Operating Netback

What Is Operating Netback?

Operating netback is a non-generally accepted accounting principle (GAAP) financial measure commonly used in the oil and gas industry to determine how much profit companies generate from their ventures. It is calculated by subtracting all costs associated with getting the oil to market, including transportation, royalties, and production expenses, from revenues.

O p e r a t i n g N e t b a c k = P r i c e − R o y a l t i e s − P r o d u c t i o n − T r a n s p o r t a t i o n Operating Netback = Price - Royalties - Production - Transportation OperatingNetback=Price−Royalties−Production−Transportation

Operating netback is presented on an absolute value and per unit basis and can be used as a benchmark to compare performance between time periods, operations, and competitors.

How Operating Netback Works

Energy resources don’t fall out of trees. A lot of time, effort, and money go into identifying oil reserves, drilling them out of the earth, and then turning them into the finished product ready for consumption.

Operating netback provides a summary of the costs associated with bringing oil to the marketplace. It tells us the amount of money the company actually generates and keeps for itself per barrel, the net profit, by deducting all operating costs from the average realized price.

Expenses that are taken into consideration and subtracted from any revenues earned include extraction, the process of drilling the oil out of the ground, refining, marketing, wages paid to staff, and transportation. Royalties, payments owed to the owner of the land being drilled into, are also factored into the equation.

Obviously, the higher the operating netback, the better. Recouping a larger percentage of the final sale price indicates greater efficiency and earnings power. 

Benefits of Operating Netback

Companies in this line of work, as well as investors, generally care more about profit than revenue. Making lots of sales is great, but what’s more important is finding out how much of this money the company actually ended up holding onto from its endeavors. A mouth-watering top line means little if the costs required to make it were just as high or higher. 

Operating netback is one measure that can help us to establish how much income was left after accounting for all unavoidable expenses. Analysts rely on operating netback to determine how efficient a company is at extracting and selling its product. The resulting figure can then be used to compare the operations of different oil and gas producers — and gauge which ones are most profitable and make the most money from their activities.

Operating netback also enables the producers to pinpoint which of its projects are more lucrative. This information can come in handy, helping to identify loss-making operations, establish potential ways to make more money in the future, and project the earnings potential of certain wells before agreeing to drill into them.

Example of an Operating Netback

Fictional company Big Oil Corp. has operations all over the globe, including in Canada. The company sells oil at an average price of $50 per barrel and, in that particular part of the world, shells out for each one $5 in royalties, $15 in production costs, and $8 in transportation costs.

Subtract these expenses from the $50 selling price and Big Oil Corp. is left with an operating netback of $22 ($50 - $5 - $15 - $8 = $22). This calculated operating netback can be compared to the specific operations' past performance or a rival company's performance in the same region.

Special Considerations

Like most other financial metrics, operating netback isn’t without flaws.

Firstly, non-GAAP measures aren’t required to comply with generally accepted accounting principles (GAAP), meaning that operating netback can be calculated by companies using different formulas. For investors, it is, therefore, necessary to ascertain how each company works out operating netback, especially when seeking to use the metric for comparative purposes.

Important

Operating netback is a non-GAAP measure, so the formula oil and gas companies use to calculate it can vary slightly.

Another important factor to bear in mind is that acceptable operating netback values can vary considerably depending on the type of projects undertaken. For instance, some countries are more expensive to operate in than others, while the costs of drilling at sea can differ from land-based extraction.

In other words, for the best results, operating netback should be applied on a case-by-case basis and comparisons should only be made among similar types of ventures.