NetbackHow much revenue a business retains for every barrel of oil sold

Patrick Louie

Any business owner would know that the revenue a business raises from the sale of its product or services isn’t necessarily its final earnings.

That is because before a business can raise such revenue, it will usually have to incur costs first.

For example, there’s the cost of manufacturing the product.

Or simply, there’s the cost of sales.

When we deduct the costs of sales from revenue (or sales), we get the business’s gross profit.

Now, gross profit is an important metric as it can present us with a business’s operational efficiency in numerical (or more accurately, financial) form.

That is how it usually is across all industries.

But the oil and gas industry uses a different term when referring to gross profit.

They use the term “netback”, which is usually expressed on a per unit of oil (usually a barrel) basis.

So basically, netback is the gross profit per unit of product but is only applicable in the oil and gas industry. Or is that really all there is to it?

In this article, we will be exploring what netback is.

How does one define netback?

What information does it tell us?

How does one calculate a business’s netback?

We’ll try to answer these questions as we go along with the article.

What is Netback?

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Netback is a summary of revenue and costs that is specific to businesses within the oil and gas industry.

It’s the difference between the revenue generated from the sale of oil/gas and all the costs incurred to bring the product (oil/gas products) to the market.

These costs typically include royalties, production costs, and transportation costs.

However, since there is no strict standard in the calculation of netback, an oil and gas business may consider other costs.

Netback is typically presented on a per unit of oil (usually a barrel) basis.

It essentially shows us how much revenue a business retains from the sale of a barrel of oil (or oil byproducts) after considering the costs of making such a sale.

So basically, netback is gross profit but specifically for businesses within the oil and gas industry.

As such, one can use it to gauge the operational efficiency of the business. We can also use it to compare the business’s performance to its competitors.

To better understand netback, let’s take a look at the usual formula we use for its calculation:

Netback = Price (Sales Revenue) – Royalties – Production Costs – Transportation Costs

The formula above will result in the total netback of the business.

To arrive at the per barrel figure, we can simply divide the total netback by the number of barrels sold.

Or we can use the per barrel figures for the calculation of netback (e.g. price per barrel of oil, royalties per barrel of oil, etc.).

Also, do note that the formula above is the usual variant. A business may add costs to the formula as necessary.

For example, if the business uses derivatives related to the sale and purchase of oil and oil byproducts, it can include the realized losses from such derivatives in the calculation of netback.

What Netback Tells Us

Netback is an important metric that can gauge an oil/gas business’s operational efficiency.

It measures how much revenue a business retains for every barrel of oil or oil byproduct it sells.

And since it can be expressed on a per barrel basis, it can also be useful when comparing the business’s performance to its competitors.

A business may monitor its netback to evaluate its operational efficiency.

The ideal scenario is to have the netback be rising or at least retaining.

This means that the business is doing well in terms of selling and producing oil and/or oil byproducts.

However, a falling netback might be an indicator of issues in the business’s operations.

Netback is a useful tool for comparison, specifically when its expressed on a per barrel of oil basis.

This allows comparison with other businesses within the same industry no matter the level of sales.

A comparatively higher netback (per barrel of oil) may indicate that the business is performing better than its competitors.

A higher netback may also indicate that the business effectively deals with price volatility in the market.

It should be able to remain profitable in times of falling prices.

Do note that when comparing a business’s netback with its competitors, you need to remember there is no strict standard in the calculation of netback.

As such, to have a more accurate comparison, it’s important to adjust the equation to ensure that what you have are comparable values.

For example, a business may include additional costs in the equation, while its competitor only includes the basic costs (royalties, production costs, and transportation costs).

Not adjusting the equation will result in values that aren’t truly comparable.

As such, the business will have to adjust its equation to only include the basic costs for a more accurate comparison.

Netback and the GAAP

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While netback is a legit calculation, it’s important to note that it’s not a Generally Accepted Accounting Principles (GAAP) equation. This result in some benefits and drawbacks.

Since the GAAP does not govern netback, there is no strict standard in its calculation.

Businesses are free to modify the netback formula according to their needs and preferences.

However, this can also result in a not-so-accurate comparison between businesses because of the difference in the valuation of netback.

It is also worth noting that netback does not consider operating and other types of fluctuating costs.

As such, it is not a reliable measure of the business’s net income. But it does a great job in assessing a business’s operational efficiency.

Netback Example

Suppose that a business generated a total of $6,750,000 from the sale of 180,000 barrels of oil and oil byproducts.

In order to generate such revenue, the business incurred royalty fees of $235,000.

The production costs of processing raw oil into marketable products amount to a total of $1,940,000.

The business also incurred $390,000 in transportation costs to bring the products to market.

From the information above, we gather the following information:

  • Price (Sales Revenue) – $6,750,000
  • Royalties – $235,000
  • Production Costs – $1,940,000
  • Transportation Costs – $390,000
  • Number of Barrels Sold – 180,000

Let’s calculate the business’s netback:

Netback = Price (Sales Revenue) – Royalties – Production Costs – Transportation Costs

= $6,750,000 – $235,000 – $1,940,000 – $390,000

= $4,185,000

As per calculation, the business’s netback amounts to $4,185,000.

Do note that this is the business’s total netback.

To calculate the netback per barrel of oil and oil byproducts, we simply need to divide the total netback by the number of barrels sold:

Netback per barrel = $4,185,000 ÷ 180,000

= $23.25

As per calculation, the business retains $23.25 in revenue for every barrel of oil and oil by-products it sells.

This figure can then be compared with the netback per barrel of other businesses within the same industry.

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  1. Oxford Institute "= FORNetback Pricing and the Oil Price Collapse of 1986 " White paper. August 25, 2022