How Much Does It Cost To Produce One Barrel Of Oil (143 Companies In 2014)?

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by: Christoph Aublinger

Summary

The profit of any oil companies depends on the price it needs to produce its goods.

In the last months I have investigated production costs of 143 upstream companies all over the world.

The margin of an upstream company does not depend on its size or whether it focuses on oil or gas (the largest producer being the exception).

Based on technology and cost level of 2013 and 2014, the oil price will be above $60 on the long term.

Background

Oil/petroleum 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 hydrocarbons 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 active 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 ExxonMobil (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 publically, therefore it is easy to get detailed and reliable information about their figures as they have to publish them in their annual report. Producers that are only active in one country (like most of the shale producers) can also be considered to be IOCs.

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 (e.g. SaudiAramco, 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. Generally, it is much harder to get information about production and cost data of NOCs. Nevertheless, quite a number of state-owned or state-influenced upstream companies are listed on Western stock exchanges, especially Russian and Chinese ones. These enterprises I have also investigated.

Within the last months I have investigated production costs from companies all over the world, ranging from the world's biggest oil majors over South American and Kurdistan upstream companies till rather small tight oil companies in the USA. Totally I have used the data of 143 companies that produced 22,361 million boe (61.26 mboepd) in 2014. Although the number of companies investigated rose from 2013 (where I calculated costs for 121 enterprises), their cumulative output is smaller. There are some reasons for this. A prominent one is the fact that two significant producers (Surgutnefte (OTCPK:SGTPY)- more than 520 million boe in 2013 and Petronas (OTC:PNADF) - nearly 800 million boe in 2013) have not published their annual report for 2014 yet and are therefore not included in these investigations. Nevertheless, the total amount of hydrocarbon output considered in this article represents a significant part of total world production. The main missing companies are NOCs (from the Middle East and Latin America). I did not write articles for all the 143 companies included in the list. For sake of completion, these numbers are added at the end of this article. The individual articles that I have published can be found using the following links - each of them also includes details about the methodology I used:

The data might are useful for investors when seen article-wise, but their full potential is only displayed when seen as a whole. This article provides a summary about all data I have compiled and calculated. In my opinion, the cash flow situation is a big threat for the upstream industry. The articles includes numbers that support this opinion. It gives an answer to the title-giving question and depicts general cost trends for the upstream industry. Additionally, I express my opinion about a lower boundary for the oil price supported by the compiled data.

Relationship between Realized Price and Percentage Liquid Produced

In many of my articles I have claimed, that there is a direct relationship between the percentage of liquid produced and the price a company can realize for it. The following chart now gives an idea how accurate this assertion is:

(source: own calculations)

Each blue dot shows one of the companies I investigated. As depicted, the relationship between realized revenue per boe and the percentage of liquid this boe consists of is very linear. The only major exception can be seen for the pure oil producers (liquid produced = 100%). Here we find Kurdish companies that only realize small prices due to political reasons as well as oil sand producers and pure off-shore producers like Maersk Oil. It makes sense that these companies cannot get the same money for their products although is it simply spoken 100% oil.

The other deviations from the fitting line can be explained by different sorts of hydrocarbons produced (think WTI and Brent) and different percentages of natural gas liquids - NGL. NGL are considered to be liquids, but realize commonly only the price of gas. Therefore, a high percentage of NGL produced lowers the average realized price significantly although the percentage of liquids produced may remain high.

Overall, it is fair to say, that realized price per boe can serve as a proxy for liquid content and reverse.

Cost of Oil Production versus Liquid Content

It is not easy to estimate production costs because of the common occurrence of oil and gas in practically all wells. This is the reason why I use the concept of boe. It is reasonable to assume that production costs of liquids will be much higher than production costs of gas. That this can also be backed by the numbers showing in the following graph:

(source: own calculations)

Once again each blue dot refers to one company. The result shows that there is a roughly linear tendency between cost of production per boe and percentage of liquids the boe consists of. The most significant deviation from this tendency can once again be found in the area of the pure oil producers. Although there are a couple of other deviations, the trend is still clearly visible.

Cost of Oil Production versus Realized Price

We have now seen the relationship between revenue and percentage liquid and production costs and percentage liquids. It follows naturally that there must also be a roughly linear relationship between costs and revenue per boe.

(source: own calculations)

And indeed, this time the pure oil producer fit in more naturally, resulting in a R2 of more than 0.67. The thick black line indicates the break-even point. This means all blue dots below the line depict companies that were operationally positive, while blue dots above the line stand for companies that were operationally negative.

The histogram shows that this was the case for 16 of the investigated companies in 2014, a year that still showed an oil price of more than $100 for the first 6 months. Overall, the upstream industry was doing well in 2014 with 72 of the companies reaching a pre-income tax margin of more than 20%.

(source: own calculations)

There is one interesting insight, when the costs - price diagram for 2014 is compared with the one for the year before. In 2014, R2 was 0.67, which indicates a pretty strong correlation between the price a company realizes for its output and the costs for production. However, in 2013 R2 was 0.76, indicating an even stronger correlation. This suggests, that the upstream industry became more diverse in 2014, meaning that internal factors (organization, efficiency) played a more important role.

Cash Flow Analysis

As I have noticed in one of my articles, 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 pay 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.

When the numbers for all 143 companies are summed up, operational cash flow amounts to $710 billion, while capital expenditure amounts to $706 billion and assets worth $105 billion were sold (a certain part of this amount can be found in capital expenditure of other companies). The industry as a whole seems to be able to fund its investment. However, there are at least two things to consider with regard to these numbers. Firstly, the data refer to 2014, a year that saw an average oil price of more than $96 per barrel. Secondly, cash flows refer to the whole company. As for many companies upstream is only one segment, the numbers are somehow biased. Other, less volatile business fields may introduce some error (e.g. ExxonMobil that also has divisions in refining and chemical engineering).

However, the true cash flow problem occurs when the focus is shifted to individual companies. The following histogram shows how many companies can fund their investment to what degree.

(source: own calculations)

113 of the companies were not able to fund their investment with operational cash flow, while 36 of the companies could not even fund 50% of their capital expenditure. The situation is especially grave for the shale producers. Among the 41 companies I classified as shale producers, not a single one could fund their investment with cash flow from operations; more than half of them could fund less than 50% of their investment from operational activities. Once again: this happened in a year with an average oil price of more than $96 per barrel.

(source: own calculations)

The usual argument for spending more money than receiving is growth. Up to now, shale has been seen as one of the big business opportunities, thought to enable huge returns with little risks. This resulted in huge amounts of cash pouring into the industry. Now, after the first shale producer went bankrupt (e.g. Quicksilver), it is questionable to what extent investors are still willing to give money to the shale industry. Slowly I begin to understand, why some people compare the shale industry with the .com-bubble.

What determines the profitability of an upstream company?

The first question I investigate here is whether gas producers are more profitable than oil producers or reverse. The chart below gives some indication.

(source: own calculations)

There is no recognizable trend between the margin of an upstream company and the percentage of liquids it produces. Highly profitable businesses can be found both among the companies more focused on gas and among the companies more focused on oil.

Economies of scale is a big topic among business schools and investors. To what extend this principle applies to the upstream industry, is depicted by the following chart.

(source: own calculations)

Company size is given as production volume in 2014. Because of the huge differences in numbers, a semi-logarithmic scale was chosen. On the first glance, there is no clear trend between the size of a company and its margin, although some observations can be made. Firstly, remarkable is the fact that no company that produced less than 1 million boe was profitable. This indicates that there exists a production threshold that a company must exceed in order to be profitable. Secondly, there is a certain production range, where all companies were highly profitable (this is, they had a margin of more than 20%). This area lies in-between 200 million boe and 1,500 million boe, playground of majors and large independents. Producers below 200 million boe don't show any relationship between size and margin, while the biggest investigated producers (i.e. Russian companies) don't do very well in terms of their margins.

An interesting trend is revealed when 'operational costs' (which I define here as costs of sales plus depreciation) are plotted against company size.

(source: own calculations)

The bigger the company, the higher the importance of operational costs. The biggest producers have only negligible general and interest expenses per output unit. This can also be seen, when SG&A expenses are plotted versus company size.

(source: own calculations)

As small companies have less costs of sales than big companies, this means they do better in the operational part of their business, but do worse when it comes to administration and finance. Here the economies of scale is visible clearly. However, I want to highlight, that these numbers do not take impairments into account.

Implications for the Oil Price

One of the most significant developments in the last year was the decrease in the oil price. For some the fall from $110 to $50 and its rise back to $65 is only the burst of a gigantic bubble, for others either a perfidious geo-strategic plan or just a market overreaction. In my opinion markets will converge to the interplay between supply and demand on the long term. While it is extremely difficult or even impossible to construct world supply and demand curves that are more than simple approximations, commodities offer an additional change of insight: production costs. No profit oriented company will ever produce oil and gas when it cannot realize its own costs - the same is true for state-owned NOCs (with rare exceptions that might include the aforementioned world conspiracy or endeavors to press competitors out of market). But even in the latter cases the effect can only be temporary. For that reason the oil price can never be below production costs on the long term. As avid followers of my articles and other publications have read, it is far from simple to estimate production costs of oil even when all data were accurate, detailed and fully available. Not one of these conditions is fulfilled to 100%.

Nevertheless, using publicly available data from annual reports I have estimated costs for 143 companies. The chart that plots production costs versus percentage of liquids produces a best-fitting linear line of y = 0.4483x +20.346 (y…price in USD, x…percentage liquids) and, therefore, costs of pure oil of $65.17. This value does not deviate significantly from the one of the previous year ($65.46). This consideration includes all 143 companies and weights all of them the same. If I do the fitting for only the larger companies (i.e. production of more than 500 million boe) I get a fit of y = 0.4384x + 16.549 and, therefore, costs of oil of $60.39 (2013: $55.14). As pointed out above, the hugest oil producers have some cost advantage, although it diminished between 2013 and 2014.

Taking these results into account I feel safe to re-state my conclusion: the price of oil at technological and production cost levels of 2014 and 2013 can never fall below $60 on the long term. I see this as a conservatives estimate for a number of reasons. Oil companies are going for the low-hanging fruits first. Therefore, marginal costs for new fields will be higher than production costs of old fields. As average decline rates for mature oil fields are 5.1% annually (NASDAQ:IEA), this issue is significant. A tendency of rising costs may not be true for shale, as we see here still strong technical development, but despite the huge attention this source gets, its percentage of world oil production is still relatively small (less than 5 million bpd at world production of more than 90 million bpd). Additionally, shareholders demand return and no company that only realizes its own costs can survive long in a capitalist system. The same thinking is true for most NOCs, as their country's budgets depend heavily on income from hydrocarbons.

Summary

In this article I have made a number of statements based on found data:

  • Realized price and liquid share of a boe behave linearly and can be used as proxy for each other.
  • Production costs depend on liquid share in a linear way.
  • A strong relationship was seen between costs and revenues for one boe.
  • The upstream industry as a whole could fund investments with cash flow from operational activities. However, there are many companies that can't do this. Of the 143 companies, only 29 could fund there capex with operational cash flow. This is especially true in the shale industry, where no producer was able to do it.
  • There was no performance difference between oil producers and gas producers in 2013.
  • There is no direct relationship between company size and margin. However, there was no company with production of less than 1 million boe that was positive in 2014. The most stable margins could be found between 200 and 1,500 million boe.
  • The advantage larger companies have compared to smaller ones lies in less SG&A expenses, but on average their operational costs (costs of sales plus depreciation) are higher.
  • Based on the costs and technology in 2013 and 2014, the oil price will most likely be above $60 on a longer term of view.

This article ends my investigation about upstream production costs for 2014.

Appendix

The additional companies I investigated are: Inpex (OTC:IPXHF), Premier Oil (OTC:PMOIF), Soco International (OTCPK:SOCLF), Cardinal Resources (OTCPK:CDNL), Raging River Exploration (OTC:RRENF) and Resolute Energy (NYSE:REN).

(source: own calculations)

Oil-ETFs:

USO, OIL, UCO, UWTI, SCO, BNO, DBO, OTC:DWTI, DTO, USL, DNO, OLO,SZO, TWTI, OLEM

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