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Definition: Operating Netback
Operating Netback is an estimation method used in oil and gas industry which gives the net income earned on one barrel of oil after subtracting all the operating costs and royalties from the revenue earned from the oil. It will give the profit margin gained from one barrel of oil. Here the operating costs would cover extraction costs, production costs, transportation costs, and wages of labours and all other costs which contribute in bringing the oil from ground to the market. Royalties are also considered as costs as that amount is to be paid to the owner of the area where the extraction process is carried out. Calculations of this operating cost may vary from company to company and from country to country as they may adopt different methods and standards for calculating their income.
Operating netback for some companies can also be negative as there operating costs may be much higher than the market price of oil. Such a situation can be because the oil rigs may be in very remote locations or the weather conditions may be very severe which may increase their operating costs. Even lack in demand of oil will lead to fall in the prices, going below the operating costs can lead to loss for the companies and their netback will be negative showing losses.
Operating netback method helps in evaluating the profit margin earned per barrel which may help the company evaluate its earnings and can compare it with other companies.
It can also help oil companies provide an estimate of entering into new areas of exploration and their profit margins in that area and thereby they can forecast there future earnings and decide whether to accept the project or not . But it cannot provide accurate estimations as the oil prices keep on fluctuating in the market so their profit margins will also keep on fluctuating.