Production payment interest definition
/What is a Production Payment Interest?
A production payment interest is the right to receive revenue from oil and gas production, where the right reverts back to the interest from which it was created after a certain amount of production volume or revenue is reached. An organization obtains a production payment interest when it purchases a percentage of the proved reserves of a field.
Example of a Production Payment Interest
An oil company owns a lease to develop an oil field. To finance the drilling and production costs, it enters into an agreement with an investor. The agreement specifies that the investor will provide $10 million to fund the development. In exchange, the investor will receive 10% of the revenues from oil production from the lease until it has received a total of $15 million (the $10 million investment plus $5 million in profit). After reaching the $15 million threshold, the production payment interest terminates, and the oil company retains full rights to the production revenue.
Advantages of a Production Payment Interest
A production payment interest is useful for the party purchasing it, since it provides a reasonably assured return on investment. It is also useful for the producer, who obtains up-front cash to pay from the production operation; this can reduce the producer’s need for other forms of funding, such as debt or an equity interest.
Accounting for a Production Payment Interest
A payment made to the holder of a production payment interest is recorded as it is received or becomes a receivable.
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FAQs
How Does a Production Payment Differ From a Royalty Interest?
A production payment differs from a royalty interest in duration and structure. A royalty interest grants the holder a continuing share of production revenues for as long as the property produces, while a production payment ends once a specified sum or quantity has been received. Thus, a production payment is a temporary financing tool, whereas a royalty interest is a lasting economic right.