How Are Oil & Gas Companies Different, Modeling-Wise?
For purposes of this tutorial, we’re going to focus on Upstream, or E&P (Exploration & Production) companies because those are the most “different” from normal companies – and they’re the most common topic in interviews. A paper writing service can write you more about it.
We will also touch on diversified, or integrated major, companies, such as Exxon Mobil since you can learn a lot about other segments by analyzing them.
So how is oil & gas modeling different?
- You Can’t Control Prices or Revenue – This is the big difference that results in most of the other differences.
- They are Balance Sheet-Centric – Just like banks or insurance firms, an E&P company is far more dependent on its balance sheet than, say, a technology or consumer retail company. The balance sheet contains its most important asset: the reserves that will generate future revenue and profit.
- Accounting is Different – You not only see different line items, but you also see two different accounting methodologies: full cost and successful efforts.
- Depleting Assets Galore – For a normal company, assets tend to move… up and to the right. Items like PP&E, inventory, accounts receivable, and so on increase as the company grows. But as an oil & gas company produces more and more and earns revenue, its assets decline because they use up all those valuable resources they found in the ground.
- Cyclicality – Going along with the first point, oil & gas companies follow commodity price cycles. Investing in an energy or mining company is almost like investing in the underlying commodity, which means you have to be comfortable with giant price swings.
The good news is that unlike banks and insurance firms, oil & gas companies still sell tangible products to people – so your models are more similar.
Oil & Gas Financial Statements – Projecting Revenue and Expenses
Before you begin projecting an energy company’s financial statements, you need to know something about the units used.
Oil is typically measured in Barrels (1 Barrel = 42 Gallons, and yes, even countries that use the metric system still use Barrels); natural gas is measured in Cubic Feet (even with the metric system), and mining companies use whatever makes sense (iron ore/coal/aluminum/copper/lead/zinc/nickel/manganese/uranium = tonnes, diamonds = carats, and gold/silver = ounces). If you wish someone could write my paper on it than search online.
You measure the company’s reserves (how much they have on their balance sheet, ready to extract, produce, and sell) and production (how much they produce and sell each day, month, quarter, year, etc.) in these units.
When you project a natural resource company’s statements, you begin by projecting its production by segment based on its reserves and its historical patterns.
So let’s say that a company has 12,000 billion cubic feet (12,000 Bcf) of natural gas in its reserves and produces 500 billion cubic feet (500 Bcf) annually.
You might assume a modest increase over that number, especially if the company is spending a lot on finding new resources.
So maybe you assume that they produce 550 Bcf next year and then 600 Bcf the year after – which you would then cross-check with equity research and their reserves (you don’t want to assume that they produce 100% of their reserves in 1 or 2 years).
And then you deduct this production from their reserves… and (hopefully) replace it with sufficient CapEx spending, linking the dollar amount of that spending to a specific amount of reserves.You can also read many college essay examples on this topic.
Revenue is trickier because you can’t set prices yourself.
But the solution is surprisingly simple: you use scenarios in Excel.
So you might create a “low” scenario where oil prices are, say, $40 per barrel, a “middle” scenario where oil prices are $70 per barrel, and a “high” scenario where oil prices are $100 per barrel.
Doing that lets you see the range of possible outcomes for a company based on commodity prices.
There’s more to it than that because you also need to take into account hedging and the fact that the company will never get the full market price due to middlemen, commissions, and so on – but that’s the basic idea.