.
In fact, farm-in agreements generally benefit governments, by making it more likely that even blocks owned by small companies can be developed.
In addition to market efficiency, farm-in/farm-out agreements can help insulate Guyana from global market uncertainty. Small companies tend to be hit particularly hard by bad market conditions like low oil prices and anemic demand. But farming out allows them to outsource development to larger companies that have greater capital reserves and can generally better weather economic storms.
Fundamentally, farm-in agreements are a tool to help make sure that promising oil areas are actually developed into revenue-producing fields. And with Guyana’s government counting on those revenues for a slate of much-needed infrastructure investments and other budget priorities, that’s an important benefit for Guyana.