When Shell, BP or another oil major reports its results, you will hear the terms upstream and downstream. They describe the two ends of the oil business, and understanding them explains why an oil company’s profits do not always move in step with the price of crude.
What upstream means
Upstream is the part of the business that finds and produces oil and gas. It covers exploration, drilling and running fields, whether onshore, offshore in the North Sea or in deep water elsewhere in the world. Upstream profits depend heavily on the prices of oil and gas: when Brent crude rises, the same barrel produced earns more money, and much of that extra revenue drops straight to profit.
What downstream means
Downstream is the part that turns crude oil into products and sells them. It includes refineries, which make petrol, diesel and jet fuel, as well as marketing, trading and the network of fuel stations. Downstream profits depend less on the crude price itself and more on the gap between the cost of crude and the price of finished products, known as the refining margin or crack spread.
Some people also talk about midstream, which covers moving and storing oil and gas, such as pipelines, tankers and storage terminals.
Why the split matters
The two sides often move in opposite directions. When crude prices jump, upstream profits rise. But if fuel prices cannot rise as quickly, refiners’ margins get squeezed, and downstream profits can fall. When crude prices drop, refiners can sometimes benefit from cheaper raw material.
That is why the big integrated companies, which own both sides, are partly hedged. Their overall profits still rise with oil prices, but not one-for-one. Pure upstream producers, by contrast, are much more sensitive to the oil price, and pure refiners respond more to margins.
A simple example
Imagine Brent rises from $90 to $110 a barrel. A company that only produces oil sees revenue per barrel jump by more than 20 per cent. An integrated major sees its production arm earn much more, but if its refineries cannot pass on the higher cost to fuel buyers quickly, its downstream arm might earn less. The group’s overall profit rises, but by less than the producer’s.
How traders use it
Traders reading oil company results check how each segment performed, rather than just the headline profit. They look at production volumes, realised prices, refining margins and the performance of the trading arm, which can be a big swing factor. They also watch how management plans to spend the extra cash, whether on new projects, dividends or share buybacks. Our guide to the oil risk premium explains why crude prices can stay high during geopolitical tension.
Common mistakes
A common mistake is assuming oil company shares must rise whenever crude rises. Refining margins, production problems, windfall charges and costs all matter. Another is ignoring gas, which is a large part of upstream income for many majors. A third is overlooking the trading divisions, which can produce surprisingly large profits in volatile markets.
The bottom line
Upstream finds and produces oil and gas; downstream refines and sells it. The two respond to different prices, which is why oil majors’ profits do not simply track crude. Reading the split is the key to understanding results day for the biggest names on the FTSE 100. If you want to test how you read sector moves, the free Samuel & Co Trading Trader Assessment is a sensible next step.
