What it means
Chemically, hydrocarbons range from methane, the main component of natural gas, to heavy tars. Crude oil is a mixture of many hydrocarbons that refiners separate into petrol, diesel, jet fuel and chemical feedstocks.
Natural gas is burned for heat and power, or processed into products such as fertiliser. The industry is usually divided into upstream, midstream and downstream.
Upstream covers exploration and production, midstream covers transport and storage through pipelines and tankers, and downstream covers refining and selling to customers. Each segment has different risks, margins and capital needs.
Revenue depends heavily on commodity prices, which can swing sharply with supply, demand, politics and weather. Producers therefore often hedge, meaning they use contracts to lock in prices for part of their output.
Costs, by contrast, are largely fixed in the short run, so a fall in price can cut profits quickly. Accounting has special features.
Companies report reserves, which are estimated quantities that can be recovered economically, and they use methods such as successful efforts or full cost to account for exploration spending. Assets are written off through depletion, a charge that spreads the cost of a field over the oil and gas produced from it.
The industry also faces long-term questions about the energy transition, environmental regulation and carbon pricing. Lenders, insurers and investors increasingly ask hydrocarbon companies to disclose emissions and plans for lower-carbon products.
These factors can change the cost of capital and the value of reserves that might never be produced. To compare oil and gas on one scale, companies convert volumes into barrels of oil equivalent.
This is a standard convention based on energy content, not price, so it does not mean that a barrel of oil and the equivalent gas always sell for the same amount.
In practice
Real-world examples.
Example
An oil producer reports quarterly results in barrels of oil equivalent. Analysts compare its production growth and cost per barrel with those of peers to judge efficiency. A company that grows output while holding costs steady usually earns a higher valuation.
Example
A fund manager reviews a pipeline company, a midstream business that earns fees for moving oil and gas. She prefers it to a driller because its income depends on volumes transported, not on the price of oil.
Example
A chemical manufacturer buys natural gas liquids as feedstock for plastics. Its finance team hedges part of its purchases to protect margins when prices rise. This gives the sales team confidence to quote fixed prices to customers for the next six months.
Formula
Calculation
Barrels of oil equivalent (boe) = Barrels of oil + (Thousand cubic feet of gas / 6)
Revenue per boe = Total revenue / Total boe
A producer sells 100,000 barrels of oil at $75 a barrel and 1,200,000 thousand cubic feet of gas at $3 per thousand cubic feet. Gas converts to 1,200,000 / 6 = 200,000 boe, so total production is 100,000 + 200,000 = 300,000 boe. Revenue is 100,000 x $75 = $7,500,000 from oil plus 1,200,000 x $3 = $3,600,000 from gas, a total of $11,100,000. Revenue per boe is $11,100,000 / 300,000 = $37.00.Case study
Seen in the real world.
Redwater Energy Partners is an illustrative, fictional company with oil wells in a mature basin and a small gas business. Its board was concerned that profits were swinging widely with the oil price, which made planning difficult.
The CFO calculated that every $10 fall in the oil price cut annual revenue by $10 x 4,000,000 barrels = $40,000,000. She proposed hedging 60% of next year's expected output using fixed-price contracts, which locked in income on 2,400,000 barrels, and keeping the remaining 40% exposed to the market.
In this illustrative story prices fell sharply during the year. The CFO had also agreed a revolving credit facility, so the company had spare borrowing capacity if cash ran short. The hedged barrels earned the agreed price, which saved the company from breaching its loan terms, although it gave up gains on the hedged portion when prices later recovered. The lesson is that hedging reduces volatility but also reduces upside.
Watch out
Common mistakes.
- Treating reserves as cash in the bank, when they are estimates that depend on prices and technology.
- Comparing oil and gas by volume alone, instead of converting to a common energy basis.
- Ignoring decommissioning costs, which are the future expenses of closing wells and restoring sites, and which can be large for offshore fields.
Questions
People also ask.
What does hydrocarbon mean in finance?
It generally means oil, natural gas and related products, and the companies that find, move and sell them.
Why do hydrocarbon prices change so much?
Supply is slow to adjust, demand shifts with the economy, and political or weather events can disrupt output, so small imbalances can move prices a long way.
What is upstream versus downstream?
Upstream finds and produces oil and gas, while downstream refines and sells the products to customers.
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