Farmout Agreement

A farmout agreement is an agreement by which the owner of an oil and gas lease agrees to assign all or part of its interest to another party once that party meets stated conditions, such as drilling a well. The owner is the farmor. The party earning the interest is the farmee. The U.S. Bureau of Mines Dictionary of Mining, Mineral, and Related Terms (1968) gives the short form: "Donation of acreage in support of a drilling deal."

Fuller definitions

• A 1981 article in the Public Land Resources Law Digest (J. R. Scott, indexed by the U.S. Department of Energy's OSTI) gives the usual definition as "a contract to assign oil- and gas-lease rights in a certain acreage upon completion of drilling obligations and the performance of any other covenants and conditions therein contained."
• The SLB Energy Glossary describes it as "A contractual agreement with an owner who holds a working interest in an oil and gas lease to assign all or part of that interest to another party in exchange for fulfilling contractually specified conditions," and notes that the assignor "usually reserves a specified overriding royalty interest, with the option to convert the overriding royalty interest to a specified working interest upon payout."

The well to be drilled, its depth, the deadlines, what is earned, and what the farmor keeps are all set by the particular agreement.

Federal leases: how the earned interest is transferred

On a federal lease, an earned interest has to be transferred under BLM's rules.

• An assignment of record title "conveys both record title and operating rights, unless operating rights have been severed" (43 CFR 3106.10(b)).
• A farmee earning rights only to certain depths cannot take an assignment of record title by depth: "An assignment of a separate zone, deposit, depth, formation, specific well, or of part of a legal subdivision, will be denied" (43 CFR 3106.10(c)). Operating rights "may only be divided with respect to legal subdivisions, depth ranges, and formations" (43 CFR 3106.10(d)).
• An overriding royalty reserved by the farmor is filed but "will not require approval" (43 CFR 3106.10(i)).

The agreement and the assignment are different documents

The farmout agreement states conditions. The assignment made after they are met is the conveyance. If the agreement is not recorded, the assignment of record may be the only public evidence of the deal.

Why it matters in mineral title research

• An unrecorded farmout can leave rights outstanding that the record does not show, so recorded assignments have to be read for references to underlying agreements.
• The farmor's retained override or back-in changes the net revenue interest before and after payout (see Net Revenue Interest and Carried Interest).
• On federal leases, the BLM case file should show the approved operating rights transfer by depth range, matching the earned interest (see Depth Severance).