What it means
The letters stand for earnings before interest, taxes, depreciation, amortisation and exploration expense. Companies that search for oil, gas or minerals spend large sums drilling wells that may turn up nothing.
Accounting rules let some companies write those costs off straight away, while others capitalise them, meaning they record the cost as an asset and spread it over time. That difference makes profits hard to compare across the sector.
By adding exploration costs back, EBITDAX gives a cleaner picture of what the producing business earns before this choice of accounting method has any effect. It lets an analyst put a successful-efforts company and a full-cost company side by side on a like-for-like footing.
Lenders and investors in the energy sector use EBITDAX heavily. Loan agreements frequently express leverage tests such as net debt to EBITDAX, and valuation multiples such as enterprise value to EBITDAX are common in sector research.
A company with a rising EBITDAX and falling debt will usually be seen as stronger than one that is going the other way. The measure has weaknesses.
Exploration is a genuine and necessary cost for a company that wants to replace the reserves it produces, so adding it back can flatter a business that spends heavily and finds little. Analysts therefore often look at EBITDAX alongside measures of reserve replacement and of cash spent on drilling.
As with other adjusted measures, EBITDAX is not defined by accounting standards. Companies decide for themselves which costs belong in the exploration add-back, so reading the reconciliation to net income is essential.
For someone outside the industry, the most useful habit is to ask what has been left out. If a company adds back large exploration costs every year, it may be spending heavily to stay in business, and the add-back can make steady performance look like growth.
Comparing EBITDAX with a measure that includes exploration shows how much of the profit is being spent on finding replacement reserves.
In practice
Real-world examples.
Example
An analyst compares two oil producers, one that writes off dry wells immediately and one that capitalises them. EBITDAX removes the accounting difference so their operating performance can be judged fairly.
Example
A bank lends to a gas producer and sets a covenant that net debt must not exceed three times EBITDAX. The company monitors the ratio every quarter to stay within the limit. Its finance director also reports the figure to the board so that any drift is spotted early.
Example
A mining company explores for copper in several countries. Its board tracks EBITDAX to see the profit of the producing mines without the swings caused by exploration campaigns.
Formula
Calculation
EBITDAX = EBITDA + Exploration expense
EBITDA = Net income + Interest + Taxes + Depreciation and amortisation
Worked example for an independent oil producer:
Net income: $2,000,000
Interest: $600,000
Taxes: $900,000
Depreciation and amortisation: $1,500,000
EBITDA = $2,000,000 + $600,000 + $900,000 + $1,500,000 = $5,000,000
Exploration expense: $1,200,000
EBITDAX = $5,000,000 + $1,200,000 = $6,200,000
To test a leverage covenant, suppose the lender allows net debt of up to 3.0 times EBITDAX. With EBITDAX of $6,200,000, the maximum net debt is $6,200,000 x 3.0 = $18,600,000. Any net debt above that figure would breach the covenant unless EBITDAX also rose.Case study
Seen in the real world.
This is a fictional story. Redstone Energy, an invented oil company, reported EBITDA of $5,000,000 and exploration expense of $1,200,000, giving EBITDAX of $6,200,000. Its net debt was $18,600,000.
The lender calculated net debt to EBITDAX as $18,600,000 / $6,200,000, which is 3.0 times, exactly on the covenant limit. The company decided to pause a risky drilling campaign for a quarter, which kept the ratio safe and showed the board how closely the measure shapes real decisions.
By pausing the campaign, Redstone cut exploration spending by $400,000 for the quarter. That did not change this year's reported EBITDAX much, but it reduced the cash going out and gave management more headroom. The board noted that the covenant was influencing strategy, and agreed to discuss resetting it with the lender.
Watch out
Common mistakes.
- Assuming exploration is a cost that can be ignored. It is essential for replacing reserves, so adding it back does not make it free.
- Comparing EBITDAX with EBITDA for non-energy companies. The measure is designed for resource businesses and is not meaningful elsewhere.
- Taking the figure at face value without the reconciliation. Definitions of exploration expense vary, so read the bridge to net income.
Questions
People also ask.
Why is EBITDAX used in oil and gas?
Companies in the sector account for exploration in different ways, and adding it back makes them comparable.
What is the difference between successful efforts and full cost accounting?
Successful efforts writes off the cost of dry wells immediately, while full cost capitalises all exploration costs.
Does EBITDAX measure cash flow?
Not exactly. It ignores capital spending, working capital changes and the cash paid on drilling.
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