Should You Lease or Buy Your Vapor Recovery Units (VRUs)?
Oil & Gas is a Capital-Intensive Industry
The Oil & Gas industry is capital intensive, and generating positive economic returns is essential to long-term success. When it comes to acquiring production equipment and facilities to serve a well site over its economic life, operators have an important financial decision to make – should I purchase the equipment outright, or lease it over time?
The Need for Vapor Recovery Units (VRUs)
Regulators, investors and key stakeholders are all driving the Oil & Gas industry to do more to reduce emissions from well sites and facilities. Many oil producing states have mandated aggressive gas capture requirements, including Colorado, North Dakota and New Mexico with other states following their leads.
Vapor Recovery Units (VRUs) capture flash gas from Vapor Recovery Towers (VRTs), oil storage tanks, produced water storage tanks, heater treaters and other production equipment so it can be sold instead of flared or vented to the atmosphere, both of which generate air emissions. Tank vapors in particular are rich in BTU content, often exceeding 3000 BTU, making some of the most valuable gas on the wellsite!
In some cases, using a VRU may be a regulatory requirement.
Capital Efficiency – to Lease or Buy?
The investment community is now favoring a return of capital from Oil & Gas operators instead of a return on capital. That means operators, especially public companies, have to pay close attention to capital budgets and free cash flow to ensure the can pay dividends and fund share buybacks.
Here is an over-simplified view of the differences between leasing and buying:
Buying a VRU is simple. You simply pay for the equipment up front and install it. The good news is that now you own it and have no further financial commitment other than ongoing maintenance and repair. The bad news is that you now have a big chunk of capital tied up in the VRU, funds that you could have used for other purposes, such as funding a drilling budget, paying a dividend, leasing new acreage, etc.
Leasing a VRU gives you the use of the VRU over a period of time, but you do not own it. Instead of making a big capital investment up front, you pay a lease payment over the lease term. The good news is that you conserved limited capital resources and have more money to work with. The bad news is you have committed to a fixed monthly lease payment for the next several years reducing your future free cash flow.
The table below summarizes the pros and cons of leasing and buying VRUs in more detail:
You pay 100% of the VRU cost up front, reducing capital resources for other projects. If financed using debt, then your debt ratios increase (e.g., debt to equity, debt to capital, etc.) which could impair credit quality and your cost of capital (interest rate).
You conserve your limited capital resources and have more money to work with to fund other projects, pay dividends, finance share buybacks. Additionally, leases in general do not negatively affect debt ratios (although lenders may still factor in lease obligations in other ways).
Cash Flow from Operations
No ongoing impact to Lease Operating Expense (LOE), although you do incur non-cash depreciation charges.
LOE is increased, reducing operating cash flow by the amount of the lease payment. Lease payments, however, tend to be lower than loan payments, if a lessor is taking the salvage value of the VRU into account.
You can move VRUs that you own to any location, anytime. You can also sell it whenever you want.
Many lessors impose administratively burdensome paperwork requirements for documenting transfers, maintenance and other factors.
Cost of Capital
A purchased VRU now has to earn the same rate of return as all your other assets.
A VRU may have more financial value to a company with a higher effective tax rate than yours. If the depreciation expense from ownership shields more taxable income for the lessor than for your company, then all other things held constant the lessor can pass along those savings in the form of lower lease payments.
Purchasers tend to hold on to equipment for a long time, even after new technology has rendered it obsolete.
Leasing is an economical way to acquire the most advanced equipment without a big up-front capital outlay and makes upgrading most cost-effective.
Important Factors to Consider When Deciding to Lease or Buy a VRU
Depending on your company’s individual situation, you may favor one acquisition method over another. Here are some of the factors we recommend considering in your VRU acquisition decision:
Operational Efficiency and Productivity. This factor is often overlooked by the finance people! Being able to deploy equipment efficiently to where it is most needed is critical to maximizing operational efficiency and productivity. Most lease agreements have strict paperwork requirements that can place an undo burden on operations and accounting staff, and failure to meet lease administration requirements can result in financial penalties. If you own a VRU, you can move it wherever you want at any time.
Capital Conservation and Asset Life. With this factor, we are considering both the economic life of the field and the useful life of the VRU. If you have a long-term commitment to operate in a specific area with an ongoing asset development plan, then owning or a long-term lease can make sense. If you expect to operate a field for only 3-5 years before selling, then using leases to conserve near-term capital resources can make more sense.
Extending Well Life. As wells age, they experience natural declines in production volumes and cash flow. Instead of plugging and abandoning the well, you can meet emissions requirements and generate incremental cash flow by swapping out a larger VRU for a smaller unit. We cover this strategy in our blog article Coping with the Decline Curve: When and How to Downsize Your VRU.
The Platinum Control Advantage – The Flexible Fleet™ Lease
If you have decided to lease your VRUs, Platinum offers a simple solution for building-in operational flexibility and efficiency from the start.
Our Flexible Fleet™ solution is a blanket lease agreement that allows you to move any Platinum VRU in your fleet to where it is most needed. No transfer forms are required to move larger units to new drills and backfill them with smaller units from other sites.
Flexible Fleet™ gives you the ability to manage your operations efficiently and easily, and is just another way Platinum fulfills our promise to help you Harness the Full Potential of Your Well Site.
Contact us today at email@example.com to learn how our Flexible Fleet lease can help you improve capital efficiency and acquire the VRUs you need to optimize operational efficiency.