Oil and gas 101 for prospective investors

A very fundamental aspect of equity investing is understanding the companies and sectors in which to invest. In the equity universe, there are a number of sectors that require some specialized knowledge to make informed investment decisions.

One of these sectors is the oil and gas sector, which is teeming with complicated terminology that can overwhelm investors new to the space. With a basic understanding of this terminology and the oil and gas business in general, investors can better understand the fundamentals of oil and gas stock.

Hydrocarbon Basics: Crude oil and natural gas are naturally occurring substances present in rock amid the earth’s crust. The origin of oil and gas is organic material-the remains of plants and animals compressed in sedimentary rock such as sandstone, limestone and shale. Sedimentary rock is a product of sediment deposits in ancient oceans and other bodies of water. As layers of sediment were deposited on the ocean floor, decaying remains of plants and animals were integrated into the forming rock.

This organic material eventually transformed into oil and gas after being exposed to a specific temperature and pressure range by geomechanics within the earth’s crust. Because oil and gas are less dense than water, which occurs in huge quantities in the earth’s sub-surface, oil and gas migrate through relatively porous sedimentary source rock toward the earth’s surface. When the hydrocarbons are trapped beneath relatively less porous cap rock, an oil and gas reservoir is formed. These reservoirs, which are simply layers of rock containing relatively large quantities of oil and gas, are our source for crude oil and gas.

To bring the hydrocarbons to surface, a well must be drilled through the cap rock and into the reservoir. Drilling rigs work in a similar fashion as a hand drill; a drill bit is attached to a series of drill pipes and the whole assembly is rotated to make a well in the rock. Once the drill bit reaches the reservoir, a productive oil or gas well can be completed and the hydrocarbons can be pumped to the surface. When the drilling activity does not find commercially viable quantities of hydrocarbons, the well is classified as a “dry hole”. Dry holes are typically plugged and abandoned.

Production and Reserves: Exploration and production (E & P) companies focus on finding hydrocarbon reservoirs, drilling oil and gas wells and producing and selling these materials to be later refined into products like Automotive Gasoline Oil, AGO known as diesel, Premium Motor Spirit, PMS referred to as Petrol, Dual Purpose Kerosene, DPK known as Kerosene and such other derivatives that attracts money into the exercise. This activity is usually referred to as upstream oil and gas activity. Today, there are hundreds of public E & P companies such as ConocoPhilips and ExxonMobil listed on the United states stock exchanges. Virtually, all cash flow and income statement items of E & P companies are directly attached to oil and gas production. Therefore, investors should develop an understanding of basic production terminology when assessing E & P stocks. Exploration and production companies measure oil production in terms of barrels.

A barrel, usually abbreviated as “bbl” is 42 United States gallons. Companies often describe production in terms of bbl per day or bbl per quarter. A common methodology in the oil patch is to use prefix of “m” to indicate 1,000 and a prefix of “mm” to indicate 1 million. Therefore, one thousand barrels is commonly denoted as “mbbl” and one million barrels is denoted as “mmbbl”. For example, when an E & P company reports a production of 7 mbbl per day, it is referring to 7,000 barrels of crude oil per day.

Production of gas is described in terms of standard cubic feet, which is a measure of the quantity of gas at 6o degrees of Fahrenheit and 14.65 pounds per square inch of pressure. Similar to the convention for oil, the term “mmcf” means 1 million cubic feet of gas. One billion cubic feet is denoted as “Bcf” and one trillion cubic feet is denoted as “Tcf”. Note that gas market prices are sold on the New York Mercantile Exchange futures market in terms of million British thermal units, or “mmbtu”, which is roughly equivalent to 970 cubic feet of gas. Investors frequently think of an mcf of gas as being equivalent to one mmbtu.

Exploration and production companies often describe their production in units of barrels of oil equivalent, BOE. In calculating BOE, companies usually convert gas production into oil equivalent production using an energy equivalent basis. In this basis, one BOE has the energy equivalent of 6,040 cubic feet of gas-or roughly one bbl to 6 mcf. Oil quantity can be converted into gas quantity in a similar fashion, and gas producers often refer to production in terms of gas equivalency using the term, “mcfe”. Note that the energy conversion basis often is not reflected in the respective market prices of oil and gas.

While it is true that the oil and gas industry is increasingly becoming unattractive, the little traction it still holds is enough attraction to investors willing to tap into its benefits. Therefore, Dollar and Cent spent in investing in the industry drives the energy needs of an increasingly demanding world that is investment-friendly. Investors are welcome!
. Adeoye is an energy expert in Lagos.