What is the price per sinking barrel?
In finance, “price per sinking barrel” is a measure used to estimate the value of a company that produces oil and gas. This calculation is done by dividing the enterprise value (EV) of the company by the number of barrels it produces in a typical day. Enterprise value measures the total value of a business.
Key points to remember
- The sinking barrel price is a measure used to gauge the approximate value of a business in the oil and gas sector.
- There are a number of other factors that investors also consider when trying to assess the value of a company in the industry, including company track record and political considerations, among others.
- The objective of measuring the price per barrel in circulation is to compare the enterprise value of the company to the number of barrels it produces each day.
- A version of this measure can also be used to estimate the value of specific projects in the oil and gas sector.
- Price per sinking barrel = EV / barrels of production per day
For those unfamiliar with the concept of EV, the same expression can be rewritten as follows:
- Price per sinking barrel = (market capitalization + total debt – total cash) / barrels of production per day
How Price Per Flowing Barrel Works
The price per barrel in circulation is a simple heuristic to estimate the approximate value of an oil and gas company. Of course, in the real world, investors and analysts understand that there are many additional factors that must be considered before determining whether a particular company is an attractive investment. These include the political risks associated with the regions in which their projects are located, the quality of their equipment and personnel, and their track record of discovering and developing new projects, among many others.
In addition to helping assess the value of oil and gas companies, the price per outstanding barrel measurement can also be used to estimate the value of specific oil and gas projects. In this way, a more detailed analysis of an oil and gas company could involve calculations of the individual price per barrel of each of their major projects. In this scenario, the numerator of the ratio would be composed of the internal costs associated with the project, instead of the EV of the company as a whole.
If the analyst observes that the company’s newer projects are showing a trend toward increasingly favorable price-per-barrel ratios, this may indicate that the company is becoming more efficient at identifying and exploiting new projects. When performing these types of project-specific analyses, the term “cost per circulating barrel” is often used to avoid confusion with enterprise-level valuation.
Enterprise value is considered a more comprehensive version of market capitalization, as it examines the company’s market capitalization, short-term and long-term debt, and cash on the balance sheet.
Concrete example of price per sinking barrel
To illustrate, consider a company with a market cap of $20 billion, $500 million in debt, and $100 million in cash. If this company produces 600,000 barrels per day, then its price per barrel in circulation would be:
- Price per sinking barrel = ($20,000,000,000 + $500,000,000 – $100,000,000) / 600,000 = $34,000
Investors and analysts can then use this metric to compare the valuation of a particular company to competing companies that have similar production plans. For example, if one of its competitors has similar projects but has a price per sinking barrel of only $25,000, then that competitor may be considered a more attractive investment opportunity.