Energy (Oil & Gas) Primer

The Oil & Gas industry is a global, capital-intensive sector defined by its three core segments: Upstream (finding oil/gas), Midstream (transporting it), and Downstream (refining it). Its profitability and credit quality are inextricably linked to volatile commodity prices.

📖 Industry Overview

Upstream (E&P - Exploration & Production)

This is the highest-risk, highest-reward segment. Companies explore for oil and gas deposits and extract them from the ground.

  • Players: Global "Supermajors" like ExxonMobil and Chevron, and independent producers focused on specific regions, like the US Permian Basin.
  • Business Model: Profit is the spread between the market price of oil/gas (e.g., WTI crude) and the cost to find and extract it. Highly sensitive to commodity prices.

Midstream

This segment acts as the "toll road" for the industry, transporting and storing hydrocarbons for a fee.

  • Assets: Pipelines, storage terminals, processing plants, LNG export facilities.
  • Business Model: Generates stable, fee-based revenue from long-term contracts, largely insulating it from direct commodity price volatility. Often structured as Master Limited Partnerships (MLPs).
  • Players: Enterprise Products Partners, Kinder Morgan, Williams Companies.

Downstream (Refining & Marketing)

This segment refines crude oil into usable products and sells them to end-users.

  • Products: Gasoline, diesel, jet fuel, heating oil, and petrochemicals.
  • Business Model: Profit is the "crack spread" - the difference between the cost of crude oil and the market price of refined products.
  • Players: Often integrated with upstream (e.g., ExxonMobil), but also includes independent refiners like Valero and Marathon Petroleum.
📈 Long-Term Trends
  • Energy Transition: The global shift to lower-carbon energy poses a long-term existential threat to oil demand. Companies face increasing pressure to invest in renewables, hydrogen, and Carbon Capture (CCUS), and may face "stranded asset" risk on long-life reserves.
  • Capital Discipline: After a decade of debt-fueled growth, the US shale industry has pivoted from "growth at any cost" to maximizing free cash flow and returning capital to shareholders via dividends and buybacks. This has significantly improved credit quality.
  • LNG Growth: Global demand for Liquefied Natural Gas (LNG) is booming, particularly in Europe and Asia, as it is seen as a cleaner "bridge fuel" to replace coal and ensure energy security. This benefits US natural gas producers and LNG infrastructure developers.
  • Geopolitics & OPEC+: The influence of the OPEC+ coalition (led by Saudi Arabia and Russia) on global oil supply and prices remains a dominant factor, creating supply-side volatility.
📊 Key Credit Metrics
Metric Segment Description & Importance
Debt / EBITDAX Upstream The key leverage ratio. EBITDAX adds back non-cash Exploration expenses. Rating agencies have specific leverage targets for different price decks.
Breakeven Price Upstream The all-in oil/gas price a company needs to cover its operating costs, capital expenditures, and dividend. A low breakeven price is a key indicator of resilience.
Fee-Based Margin % Midstream The percentage of gross margin derived from stable, fee-based activities. The higher, the better. 85%+ is considered strong.
Crack Spread Downstream The margin a refiner gets from "cracking" crude oil into products (e.g., the 3:2:1 spread). This is the key profit driver and can be tracked daily via sources like the EIA.
❗ Specific Risk Factors
  • Commodity Price Volatility: This is the single most important risk, especially for the upstream segment. A sharp drop in oil prices can quickly erase profitability and cash flow.
  • Geopolitical Risk: Supply disruptions from conflicts or sanctions can cause wild price swings.
  • Regulatory & ESG Risk: Stricter environmental regulations on emissions (methane), pipeline approvals, and investor pressure to decarbonize are making it harder and more expensive to operate. Access to capital is becoming more difficult for companies with poor ESG profiles.
  • Reserve Risk (Upstream): The risk that proved reserves are revised downwards, or that the cost to extract them is higher than expected.
💡 Monitoring & Underwriting Tips
  • Know the Price Deck: Understand your institution's commodity price assumptions. A company's creditworthiness depends entirely on these assumptions. Stress test financials using lower-price scenarios.
  • Check the Hedges: For upstream producers, a strong hedging program that locks in prices for future production is a major credit positive, as it provides cash flow certainty and protects against downturns.
  • Focus on Cost Position: Low-cost producers are the most resilient. Analyze "all-in" breakeven costs, including operating costs, capex, and dividends.
  • For Midstream, It's All About the Contract: Analyze the contracts. Are they fee-based with minimum volume commitments? What is the contract length? How strong is the counterparty (the upstream producer)?
  • For Downstream, Track the Crack Spread: Refining is a spread business. Monitor crack spread trends to understand the outlook for refiner profitability.