The oil and gas industry is one of the largest sectors in the world in terms of dollar value, generating an estimated $5 trillion in global revenue as of 2022.1 Oil is crucial to the global economic framework, impacting everything from transportation to heating and electricity to industrial production and manufacturing.
Investors looking to enter the oil and gas industry can quickly be overwhelmed by the complex jargon and unique metrics used throughout the sector. This introduction is designed to help anyone understand the fundamentals of companies involved in the oil and gas sector by explaining key concepts and the standards of measurement.
Upstream businesses consist of companies involved in the exploration and production of oil and gas. These are the firms that search the world for reservoirs of the raw materials and then drill to extract that material. These companies are often known as "E&P" for "exploration and production."
The upstream segment is characterized by high risks, high investment capital, extended duration as it takes time to locate and drill, as well as being technologically intensive. Virtually all cash flow and income statement line items of E&P companies are directly related to oil and gas production.
E&P companies do not usually own their own drilling equipment or employ a drilling rig staff. Instead, they hire contract drilling companies to drill wells for them and the contract drilling companies generally charge for their services based on the amount of time they work for an E&P company.
Drillers do not generate revenue that is tied directly to oil and gas production, as is the case for E&P companies. Once a well is drilled, various activities are involved in generating and maintaining its production over time. These activities are called well servicing and can include logging, cementing, casing, perforating, fracturing, and maintenance. Oil drilling and oil servicing thus represent two different business activities within the oil and gas industry.
Midstream businesses are those that are focused on transportation. They are the ones responsible for moving the extracted raw materials to refineries to process the oil and gas. Midstream companies are characterized by shipping, trucking, pipelines, and storing raw materials.
The midstream segment is also marked by high regulation, particularly on pipeline transmission, and low capital risk. The segment is also naturally dependent on the success of upstream firms.
Downstream businesses are the refineries and gas stations. Refineries are the companies responsible for removing impurities and converting the oil and gas to products for the general public, such as gasoline, jet fuel, heating oil, and asphalt. Gas stations are where consumers fuel up at the pump.