API gravity

Definition

American petroleum Institute's inverted scale for denoting the 'lightness' or 'heaviness' of crude oils and other liquid hydrocarbons. Calibrated in API degrees (or degrees API), it is used universally to expresses a crude's relative density in an inverse measure lighter the crude, higher the API gravity, and vice versa because lighter the crude higher its market value. Oil with API greater than 30º is termed light; between 22º and 30º, medium; below 22º, heavy; and below 10º, extra heavy. Asphalt on average has an API gravity of 8°, Brent Crude of 35.5°, and gasoline of 50°. Formula: {(141.5 ÷ relative density of the crude (at 15.5°C or 60°F)} - 131.5.

Heavy crude

Crude oil with 22 degrees or lower API gravity, due to the presence of asphaltines and other heavy hydrocarbon fractions.

API gravity

One of the most important characteristics of crude oil is its density: whether it is light or heavy.

Although it would be possible to quote densities using normal units (such as kg/litre), the oil industry convention is to use API (American Petrochemical Institute) gravity. API gravity is:

(141.5 ÷s) - 131.5

where s is specific gravity at 60 degrees Fahrenheit.

The specific gravity is the ratio of the density of the oil to the density of water.

There is an inverse relationship between API gravity and density; the higher the density the lower the API gravity. Light crudes are generally those with an API gravity over 40. Those with an API gravity below 40 are regarded as heavy.

The density of oil (as measured by API gravity) is one of the key factors used to classify and grade types of crude oil.

Crude oil

Crude oil is a mixture of liquid hydrocarbons, often found together with natural gas. The main characteristics of crude oil are:

its density; in the oil industry this is usually measured by its API Gravity. its sulphur content.

Crude oil is normally described as sweet (low sulphur) or sour (high sulphur) and light or heavy (depending on its density). Heavier oils may also be described as medium (self explanatory) and bitumen (so heavy it is solid).

A light crude oil is generally one with an API gravity of less than about 40. Brent crude, an important benchmark crude, has an API gravity of 38 to 39. Heavy crudes will typically have an API gravity of 20 or less - the higher the API gravity, the lower the density.

Sweet crude oil has a sulphur content less than 0.5%, anything more is sour.

Heavy crude is:

harder to handle (it is two thick to pump easily through pipelines unless diluted with light crude)

more expensive to refine to produce the most valuable petroleum products such as petrol, diesel and aviation fuel.

Sweet crude is preferable to sour because it is also (like light crude) more suited to the production of the most valuable refined products.

Almost every oil field produces crude with a unique mixture of characteristics. It is therefore easiest to follow the prices of key benchmark varieties. The more important benchmark prices include Brent, West Texas Intermediate, The OPEC basket price, Dubai crude, Tapis (Malaysian) and Minas (Indonesian).

Barrel of oil

A barrel of oil is 42 US gallons or 159 litres.

The term comes from the size of the old wooden whiskey barrels used to transport oil in the mid nineteenth century. This unit of measurement has remained unchanged despite the replacement of wooden barrels by larger steel barrels, and the replacement of the latter by pipelines.

Barrels of oil per day (bpd) is a standard unit of oil production.

As oil and gas are often produced from the same fields, it is common to measure reserves and production in barrels of oil equivalent.

Boe (barrels of oil equivalent)

The basic unit used to measure oil and gas production is barrels of oil equivalent (boe). It is often necessary to use millions or billions of barrels of oil equivalent (mboe or bboe) when discussing oil reserves. Production volumes are measured in boed (barrels of oil equivalent a day) or mboed (millions of barrels of oil equivalent a day).

A boe is the amount of energy contained in a barrel of crude oil. Approximately 6,000 cubic feet of natural gas is considered equivalent to one barrel of oil, but the exact rate varies depending on the type of gas.

This measure is used to quantify the output of an oil company in way that:

allows output of oil (measured in barrels) and gas (measured by its volume) to be added together to form one figure

measures production volumes rather than values.

Investors do also have another single figure that measures output of both oil and gas: the value of production. As this is dependent on the volatile prices of both commodities it does not tell us much the actual level of production.

Dry natural gas

Dry natural gas is what remains in natural gas after:

the liquefiable hydrocarbons have been removed any significant amounts of non-hydrocarbon gases have been removed.

Dry natural gas is also called consumer grade natural gas.

LPG (Liquefied Petroleum Gas)

Liquefied Petroleum Gas (LPG) is obtained by extraction from natural gas or from refinery processes.

It is stored under pressure, but because this causes it to liquefy it needs less storage space and can be handled more easily than it could be as a gas.

Most LPG is used for fuel, but it is also used as a refrigerant and an aerosol propellant. As a fuel it is used for domestic gas supplies, as an automotive fuel and, to a limited extent, for electricity generation.

Like other oil and gas products, demand for LPG is cyclical.

Natural gas

Natural gas is usually found together with oil but the proportion of oil to gas varies and either may be the main product of a field. This is why boe is used as a measure of volume.

Like crude oil, it is a mixture of hydrocarbon compounds, mostly methane. Methane (CH4) is colourless, flammable, and odourless (which causes some safety problems). It is a greenhouse gas.

Natural gas is sold in the form of various extracts such as dry natural gas and LPG.

Oil Reserves

Reserves are the amount of oil or gas that has been discovered and that can be extracted profitably with existing technology under present economic conditions.

Reserves are categorised as being proven, probable or possible. There are, unfortunately, no standard definitions for these terms which can vary between companies and countries. The definitions are generally broadly similar.

The lack of definitions does create an opportunity for companies to manipulate the numbers. In the UK, definitions are usually similar to those used by the DTI, but companies have wide discretion. In the US, the SEC imposes definitions on listed companies.

National reserve numbers are often very inaccurate, as national governments have strong motives to exaggerate their reserves: for example, it strengthens the countries financial position, making it easier and cheaper to borrow.

Global reserve numbers, especially those produced by inter-governmental agencies, are similarly suspect.

The problem in all cases, is that almost everyone in the industry or government as motives to be optimistic about reserves.

OPEC basket price

OPEC has tied its production management activity to the goal of maintaining the OPEC Basket price which is a simple average price of a "basket" of seven crude oils, including: Algeria's Saharan Blend, Indonesia's Minas, Nigeria's Bonny Light, Saudi Arabia's Arab Light, Dubai's Fateh, Venezuela's Tia Juana Light, and Mexico's Isthmus (a non-OPEC crude oil).

OPEC uses the price of this basket to monitor world oil market conditions. Of the major benchmark crude oils West Texas Intermediate and Brent are lighter and sweeter, and therefore more expensive, than the OPEC basket.

Possible oil reserves

Possible oil reserves are, as the name implies, oil reserves that have a significant probability of being commercially exploitable, but which can not be said to be probable.

In the UK the DTI defines these as those oil reserves with a less than 50% chance of being technically and commercially producible.

As with proven and probable reserves the exact definition varies.

Probable oil reserves

Probable oil reserves are those that are not (yet) proven reserves, but which are likely to be exploitable.

In the UK, the DTI defines these as those reserves which are estimated to have a better than 50% chance of being technically and commercially producible, but companies have can use their own definitions.

As with proven oil reserves, the exact definition may vary from company to company.

Proven oil reserves

Proven oil reserves are those that are known to exist and be exploitable to a high degree of certainty.

In the UK the DTI defines probable reserves as those with a 90% probability of being technically and commercially producible.

The exact definition of proven reserves varies from company to company and from country to country. The numbers disclosed by national governments of a country's reserves are also often manipulated.

Oil reserves and valuation

From the point of view of an investors, oil reserves are the most important element in valuing an oil company. The NPV of an oil company are the value of the oil it has, plus the value of the oil it will discover, less the cost of discovering and extracting that oil.

The value of an oil company (e.g. market cap or enterprise value) compared to the value of its reserves is an important metric.

The proven oil reserves are important because they are (almost!) certain — the proven oil reserves are the element of the value of an oil company that investors can rely on: but this is only part of the total value.

One obvious problem with all this (or with valuing oil companies by any method) is that the oil price is very volatile, and what oil prices will be in the long term is highly unpredictable.

Upstream

The oil and gas industry can be divided into two types of operation: upstream and downstream:

Upstream operations are concerned with the production of crude oil and natural gas. They also include exploration and transportation.

Downstream operations include refining and distribution of refined oil.

The major oil companies such as BP and Shell usually have both upstream and downstream activities. These are called integrated oil companies.

Smaller companies tend to be specialised: there are several London listed upstream companies such as Premier Oil and Burren Energy.

Upstream companies are heavily exposed to the risk of changes in oil prices. The risk goes both ways (profits will rise if the oil price does, as well as fall if the oil price falls). Changes in prices for downstream companies' supplies are usually passed on to customers. Their profits are less effected by changes in oil prices.

Downstream

Downstream operations, in the oil and gas industries, include refining and distribution, as opposed to upstream (exploration and production).

The major oil companies tend to be integrated (have both upstream and downstream operations) whereas the smaller ones tend to specialise