Oil and gas economics and supply chain: breakeven, refining margin, operations
What one barrel costs, when a field is worth developing, how a refinery earns its margin, and how oil, products and LNG move around the world.
Industry brief, with a one-minute summary: Oil and gasKey takeaways
- An upstream barrel is worth producing when the oil price covers the cost to develop and lift it plus the government's share.
- Upstream operations cases are about uptime (lost production days), cost per barrel and safety.
- Exploration: geologists use seismic surveys (sound waves) to map rock, then drill exploration wells.
- Development: for a large field this can take 3 to 7 years from discovery to first oil.
- Production: operators keep wells flowing, inject water or gas to hold up pressure, and fight natural decline.
Key idea
An upstream barrel is worth producing when the oil price covers the cost to develop and lift it plus the government's share. A refinery earns the gap between what its products sell for and what its crude costs.
Think of the cost of one barrel in layers. The lifting cost is the running cost of the wells. The development cost is the money spent on wells and facilities, spread over every barrel the field will produce. Transport takes the oil to a port or refinery. Royalties and taxes go to the government. A cash breakeven counts only running costs, so it tells you whether to keep an existing field running. A full-cycle breakeven counts everything, so it tells you whether to build a new field. Do not confuse either one with a fiscal breakeven: the oil price a government needs to balance its budget, which the IMF estimates for Gulf and other producer countries.
| Type of resource | Example regions | Lifting cost | Full-cycle breakeven for new projects |
|---|---|---|---|
| Large onshore conventional fields | Saudi Arabia, UAE, Kuwait, Iraq | Very low, often a few USD | Low |
| Offshore shallow water | Gulf offshore, North Sea, Malaysia | Low to medium | Medium |
| Deepwater | Brazil, Guyana, Gulf of Mexico, Angola | Low to medium | Medium; large upfront cost, long lead time |
| Shale (tight oil) | United States (Permian), Argentina (Vaca Muerta) | Medium | Medium to high; US survey answers for new wells often cluster in the USD 60s |
| Oil sands and heavy oil | Canada, Venezuela | Medium to high | High for new projects |
So-what
Low-cost producers stay profitable when prices fall. High-cost producers are the first to cut drilling when prices fall, which is why their costs tend to anchor the price over time.
Worked case
Is a new oil field worth developing?
The prompt
Dunewell Petroleum (a fictional company) can develop an onshore field with 100 million recoverable barrels. Development capex is USD 1,200 million. Lifting cost is USD 9 per barrel and transport is USD 3 per barrel. The government takes a royalty of 20 percent of the oil price. The field would produce 10 million barrels a year. What is the full-cycle breakeven oil price, and what is the yearly cash margin at USD 70 per barrel? Ignore income tax and the timing of cash for now.
The structure
- Breakeven price = cost per barrel divided by the share of the price the company keeps
- Development cost per barrel = capex divided by recoverable barrels
- Total cost per barrel = development + lifting + transport
- Company keeps (1 minus royalty rate) of each dollar of price
- Cash margin = price after royalty minus running costs
Working it through
1. Development cost per barrel
USD 1,200 million spread over 100 million barrels.
Development cost (USD per barrel):1,200 ÷ 100 = 122. Total cost per barrel
Development 12, lifting 9, transport 3.
Total cost (USD per barrel):12 + 9 + 3 = 243. Breakeven price
The company keeps 80 percent of the price, so the price must be 24 divided by 0.8.
Full-cycle breakeven (USD per barrel):24 ÷ (1 - 0.2) = 304. Cash margin per barrel at USD 70
Keep 80 percent of 70, then pay lifting and transport. Development capex is already spent, so it is not a cash cost each year.
Cash margin (USD per barrel):70 × (1 - 0.2) - 9 - 3 = 445. Yearly cash margin
44 dollars on 10 million barrels a year.
Yearly cash margin (USD million):44 × 10 = 440
The recommendation
Dunewell should take the field forward to a full investment case, because its full-cycle breakeven is about USD 30 per barrel, well below USD 70. First, total cost is USD 24 per barrel, including USD 12 of development capex. Second, at USD 70 the field earns a cash margin of USD 44 per barrel, about USD 440 million a year. The risk is that prices stay low for years or capex overruns. As a next step, test the field at a lower price, add income tax, and discount the cash flows to find its NPV.
Risks: Reserves may be smaller than expected; Capex overruns are common on large projects; Fiscal terms can change; Prices can stay low for years.
Refining: a margin business
A refinery buys crude and sells a basket of products. Its gross margin per barrel is the value of that basket minus the crude price. Two things decide the basket: product prices, and yields (the share of each barrel that becomes gasoline, diesel, jet fuel and so on). A complex refinery has extra units that turn heavy, cheap parts of the barrel into valuable light products, so it can buy cheaper heavy crude and still make more diesel and gasoline. A quick industry shortcut is the 3-2-1 crack spread: three barrels of crude become two barrels of gasoline and one of diesel.
Worked case
Refining margin of a coastal refinery in India
The prompt
A refinery in India (fictional) has capacity of 200,000 barrels per day and runs at 90 percent utilization. Crude costs USD 75 per barrel. Each barrel yields 45 percent gasoline worth USD 90 per barrel, 35 percent diesel worth USD 100, and 20 percent fuel oil worth USD 60. Operating costs are USD 5 per barrel. What is the net margin per barrel and the yearly profit before tax, in USD million?
The structure
- Yearly profit = barrels processed x (product basket value minus crude cost minus operating cost)
- Basket value = sum of yield x product price
- Gross margin = basket value minus crude
- Net margin = gross margin minus operating cost
- Barrels processed = capacity x utilization x 365
Working it through
1. Basket value
Weight each product price by its yield.
Basket value (USD per barrel):0.45 × 90 + 0.35 × 100 + 0.2 × 60 = 87.52. Gross margin
Basket value minus the crude price.
Gross margin (USD per barrel):87.5 - 75 = 12.53. Net margin
Subtract operating costs of USD 5.
Net margin (USD per barrel):12.5 - 5 = 7.54. Yearly profit
200,000 barrels a day at 90 percent for 365 days, times 7.5 dollars.
Yearly profit before tax (USD million):200,000 × 365 × 0.9 × 7.5 ÷ 1,000,000 = 493
The recommendation
The refinery should focus on yields, crude choice and uptime, because it earns only about USD 7.5 per barrel, about USD 493 million a year. First, the product basket is worth USD 87.5 per barrel against USD 75 of crude, a gross margin of USD 12.5. Second, operating costs take USD 5 of that, so making more diesel at USD 100 and less fuel oil at USD 60 is the biggest lever. The risk is that crude prices rise faster than product prices. As a next step, test which cheaper crudes the refinery can handle.
Supply chain and operations, step by step
From rock to customer
- 1Exploration: geologists use seismic surveys (sound waves) to map rock, then drill exploration wells. Many wells find nothing, so exploration is the riskiest spend.
- 2Development: for a large field this can take 3 to 7 years from discovery to first oil. Offshore platforms, subsea equipment and processing plants are built by contractors such as oilfield service companies (for example SLB, Halliburton and Baker Hughes).
- 3Production: operators keep wells flowing, inject water or gas to hold up pressure, and fight natural decline. Uptime and safety are the main operating goals.
- 4Midstream: crude moves by pipeline to ports and refineries, or by tanker. A very large crude carrier (VLCC) holds about 2 million barrels. Gas moves by pipeline, or as LNG: it is cooled to about minus 162 degrees Celsius, shipped, then warmed back into gas at an import terminal.
- 5Chokepoints: a large share of seaborne oil and LNG passes a few narrow sea routes, such as the Strait of Hormuz, the Bab el-Mandeb at the south of the Red Sea, the Suez Canal and the Strait of Malacca. A disruption at one of them changes prices and freight costs worldwide.
- 6Refining: refineries run around the clock and stop for planned maintenance (a turnaround) every few years. Planners choose which crudes to buy (the crude slate) and which products to make each month.
- 7Distribution and retail: products go by pipeline, rail, truck or coastal ship to depots, then to stations, airports and ports. Retail stations earn a fuel margin per litre plus income from shops, car washes and, increasingly, electric vehicle charging.
Upstream operations cases are about uptime (lost production days), cost per barrel and safety. Refining cases are about utilization, yields and energy use. Retail cases are about volume per station and non-fuel income. For the method, use the Operations and process improvement module and the Capacity, supply chain, and footprint module.
Crude costs USD 80 per barrel. Gasoline sells for USD 95 per barrel and diesel for USD 110 per barrel. What is the 3-2-1 crack spread in USD per barrel of crude?
A field in the North Sea produces 100,000 barrels per day and declines 12 percent a year with no new drilling. How many barrels per day will it produce after two years?
Sources for this lesson (3)
- Recognized public explanations of case-interview concepts and frameworks
- Federal Reserve Bank of Dallas, Dallas Fed Energy Survey
- IMF, Regional Economic Outlook (Middle East and Central Asia), fiscal breakeven oil prices
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