A farm-out is a form of agreement used wherein one company wishes, through drilling, to earn a working interest in acreage controlled by another firm. If company A has acreage, for which it cannot justify the expense and/or risk of drilling, it may enter into a sharing agreement with company B who is willing to bear the initial expense of drilling. Company B believes the acreage is in some way highly prospective, yet does not own it. Under such an agreement, the first company, (the farmor), assigns its acreage to a second company, (the farmee) in exchange for the second company agreeing to undertake certain drilling and testing responsibilities. The first company retains a partial working interest in the assigned acreage and receives a percentage royalty on the wells drilled by the second company. The industry standard agreement calls for the second company earning a two thirds interest with the first one retaining a one third share, although the terms of any said agreement are completely negotiable and dependent upon the situation.
The arrangement from the viewpoint of the second company is considered to be a farm-in agreement.