Oil is the single most traded commodity on our planet. As some derivative of oil can be found in nearly all products of daily life, it is hardly possible to exaggerate the importance of oil for our civilization.
Not all enterprises that are called "oil companies" actually produce oil. The oil and gas industry is commonly divided into three parts: upstream, midstream and downstream. Only the upstream industry (also called E&P - exploration and production) produces oil. Midstream is active in transportation and downstream is involved in refining of crude oil. Most companies are involved in more than one of these sectors.
Companies active in upstream can be roughly divided into two groups: NOCs and IOCs.
IOC is standing for International Oil Company. Here one can find well-known names like Exxon Mobil (NYSE:XOM), Shell (NYSE:RDS.A) or BP (NYSE:BP). The operations of these companies are not confined to a particular region, so they produce a variety of different blends. All of these companies are traded publicly, so it is easy to get detailed and reliable information about their figures as they have to publish them in their annual report.
NOCs are National Oil Companies. Among this group are giants like Saudi Aramco, Pemex or China National Petroleum Corporation. Some of these companies are totally government-owned (Saudi Aramco, KPC). There also exists some kind of hybrid, a company that had once been state-owned but was then partially privatized. In this case the government still holds a certain amount of shares, normally sufficient for blocking minority. NOCs generally tend to confine their operations to their country of origin. It is much harder to get information about their production and cost data. Hence, I will confine myself in the evaluation of production costs on IOCs.
The oil and gas industry is a very concentrated industry. As a newcomer would need a lot of money and know-how to start its operations, moat is very deep. Hence, the number of companies in this sector remains very stable and most enterprises have decade-long experience.
Oil is hardly ever produced as pure liquid. Normally it comes as a mixture with natural gas and gas condensate. Although I only consider companies here that mainly lift oil, they also produce significant amounts of gas. Hence, it does not make much sense to apply costs to the production of oil alone. To deal with this issue the concept of barrel oil equivalent (BOE) has been perceived. 6000 cubic feet of gas at standard conditions are about one boe. All costs mentioned below refer to one boe, meaning that are the costs related to the production of 1 bbl of oil, 6000 scf of natural gas or a combination of both.
Commonly, costs are divided in costs that can directly be related to production (cost of sales) and costs that cannot directly be related to output (overhead). However, many oil companies are also active in downstream and midstream or other economic sectors (e.g. Exxon Mobil in chemical engineering). Hence, I have divided sales, general and administration expenses (SG&A) by total revenues and multiplied it with the revenue of the E&P division to get SG&A for E&P. I did the same for any similar type of cost (marketing expenses, R&D) and for financial expenses. Depreciation of assets, on the other hand, can be directly linked to oil production.
Costs of sales are divided into 3 sub-categories:
- Exploration costs
- Lifting costs
- Non-income related taxes
Lifting costs are the costs associated with the operation of oil and gas wells to bring hydrocarbons to the surface after wells (facilities necessary for the production of oil) have been drilled. This figure includes labor costs, electricity costs and maintenance costs.
Exploration costs are costs related to all attempts to find hydrocarbons. This category includes cost for geological surveys and scientific studies as well as drilling costs.
Non-income related taxes: as production of hydrocarbons is such a lucrative business, governments also want to have their shares. There exists an abundance of different model how the state can profit from hydrocarbon production (profit sharing, royalties, etc.).
It might be, that different companies use different categories for the same type of expenses, but eventually the sum of all costs should be their total cost for producing 1 boe.
The following figure shows the pattern of the cost model:
Application on the 4 most important IOCs
I have applied the cost model on the world's 4 most important IOCs: Exxon Mobil, BP, Chevron (NYSE:CVX) and Shell. Together they were responsible for 8.4% percent of the world's oil production in 2012. I only have used the figures from their annual statement for 2013.
The results can be found in the table below:
(all numbers in $/boe)
Implications for the investor
Total costs per boe for the 4 most important IOCs moved in a similar range with small advantages for Exxon Mobil and Chevron, while BP and Shell had slightly higher production costs. I want to note that I did not include any impairment in my calculation. I also did not take into account the costs related to BP's Deepwater Horizon accident, which are still significant. The aftermath of this incident, combined with the highest production costs among the biggest oil producers, makes BP the least attractive investment in this group.
Additionally, the results suggest a lower boundary for the oil price. It can never fall below production costs in the long term. It is reasonable to assume that other IOCs will also have similar cost per boe. Hence, it is highly unrealistic for oil prices to fall below $50 (if one adds a certain profit margin). Lifting costs and exploration costs are rising, as companies went for the easy-to-reach oil reserves first. This tendency was especially visible in the period between 2011 and 2013, when average lifting costs for the 4 major IOCs rose by 26.7%.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.