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Financing Vehicles for Oil and Gas Producers
A Volumetric Production Purchase or VPP is a financing tool used in the oil and gas industry under which an oil or gas producer conveys a certain volume of oil or gas in the ground to a Capital Source in return for an up-front cash payment.  

The Producers: Capital Sourcing and Breaking the Bank…

Independent producers may have limited access or are over-leveraged and may have tapped out their sources of:

        Conventional bank financing

        Mezzanine financing

        Private equity

 Such producer is typically a private, closely held, independent producer with gross production of 150 to 1,000 barrels of oil per day, located in the mid- continent US.  

Initial areas of focus are mature producing basins in Texas, Oklahoma, Kansas, Colorado and Wyoming.  VPP financing is limited to no more than 60% of operator’s daily net production.  

The focus is on settled, stable, stripper type production, spread across as many wells as possible. 

The Structure of VPP  Transactions

VPP transactions are structured as an advance payment to an oil producer for the  purchase of their oil, to be delivered by that  producer over a medium term, typically 36 months.  This is secured against an oil producer’s oil reserves and is a legally enforceable obligation to deliver a defined volume of crude oil over a defined period.  

VPP financing enables an oil producer to monetize oil that it has yet to produce from its PDP (Proved Developed Producing) and fund the development of its PUD (Proved Undeveloped) locations. 

Thereafter, the producer must deliver volumes of oil or gas to the VPP purchaser on a monthly basis over the life of the VPP, (usually 3-4 years), free of any cost to produce and extract the minerals.

A VPP can be classified as a temporary override.  

The VPP purchaser acquires legal title to the oil and gas and is included on the Division Order for the life of the VPP term.  

The Capital Source purchasing the VPP is protected in the event of the producer's bankruptcy because it actually owns the oil, gas or other minerals in the ground and thus avoids being a mere unsecured creditor.  

Underwriting the Transaction

The Capital Source makes an advance payment representing a negotiated sales price which is a discount in relation to the corresponding current and forward market price of crude oil for the oil volumes thus contracted to be delivered. 

The forward production decline rates of these wells can be accurately projected with a high degree of confidence. The funding source will provide financing to such established operators, typically with stable, stripper type production, which is spread across as many wells as possible. 

The VPP is fully hedged as to market risk so the primary risk of the transaction is delivery risk, i.e. can the Producer meet the delivery obligation? That risk is managed through two primary methods: 

Over collateralization. The producer must show the capability and history of being able to produce at least 150% of the delivery requirement. 

Due diligence on past production. We obtain third party petroleum engineering reports, operating history, credit history, tax returns, etc., being the same type of underwriting accomplished by commercial banks. A VPP can be a great financing source for the small to medium sized producer looking to leverage their existing production for CAPEX, acquisitions and debt re-payment.

Case Study Next..... 


Edited by BlackLine Resources

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