Farm-in and farm-out operations in the O&G sector: how do they work?

With the change in some criteria for exploration and production in the country (such as the New Gas Law), the O&G sector has an optimistic forecast about the entry of new players into the Brazilian market in the coming years.

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Even when there are no new auctions blocks and oil fields in sight, this does not mean that companies are prevented from entering and negotiating within this market. This is the process called farm-in/farm-out.

With the participation of our guest Fernanda Delgado, professor and researcher at FGV Energia, learn what these operations are, how they work and what is the best time to participate in this type of transaction.

What is farm-in?

The exploration and production of oil and gas in Brazilian seas is carried out under the concession of delimited areas. The best known form of acquisition of these areas is the auction of oil exploration areas.

In this process, the Federal Government makes available areas for bidding disputes between companies authorized to carry out this exploration. As in any bidding process, whoever offers the best conditions wins.

But that does not mean that whoever loses in the auction is prevented from entering the market until the next one happens. After all, these processes vary a lot in frequency and exploration particularities depending on the research carried out for new reserves — we have already had many years without auctions in the country.

An alternative, therefore, for these players, is the procedure known as farm-in. “It is the oil industry term for a negotiation in which an unlicensed company (without the license that was originally granted by the government) acquires the participation of a licensed company that is operating in that area”, explains Fernanda.

This transfer encompasses all obligations required in the original concession contract, which become the responsibility of the agent who carried out the farm-in. Likewise, it also retains the exploration rights defined in the contract and the percentage of profits arising from production.

The same can happen with fields already in production, as is the case of older assets, when a smaller E&P company takes over an oil field from a larger company.

In other words, it is a way to enter the market even when the Union does not have areas available. The company that did not succeed or, for some reason, did not win the auction may in the future act in part of this concession by negotiating directly with the concession holder.

However, for this to happen, the company that will carry out the farm-in will have to prove to the ANP that it is technically qualified and financially qualified to assume the block or field in question.

What about the farm-out?

Farm-in and farm-out are actually two sides of the same negotiation process—just working in opposite directions. While the first is the entry of companies into O&G exploration, the farm-out takes place when a business with the current concession is willing to give up part or all of its available area.

Making a simpler analogy about the process, the farm-in is the buyer and the farm-out is the seller. There are several reasons for a company to decide to have a share of the license for other players.

This occurs, for example, when the reserve proves to be greater than the business’s ideal productive capacity, when the business is profitable or even when profitability drops to the point where the business can be taken over by a smaller company.

How do they work in the Oil and Gas sector?

As the process from auction to start of production can take almost eight years, it is very difficult to predict when and how these opportunities will appear in the market. However, from the converging point of interest between the two companies, it becomes a common negotiation.

“This transfer”, explains the professor, “is made by exchanging exploratory rights or other types of commitments in exchange for the right to a license, in exchange for money or for some type of participation – such as shares”.

“It is an agreement between the holder of a federal lease and a third party who did not participate in this original auction, but who, based on this negotiation, can explore, prospect, work and operate for a predetermined period in the negotiation or until the end of the validity of that concession”.

In this way, farm-in and farm-out always happen simultaneously. It is the desire on the one hand to give up part of its license to obtain other advantages and the desire on the other side to enter O&G production.

As it is impossible to obtain concessions outside the context of government auctions, this procedure becomes the only more direct and negotiable alternative to increase the mutual growth of companies in the sector.

When is the best time to farm-in/farm-out?

The decision to participate in this type of negotiation depends on several factors, which is why each business in the sector needs to carefully analyze its options and the consequences of each alternative. See the most common reasons for players to choose this type of procedure.

Farm-in

The most favorable time for the farm-in, given everything we’ve analyzed so far, is when there are interruptions in oil auctions. This happened in Brazil during the pandemic, when there was a significant reduction in demand and, consequently, in the price of a barrel.

In this type of scenario, when the resource devalues, the available areas tend to be cheaper as well. It is a good investment opportunity betting on the sector’s future recovery. Another interesting situation for farm-in is the availability of mature fields, which are already at the end of their exploratory period.

“These areas are sold to companies that are specialists in these types of fields, working in secondary or tertiary recovery. They use other techniques to extract a greater amount of hydrocarbons in these areas”, explains Fernanda.

Thus, an area that no longer brings significant profits to one business can be a great revenue generator for another. In this transaction, everyone wins.

Farm-out

And what makes an O&G player give up part of its concession license? According to Fernanda, everything depends on the company’s strategy. “This could happen because there was a change in management, or because it acquired another area and wanted to adjust its portfolio. It is very common for oil companies to move in and out of assets, managing their production portfolio”.

An example of this is when the salesperson wants to get rid of a peripheral area, which is not worth it because it is a little distant or in less than ideal condition relative to its main operations.

It may also be a good idea to farm-out in greenfiled fields, that is, in the beginning of operation, to carry out a farm-in in others that are already operational, depending on the particularities of the business and its objectives; or simply when it is necessary to raise funds for an essential investment.

Regardless of the reason, the farm-in/farm-out are business models and opportunities for entry and operational adaptation in the routine of the O&G sector. It is a chance to enter the market and increase operations even in low moments, always believing in recovery.

But of course, to participate in this and other markets involving maritime exploration and export, you need a specialized partnership that simplifies and streamlines your decisions in practical actions with intelligence. How about getting to know Wilson Sons solutions and getting in touch with us?