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.
Production Payment Interest FAQs
Can a production payment interest be based on volume instead of dollars?
Yes. A production payment interest can be structured around a specified quantity of oil or gas rather than a fixed dollar amount. In that case, the holder receives production until the stated volume is delivered. The economic value still depends on commodity price levels, timing of production, and field performance.