A Volumetric Production Payment (VPP) is a powerful financial tool where the owner of an oil or gas interest can sell or borrow against a specific volume of production from a field or property. The investor or lender receives a specified monthly quota—often in raw output, marketed by the VPP buyer—or a percentage of the monthly production from that property. Buyers often include investment banks, hedge funds, energy companies, and insurance firms.
Key Highlights
- Generate Cash Flow: VPPs allow conversion of a portion of oil or gas production into cash flow for investors.
- Qualified Buyers: Typically, financial entities or energy companies ensure the future delivery of oil or gas.
- Retention of Property: Sellers, usually oilfield companies or drillers, can monetize capital investments while retaining property ownership.
Understanding Volumetric Production Payments
VPP structures are often integrated as part of pre-export financing (PFX) packages, where financial institutions provide funds based on proven volumes of buyer orders. For the oil producer (the borrower), funding is crucial to produce and supply oil and gas. The VPP serves to repay the borrowing under PFX, usually providing stronger credit quality as cash flow from the VPP prioritizes the PFX over other creditors.
While VPP buyers do not typically have to contribute in production activities, they often hedge their expected receivables in the derivatives market to mitigate risks and secure expected profits.
VPP deals enable sellers to retain full property ownership while liquidating portions of their capital investments. This liquidity can be used for capital upgrades or debt repayment, offering flexibility and financial benefits.
Essential VPP Deal Components
A VPP deal usually expires after a pre-determined period or once a total specified volume of the commodity is delivered. These interests are considered non-operating assets, similar to royalty payments or loan repayment systems. In a royalty payment setup, if a producer misses their quota for a scheduled period, the shortfall rolls over to subsequent cycles until complete. Conversely, a loan repayment framework considers missed payments a default.
Related Terms: Royalty Payment, Capital Investment, Pre-Export Financing, Derivatives.
