Netback Explained: A Key Metric for Oil & Gas Valuation

Netback is a calculation used to assess companies specifically in the oil and gas industryOil & Gas PrimerThe oil & gas industry, also known as the energy sector, relates to the process of exploration, development, and refinement of crude oil and natural gas. It. This benchmark considers the revenueRevenueRevenue is the value of all sales of goods and services recognized by a company in a period. Revenue (also referred to as Sales or Income) generated from the sale of oilCrude Oil OverviewCrude oil is a naturally occurring mixture of hydrocarbons found underground. It can appear in the form of a highly viscous liquid to a thick and gas, and nets it against specific costs required to bring the product to market. Often this is shown as a per barrel measurement. It essentially shows how much the company retains from the sale of a single barrel of oil or oil byproducts. Netback per barrel can be used to assess company efficiency over time or to compare a company to its competitors.

Quick Summary

• Netback is a benchmark used in the oil and gas industry to assess the profitability and efficiency of a company based on the price, production, transportation, and selling of their products
• This benchmark is calculated by subtracting royalties, transportation, and other operating costs from revenue
• Netback/barrels of oil/byproducts is a useful metric for assessing a company over time and comparing the company to its competitors
• This benchmark can be found in the management discussion and analysis section of a company’s annual report

How is Netback Calculated?

Netback is calculated by starting with revenueRevenueRevenue is the value of all sales of goods and services recognized by a company in a period. Revenue (also referred to as Sales or Income) and subtracting the costs of production, transportation, marketing, and other costs of bringing the oil and gas to market.:

Netback = Oil and Gas Revenue – Realized Loss on Financial DerivativesDerivativesDerivatives are financial contracts whose value is linked to the value of an underlying asset. They are complex financial instruments that are – Royalties – Operating Expenses ExpensesAn expense is a type of expenditure that flows through the income statement and is deducted from revenue to arrive at net income. Due to the– Transportation

Netback is often calculated as a per barrel of oil equivalent (BOE) instead, giving a more useful figure to assess the company by:

Netback/BOE = Price – Realized Loss on Financial Derivatives/BOE – Royalties/BOE – Operating Expense/BOE – Transportation/BOE

Why is Netback Important?

Netback is an important benchmark because it is a very useful measure for assessing a company without the bias of non-operating, financingFinancingFinancing refers to the methods and types of funding a business uses to sustain and grow its operations. It consists of debt and equity capital, which are used to carry out capital investments, make acquisitions, and generally support the business., or other costs. Calculating this metric essentially tells an analyst how efficient the company is at producing and selling its oil and gas products. Taking this number per unit of barrels of oil equivalent gives a type of efficiency ratioRatio AnalysisRatio analysis refers to the analysis of various pieces of financial information in the financial statements of a business. They are mainly used by external analysts to determine various aspects of a business, such as its profitability, liquidity, and solvency.. By monitoring netback/BOE over time, the efficiency of the company’s production, transporting and selling can be evaluated. A falling netback/BOE might indicate issues that should be further looked into.

Netback/BOE is also a very useful measure to look at when comparingComparable Company AnalysisThis guide shows you step-by-step how to build comparable company analysis ("Comps") and includes a free template and many examples. different companies. Depending on the value, an analyst will be able to judge whether a company can more efficiently produce and market oil, allowing them to retain more profits from the sale of each barrel of oil. A higher netback/BOE will also show how able a company is at dealing with price volatility in the market. A higher netback/BOE suggests that in times of falling prices, the company would still be able to remain profitableProfitProfit is the value remaining after a company’s expenses have been paid. It can be found on an income statement. If the value that remains.

Netback, however, is not a standardized equation. Different companies may calculate netback and netback/BOE using various methods and may include or exclude different items. Netback/BOE can still be used to look at changes over time for a specific company, however, when comparing the netback of competitors it is important to adjust the equation to ensure they are comparable values.

Netback – Worked Example

Let us consider an example of calculating the netback of a company. Say a company has oil and gas revenuesRevenueRevenue is the value of all sales of goods and services recognized by a company in a period. Revenue (also referred to as Sales or Income) of $11,000,000. They pay royalties of $300,000, transportation costs of $500,000, and have operating expenses of $3,800,000. If they sold 275,000 barrels of oil equivalents, what is their operating netback in dollars, and in dollars per barrel?

To calculate the operating netback, we start with revenues and subtract the costs of bringing the product to market:

Netback = $11,000,000 – $300,000 – $500,000 – $3,800,000 = $6,400,000

Here we see that the total netback is $6,400,000. To make this number more useful for analysts, netback per barrel can be calculated. Netback per barrels of oil can start with price, and each cost can be thought of as a per barrel cost. However, to calculate netback/BOE we can also simply divide the netback by the number of barrels:

Netback/BOE = $6,400,00/275,000 BOE = $23.27/BOE

The calculation for netback is generally found in the management discussion and analysisWhat is MD&A?The Management Discussions and Analysis (MD&A) is a section of the annual report or SEC filing 10-K that provides an overview of how the company performed in the prior period, its current financial condition, and management's future projections. of a company’s annual report. This benchmark is most often shown in a table. Below illustrates what would generally be seen for a company:

Additional Resource

Thank you for reading CFI’s article on the netback benchmark. If you would like to learn more about related concepts, check out CFI’s other resources:

• Oil and Gas PrimerOil & Gas PrimerThe oil & gas industry, also known as the energy sector, relates to the process of exploration, development, and refinement of crude oil and natural gas. It
• Crude Oil OverviewCrude Oil OverviewCrude oil is a naturally occurring mixture of hydrocarbons found underground. It can appear in the form of a highly viscous liquid to a thick
• Financial Modeling Oil and GasFinancial Modeling Oil And GasFinancial modeling in oil and gas is the practice of building a Net Asset Value (NAV) model for an energy project to forecast cash flow. CFI’s FMVA certification
• CommoditiesCommoditiesCommodities are another class of assets just like stocks and bonds. Most commodities are products that come from the earth that possess