With so many companies listed as being a part of the oil sector, confusing their roles is almost inevitable. When most people think "oil company," they are picturing the exploration and production part of the industry—the people who find deposits and drill wells. In this article we’ll explore two other important types of oil company—service companies and refiners—and what makes them unique.
- The oil sector is crucial to providing the world with energy and petroleum products.
- The industry is segmented primarily into upstream, midstream, and downstream activities, with both specialized and integrated firms.
- In addition, there are oil services firms that provide auxiliary support to primary oil companies.
Upstream, Midstream, and Downstream
The oil industry is split into three phases:
Upstream firms deal primarily with the exploration and initial production stages of the oil and gas industry. Oil and gas exploration is an important part of the upstream sector. Petroleum exploration requires very sophisticated techniques, and the technology available for petroleum exploration is rapidly advancing. Normally, exploration starts in an area that has high potential to hold a resource, usually due to the local geology and known nearby petroleum deposits. In a high-potential area, further exploration is completed to delineate a resource. Geophysical and geochemical analysis is done using techniques including induced polarization (IP) surveys, drilling and assaying, electrical currents, and so on. In the exploration phase, the goal is to locate and estimate the potential of a resource.
If an area shows potential to host a resource, exploratory wells are drilled to test the resource. In the oil and gas sector, test drilling is an important component of the exploration phase. In the event that the exploratory well is successful, the next step is to construct wells and extract the resource. Upstream companies also operate the wells that bring the crude oil or natural gas to the surface.
Midstream activities include the processing, storing, transporting, and marketing of oil, natural gas, and natural gas liquids. The midstream activities take place after the upstream phase, and through to the endpoint of sale. Many oil and gas companies are considered integrated because of their ability to combine upstream, midstream, and downstream activities as part of their overall operations.
The midstream industry designation is much more prevalent in the oil industry in the United States and Canada than in the rest of the world because of the large privately-owned oil pipelines and storage facilities in these countries.
Downstream operations are the processes involved in converting oil and gas into the finished product. These include refining crude oil into gasoline, natural gas liquids, diesel, and a variety of other energy sources. The closer an oil and gas company is to the process of providing consumers with petroleum products, the further downstream the company is said to be. The downstream process is the one that provides the most products that are closely linked to consumers, and it is the sector of the oil and gas industry that people can relate to the most. Some of these products include liquefied natural gas, gasoline, heating oil, synthetic rubber, plastics, lubricants, antifreeze, fertilizers, and pesticides.
The downstream industry also plays a key role in other sectors and industries of the economy that may not necessarily be obvious to some, including the medical field. The downstream process has a big influence on some of the products and equipment needed and used by medical professionals. Similarly, the downstream process plays a key role in the agricultural sector because of its relationship to pesticides and fertilizers, as well as the fuel needed for farming equipment.
Oil Service Firms
Service companies work across all the phases of production. These are firms like Halliburton (HAL) and Baker Hughes (BHI). They provide services like engineering, fluid hauling, maintenance, geological surveying, non-destructive testing, and so on. Although they work across all the phases, oil service firms make the most money when upstream production is booming. On the midstream and downstream, oil service firms see regular income that can see them through dips in upstream activity, but it is the upstream activity is a huge driver of revenue. This is because they have new business coming in and new projects to bid on.
Oil refining is a purely downstream function, although many of the companies doing it have midstream and even upstream production. This integrated approach to oil production allows companies like Exxon (XOM), Shell (RDS.A), and Chevron (CVX) to take oil from exploration all the way to sale. The refining side of the business is actually hurt by high prices, because our demand for many petroleum products, including gas, is price sensitive. However, when oil prices drop, selling value-added products becomes more profitable.
There are some purer refining plays, like Marathon Petroleum Corporation (MPC), CVR Energy Inc, (CVI), and Valero Energy Corp (VLO). These companies enjoy lower energy prices, and benefit from stronger U.S. production because crude can’t be exported; only the refined products can be. This means that refiners have the whole of the shale oil supply to work with, and their input costs have dropped with the new supply.
One area service companies and refiners agree on is creating more pipeline capacity and transport. Refiners want more pipeline to keep down the cost of transporting oil by truck or rail. Service companies want more pipeline because they make money in the design and laying stages, and get a steady income from maintenance and testing.
The Bottom Line
Oil service companies and refiners both play an important role in the oil industry, but they tend to profit more in opposite markets. Oil service firms make money when high demand for crude oil is driving exploration and production. Refiners make money when the demand for fuel and value-added petroleum products is high, and they don’t mind when the price for crude goes lower. Both offer a compelling investment opportunity, depending on where the price of crude is.