Volumetric Production Payment (VPP)

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Volumetric Production Payment (VPP)

Overview

A Volumetric Production Payment (VPP) is a financing structure in which the owner of oil or gas reserves sells or pledges a specified volume (or percentage) of future production to an investor in exchange for upfront cash. The investor receives a stated monthly quota of the commodity (or the cash equivalent), while the producer retains ownership of the property but monetizes a portion of its future output.

How VPPs Work

  • The producer transfers the right to a fixed volume or percentage of future production to the buyer for a defined term or until an agreed total volume is delivered.
  • The buyer receives the commodity (or cash proceeds from marketing it) according to the contract schedule.
  • VPPs can be structured as sale-of-production (the buyer acquires the volumes) or as a financing arrangement where delivered volumes are used to repay a loan.
  • VPP buyers typically hedge their exposure in derivatives markets to manage commodity price risk.

Typical Parties

  • Sellers: Oil and gas producers or owners of mineral interests looking to raise cash without selling the underlying asset.
  • Buyers: Investment banks, hedge funds, energy companies, insurance firms, or other institutional investors seeking predictable commodity cash flows.
  • Lenders/Intermediaries: In some cases, VPPs are used within pre-export financing (PFX) packages where a financial institution advances funds backed by the VPP cash flows.

Deal Mechanics and Variations

  • Termination: A VPP usually ends when a specified time period expires or when the cumulative committed volume has been delivered.
  • Non-operating asset: The VPP interest is non-operating—buyers do not participate in production operations.
  • Repayment vs. Royalty-style:
  • Royalty-style: If production falls short in a period, the shortfall is typically carried forward until the buyer is made whole.
  • Loan-style: If production shortfalls are treated as missed payments, they can trigger default under a loan-repayment structure.
  • Credit quality: When used in PFX, VPP-backed cash flows often improve the credit profile because payments from production are prioritized to repay the financing.

Uses of Proceeds

Producers commonly use VPP proceeds to:
– Fund capital expenditures and development.
– Repurchase shares or pay down other debt.
– Improve liquidity without relinquishing ownership of the asset.

Risks and Considerations

  • Commodity risk: Price volatility affects the value of delivered volumes; buyers usually hedge this risk.
  • Production risk: Lower-than-expected production can delay or reduce buyer receipts and may affect repayment treatment depending on structure.
  • Counterparty/credit risk: Buyers assess the producer’s ability to maintain production and manage operations.
  • Structural complexity: Legal and accounting treatment varies by jurisdiction and by whether the deal is characterized as a sale, loan, or royalty.

Example (Simplified)

A producer sells a VPP that entitles the investor to 5,000 barrels per month from a field until 60,000 barrels have been delivered. The investor pays the producer upfront. Each month the investor receives the physical barrels (or cash equivalent). If production lags, the shortfall is carried forward until the total 60,000 barrels are delivered.

Key Takeaways

  • VPPs convert future oil or gas production into immediate cash while the producer retains ownership of the asset.
  • Buyers receive defined volumes or payments and commonly hedge commodity exposure.
  • Structures can resemble royalties or loan repayments; terms determine treatment of production shortfalls and default risk.
  • VPPs are useful for producers needing liquidity and for investors seeking commodity-linked cash flows with defined delivery schedules.