Volumetric Production Payment - VPP

DEFINITION of 'Volumetric Production Payment - VPP'

A type of structured investment that involves the owner of an oil and gas interest selling a specific volume production in that field or property. The investor receives a stated monthly quota – often in raw output, which is then marketed by the VPP buyer – or a specified percentage of the monthly production achieved at the given property.

A VPP deal is typically set to expire after a certain length of time or after a specified aggregate total volume of the commodity has been delivered. A VPP interest is considered a non-operating asset, akin to a royalty-payment system. If the producer can't meet the supply quota for a given month (or whatever schedule is used), the unmet portion will be made up for in the next cycle, and so on until the buyer is made financially whole.

Buyers could include investment banks, hedge funds, energy companies and insurance companies.

BREAKING DOWN 'Volumetric Production Payment - VPP'

The buyer does not have to contribute any time or capital to the actual production of the end product. However, many investors in these types of interests will hedge their expected receivables (the volumes laid out in the contract) via the derivatives market to protect against commodity risk or otherwise lock in the expected profits.

A VPP deal allows the seller to retain full ownership of the property while monetizing some of their capital investment. This ability to "cash out" some of the value of an oil field, for example, allows the seller to invest in capital upgrades, pay down debt or repurchase shares.

The VPP investor will typically perform strong due diligence both initially and on an ongoing basis, having inspections done of the site while constantly analyzing production reports to ensure that the contract's terms are being met.

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