Europe is generally not known as an oil producing continent. Although there had been some significant deposits, due to the continent's high demand for hydrocarbons, they were depleted many years ago. In 2010, Europe needed to import 50% of its natural gas demand and 70% of its liquid demand. Additionally, dependency is expected to rise significantly within the next ten years.
The only remaining relevant area of hydrocarbon production in Europe is the North Sea area and partially the Norwegian Sea. Production in the North Sea stepped up strongly supported by governments after Europe recognized its hydrocarbon dependency after the first and second oil crisis in the 1970s. Many areas in Norway and the UK became rich because of that development. Nevertheless, due to its off-shore nature production costs in the North Sea tend to be high. Additionally, production has peaked a long time ago and - unlike in America with its tight oil boom - there are no signs that the trend will change soon.
European companies were always forced to look for their assets outside the continent. Generally the can be divided into former NOCs (with a government that lost control more or less) and companies that are not related to any specific country. But I also consider enterprises from North America with their assets only in Europe to be European. Most of the majors whose production costs I have already calculated are originally also from Europe, but no one would call them European companies. In that article I calculate production costs for a number of European companies. Some of them are divisions of much bigger conglomerates: Bankers Petroleum (OTCPK:BNKJF), BG Group (OTCQX:BRGXF), Galp Energia (OTC:GLPEF), Ithaca Energy (OTCPK:IACAF) and Maersk Oil (OTCPK:AMKAF).
The key point for me is to catch the real production costs of hydrocarbons as accurate as possible. For that reason I only consider costs that are directly related to oil and gas production. As the upstream business is a pure commodity business, many companies have bought derivatives to hedge their sales. As gains or losses from that instruments are not directly related to production, I do not consider them directly in my method. Nevertheless, as they might have impact on the future of the company, I mention them if they are significantly high. The same is true for impairments.
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. Let's say the price for 1 barrel of oil is around $60 and the price for 1000 scf of gas is about $3. This means, revenue from 1 boe of oil is higher than revenue for 1 boe of gas ($60 versus $18). As there are also fields that only produce gas, this article tends to underestimate the costs of oil production.
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. ExxonMobil (NYSE:XOM) 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, Depletion and amortization, 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
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.
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.
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:
As I have noticed in one of my articles, that cash flow situation does not look well for the majors. In the long term, a profitable company must be able to generate enough cash flow to cover its capex and to buy money back to its shareholders (either via dividends or share buybacks). Therefore I included operating cash flow and total capex in my data. Operating cash flow and capital expenditure both refer to the whole company. Capital expenditure is investment in assets as well as in subsidiaries if they are not consolidated. This number does not include any subtractions because of the selling of assets. I also add the cash flow companies generated through sale of assets.
Application on 5 European companies
Of the five companies in the article, I have already considered 3 in my investigations about 2013's production costs. The two newcomers are Galp and Ithaca. Galp is a conglomerate of various Portuguese companies that are related to the upstream and downstream business. Its IPO on the Lisbon Stock Exchange took place in 2006. The company has assets in Portugal, but also in many countries that were former Portuguese colonies (e.g. Brazil, Mozambique, and Angola). Ithaca Energy is a North Sea operator. Not surprisingly, the Aberdeen-headquartered enterprise's assets are located in Norway and the UK. Current activities are focused on the Greater Stella Area of the UK Central North Sea. All companies which the exception of Galp stated their results in USD. For the Portuguese company I have used a conversion factor of EUR1 = USD1.329.
The results can be found in the table below:
(source: own calculations based on the ARs for 2014)
Liquids do not only mean classical oil, but also natural gas liquids - NGL.
I have also applied my methodology on the following companies:
- 2013's Costs for 121 Companies
- Independents I
- Independents II
- Independents III
- Shale Oil Producers I
- Shale Gas Producers
- Oil Sand Producer I
- Oil Sand Producer II
- Shale Oil Producers II
- Shale Oil Producers III
- Shale Oil Producers IV
- Shale Oil Producers V
- Majors I
- Majors II
- Smaller US Companies I
- Smaller US Companies II
2014 saw a drop in the oil price of more than 50%. However, capex budgets for that period were decided earlier in a high price environment. Of the three companies, I investigated the year before, two increased their production, while one decreased it - BG.
Bankers is a Canada-listed upstream company that gets its whole production from the European country of Albania. In 2013 as well as in 2014 the company's production consisted of 100% oil. The fall in the oil price can easily be seen on the balance sheet, as average realized revenue went down to $77.21, a significant discount to the Brent price that amounted $98.95 in the same period. On the other hand, the company was successful in the reduction of its costs. Especially remarkable is the reduction in financial costs. Eventually, Bankers achieved a high margin of more than 32%.
Lately, BG got a lot of attention in the media, as the company was acquired by Shell in early April. The enterprise is one of the relative few companies that decreased their production in 2014 compared to 2013. Because BG could increase its percentage of liquids produced, the company could increase its average realized revenue per boe. But costs also rose significantly. Costs of sales per boe increased by roughly 50% and depreciation by more than 40%. Nevertheless, the very low SG&A and interest expenses should also be noted. Below the line, pre-income tax margin fell to still very healthy 30%.
Galp is merely an oil producer and could therefore realize a relatively high average price per boe sold. Although it is the only upstream company in Portugal and has assets in many continents, it produced merely 11.13 million boe in 2014. High are the exploration-related costs per boe, but costs of sales are roughly average and so is depreciation. As one can expect from a government-related company, financial expenses per boe are low. Eventually, Galp had a pre-income tax margin of 11%, hardly a reason for joy. The company was able to fund its capital expenditures with operational cash flow, but this includes the whole business and not only the upstream segment.
The North Sea-centered Ithaca had high costs as one can expect from a company that produces only off-shore. Total cost of sales in 2014 are among the highest I saw for any company and depreciation per boe is also significant. However, the products of Ithaca is high quality oil that could achieve a high price on the markets. For such a small company (slightly less than 4 million boe produced in 2014) SG&A expenses are rather low and even financial expenses per boe are somewhat acceptable in relationship to realized revenue for the quantity. Additional items on the company's balance sheet were impairments of $441 million and gains on derivatives of $175 million.
Maersk Oil, a part of the big Maersk conglomerate (mostly associated with shipping), is the next high cost, off-shore oil producer. Realized revenue per barrel oil fell by more than 10%, most attributed to the fourth quarter. Maersk Oil was relatively good in handling the company's costs. Costs of sales went down by nearly $8 per barrel and depreciation went down by $4 per barrel. Eventually, profit margin was nearly equal with 15%. An additional item on the income statement were impairment losses of $2.2 billion (amounts more than a quarter of total revenue in 2014). Interesting is the statement of cash flows. The whole company was barely able to cover capex with cash generated from operational activities.
Overall, European companies were still positive on 2014's price level. Naturally, many European oil producers are active in the North Sea or off-shore otherwise and they felt the fall in the oil price strongly. As some of them only produce oil, they might be a proxy for production costs of oil (although a bit on the high side). Although cost reduction effort are clearly recognizable, it is more than questionable, if any of the North Sea companies could survive long term with an oil price level of $60 for Brent (without hedging). This once again supports my opinion that the current oil price level is not sustainable.
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