The Economics of Oil and Gas in One Picture

Every oil and gas project, large or small, comes down to one question: will the money that comes in be worth more than the money that goes out? Engineers design the wells and plants. Geoscientists find the oil and gas. But the decision to spend the money is an economic decision, and it is made with the numbers you will learn to read in this course.

The basic equation is short:

Net cash flow = revenue − costs − government take

• Revenue is the volume sold multiplied by the price received.
• Costs are the money spent to find, develop, operate and finally remove the facilities.
• Government take is everything the host government receives: royalties, taxes and its share of production.

Four features that make the industry different

1. Very large investment before any revenue. An offshore development can need several years and very large sums before the first barrel is sold.
2. Long life. A field can produce for 20, 30 or more years, so decisions made today depend on prices and costs far in the future.
3. High uncertainty. Nobody knows exactly how much oil or gas is in the ground, what it will cost to produce, or what it will sell for.
4. A strong role for government. In most countries the state owns the resource under the ground. Companies earn a share of the value in return for their money, skills and risk.

A first worked example

A small field sells 1 million barrels of oil in one year at a hypothetical price of $60 per barrel. Revenue is 1,000,000 × $60 = $60 million. Operating costs that year are $15 million. The government receives $20 million in royalty and tax. Net cash flow for the year is $60m − $15m − $20m = $25 million.

That looks good. But the company spent $90 million building the field before the first barrel. One good year does not answer the investment question. To answer it, you need the whole life of the field, and you need to account for when each dollar arrives. Those are the tools of Modules 3 and 4.