The oil and gas industry is one of the largest sectors in the world in terms of dollar value, generating an estimated $4.2 trillion in global revenue as of late 2024. 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.
About Hydrocarbons
Hydrocarbons make up crude oil and natural gas, which are naturally occurring substances found in rock in the earth's crust. These organic raw materials are created by the compression of the remains of plants and animals in sedimentary rocks such as sandstone, limestone, and shale.
The sedimentary rock itself is a product of deposits in ancient oceans and other bodies of water. As layers of sediment were deposited on the ocean floor, the decaying remains of plants and animals were integrated into the forming rock. The organic material eventually transforms into oil and gas after being exposed to specific temperatures and pressure ranges deep within the earth's crust.
Oil and gas are less dense than water, so they migrate through porous sedimentary rock toward the earth's surface. When the hydrocarbons are trapped beneath less-porous cap rock, an oil and gas reservoir is formed. These reservoirs of oil and gas represent our sources of crude oil and natural gas.
Hydrocarbons are brought to the surface by drilling through the cap rock and into the reservoir. Once the drill bit reaches the reservoir, a productive oil or gas well can be constructed 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, which is typically plugged and abandoned.
Upstream, Midstream, Downstream
The oil and gas industry is broken down into three main segments: upstream, midstream, and downstream.
Upstream
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, and 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
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
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.
