The Importance of Oil and Gas Financial Analysis

The Importance of Oil and Gas Financial Analysis

The oil and gas industry faces great challenges. Diminishing reserves are forcing companies to operate in remote and hostile environments, while the cost of extracting energy has gone up steadily in recent years.

Furthermore, a study shows that 40% of new capital projects experience cost overruns. As a result, complex supply chains in the oil and gas sector may have trouble delivering projects on time and within budget. By developing innovative technological solutions, however, the industry hopes to increase the world’s reserves, ushering in a new age of exploration and production.

With these complex challenges, every upstream oil and gas company should focus a substantial amount of their efforts on oil and gas reservoir financial analysis to aid in resource discovery and boost production. Understanding the complex properties of a reservoir is essential because geologists, engineers, and executives make strategic decisions to achieve the highest return while giving themselves a competitive edge. Along with flexible, upstream solutions, companies can boost earning potential, reduce costs, and maximize revenue.

Understanding the Importance of Oil and Gas Reservoirs

Reservoirs are the most valuable asset to oil and gas operators because they represent the fruits of the drilling and completion operations that come at a substantial cost. Understanding the geological makeup of a reservoir is crucial for operators because it helps them achieve the highest returns for their E&P efforts. By understanding their existing oil reservoirs operators can make better decisions about where to drill new wells.

Another instance where more knowledge about the field, play or individual well is crucial is during the process of extracting the hydrocarbons. Wells with a high sulfur content or condensate can adversely affect extraction equipment, causing difficulties for oil and gas facilities. The dispersion of solid particles could, for instance, block oil transportation. By understanding fluid mechanics, those in the industry can improve well productivity, equipment design, and well storage capacity.

The Challenges to Reservoir Production

Enhancing the reservoir productivity involves conducting a comprehensive examination of overall operations, including current wells and other systems. A thorough analysis of a reservoir’s performance usually includes the following:

  • Analyzing subsurface geology and reservoir history – By examining subsurface geology (the study of the physical properties of rocks below the ground surface) and the production history of the reservoir, companies can compare its existing potential with its current performance.
  • Identifying constraints – After analyzing the end-to-end production systems, it’s easier to single out issues and improve overall operations.
  • Increasing productivity – This involves locating production bottlenecks, predict potential gains from additional wells, and conducting an infrastructure analysis to determine full performance potential.

Another important factor that has a significant impact on a company’s performance is managing financial responsibilities. Conducting a financial analysis in the oil and gas sector is different because of the unique needs of natural resource companies. Unlike others in the consumer industry, oil and gas businesses have no control over the price of their products. As a result, it can be a challenge to predict future revenues.

Untapped Opportunities to Enhance the Bottom Line

Some business owners may have the technical know-how to manage operations, but not all of them have the resources to address complex financial issues. The price of both oil and natural gas is, in fact, contributing to the margin erosion within the industry.

Figures show, for instance, that the global price of natural gas has gone down significantly, which could have a major impact on the performance of upstream companies. Statistics from IBIS, in particular, reveals that overall price fluctuations have driven a revenue volatility of 43.2% over the past five years.

By implementing the following key strategies, however, companies can enhance cash management practices, improve cost reduction efforts, and increase their bottom line.

  • Strategic cost reductions
    • Strategic sourcing – Effective cost-reduction efforts give companies a competitive advantage because they allow them to respond quickly to changes in the supply market. As such, businesses should review spend profiles before deploying resources to reduce operational costs.
    • Proper revenue calculation – Gross income plays a huge role in influencing the price of oil and gas sold on the open market. Higher prices, after all, increase revenue. A proper calculation of product sales during the fiscal year is essential because it helps businesses determine their net income as well as incurred losses.
    • Accurate cost calculations – When it comes to oil and gas items, factors like efficiency and transportation costs should be included in cost calculations. By researching all the major cost components of purchases, businesses can make more informed purchasing decisions.
  • Strategic cost management
    • Minimizing financial leakage – Sometimes, businesses make overpayments to suppliers — an issue caused by duplicate payments, outstanding credits, and unsupported charges. Given the rapid growth and consolidation in the oil and gas industry, companies should review supplier payments regularly to avoid financial leakage.
    • Reserves appraisal – Reserves are predictive estimates of sources in the ground based on current exploration activities. Since the oil and gas assets still need to be sold, they are considered a part of the inventory of financial statements. In fact, the Securities and Exchange Commission requires oil and gas companies to consider reserves as a supplement to their financial statements.
    • Reducing fixed costs – Standardizing cost structure can help solve financial issues after several years of ramping up production. By integrating instruments, sensors, and other technologies, companies can monitor wells more consistently and save up on maintenance costs. Removing excess inventory can also reduce storage and equipment costs.
    • Improving payment structures – Businesses should negotiate with suppliers to come up with optimized payment terms. Following a standardized supplier payment structure can lead to enhanced working capital performance.
    • Days sales outstanding management – Days sales outstanding refers to the overall order-to-cash process, indicating how long it takes a company to receive cash after placing an order. In some areas of the oil and gas industry, therefore, some companies have adopted an electronic ticketing system to decrease time, resolving back-end issues and speeding up communication through more efficient and electronic means.

Some companies operating in the oil and gas industry fail to take advantage of opportunities to increase their bottom line. Others rely on traditional practices to improve future operations while overlooking strategies that could help increase yields. But reassessing existing practices can help businesses achieve their goals faster.

While growing and managing a business in the industry has its challenges, managing financial difficulties can maximize profit while holding a distinct edge over the competition. By embracing systemic improvements and conducting a thorough oil and gas financial analysis, businesses can reap significant cost savings and position themselves for success.