Crude oil prices are a major driver of the valuation of energy stocks and therefore energy ETFs as higher crude oil prices result in higher revenues and valuation for oil producers. Higher prices also incentivize oil producers to spend more money on drilling, which boosts business for oilfield service companies (companies which provide services to producers such as drilling and fracking), and therefore the revenues and valuation of those companies as well. Therefore, crude oil prices are a critical indicator to watch for those owning stocks or ETFs in the energy sector.
Last week West Texas Intermediate (WTI) crude oil prices dropped from $97.77/barrel to $95.98/barrel, reversing the prior week’s gains. Brent crude closed at $118.90/barrel, up from $116.76/barrel the prior week. Note that WTI is more representative of the price that producers receive in the US and Brent is more representative of the price that producers receive internationally. Market participants noted that worries of even more supplies of oil flowing into Cushing, Oklahoma (where WTI is priced) may have caused WTI crude to trade down. If WTI crude moves down relative to Brent crude, this generally favors producers with international assets such as Exxon Mobil (XOM) or Chevron (CVX) as much of their production will receive prices more closely linked to Brent crude. On the other hand, many domestic producers such as Chesapeake Energy (CHK) or Range Resources (RRC) receive prices more closely linked to WTI crude. Notable exceptions are producers with Gulf of Mexico assets, such as Energy XXI (EXXI), whose production is not constrained inland by transportation bottlenecks.
The below graph shows historical WTI crude oil prices. Despite this week’s drop in WTI oil prices, oil has experienced a rally over the past several weeks and some market participants have cited positive economic indicators as the drivers for this.
As previously mentioned, higher crude prices generally have a positive effect on stocks in the energy sector. The below graph shows WTI crude oil price movements compared to XLE and XOM on a percentage change basis from January 2007. One can see that crude oil, the XLE ETF, and XOM (one of the largest companies in the energy space) have largely moved in the same direction over the past several years.
As demonstrated in the graph above, crude oil prices are a major driver in the valuation of many energy investments. Oil prices affect the revenues of oil producers, and therefore the amount of money oil producers are incentivized to spend on oilfield services, therefore this week’s upward movement in prices was a positive for the sector. Investors with energy holdings may find it prudent to track the movements of benchmarks such as WTI and Brent.