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Non-farm payrolls figures fuel oil price rally, positive catalyst for names such as XOM

2013.06.10 - Nonfarm PayrollsEnlarge Graph

  • The U.S. is the world’s largest consumer of oil and, therefore, the state of the U.S. economy is an important determinant of world oil demand. One indication of the strength of the U.S. economy is the national unemployment rate.
  • The report for May’s unemployment rate was 7.6%, above survey estimates of 7.5% and April’s rate of 7.5%, which on surface was negative, though the higher unemployment rate was as a result of more laborers returning to the workforce and, therefore, was not construed by the market to be a sign of a weaker economy.
  • Additionally, U.S. payrolls (jobs) grew by 175,000, more than survey estimates of 163,000, which was a positive indicator for the U.S. economy and, therefore, bullish for oil demand and oil prices.

Oil prices are ultimately determined by supply and demand forces, and oil consumption is one factor in the demand equation. U.S. employment figures affect U.S. oil consumption as employment is one measure of how strong or weak the domestic economy is. Additionally, the more people who are employed, the more miles are driven to and from work, which drives a portion of demand for oil as some of the commodity is used to make transportation fuels. Therefore, many market participants track U.S. employment figures as one indicator of the demand for oil, and consequently oil prices which affects the earnings of upstream energy producers, such as Exxon Mobile (XOM), Chevron Corp. (CVX), Hess Corp. (HES), and ConocoPhillips (COP). Lower valuations of these companies also affect ETFs, such as the Energy Select Sector SPDR (XLE), which is comprised of a number of upstream energy producers in addition to oilfield service providers and refiners.

On June 7th, the Bureau of Labor Statistics reported that the unemployment rate for May 2013 was 7.6%, more than economists’ expectations of 7.5%. This was also higher than the prior month’s reported figure of 7.5%. Hence, this was seemingly a negative indicator for the U.S. economy and, therefore, oil demand and oil prices. However, the market did not construe the report as a sign of economic weakness as the higher unemployment rate was a result of more laborers entering the workforce.

Additionally, the change in non-farm payrolls was 175,000 for the month of May, compared to survey estimates of 163,000, which was a significant surprise to the upside. Oil (WTI Cushing benchmark) finished up on the day at $96.03/barrel compared to $94.76/barrel the day prior.

The below chart demonstrates the relationship between the number of U.S. jobs and U.S. oil demand on a percentage change basis from January 2001. Though for various reasons (such as seasonality) the demand for oil fluctuates much more than the jobs figure, the trends of U.S. jobs and oil demand appear to be closely linked.

2013.06.10 - Jobs vs Oil DemandEnlarge Graph

Therefore, market participants watch the U.S. employment figures as one indicator of domestic oil demand. A worse than expected report on employment can cause oil prices to trade down, and likewise a better than expected report on employment can cause oil prices to trade up. Given higher oil prices, upstream energy companies realize lower revenues which ultimately affect earnings and valuation. The below graph represents the price of WTI crude oil (the U.S. benchmark crude), plotted against the stock price of Exxon Mobil (XOM), and the Energy Select Sector SPDR (XLE), an ETF designed to track the performance of the energy sector on a percentage change basis since January 2007.

2013.06.10 - WTI vs XLE vs XOMEnlarge Graph

One can see in the above graph that crude oil prices, XOM, and XLE have typically moved in the same direction over the past six years.

The below flow chart summarizes why market participants watch employment figures.

2013.06.10 - Flow ChartEnlarge Graph

More people employed implies greater oil demand and higher oil prices. Higher oil prices benefit the earnings of companies which produce and sell oil. Therefore, this month’s better than expected employment figures (non-farm payrolls) were a positive indicator for the valuation of oil companies, such as XOM, CVX, COP, and HES, as well as for energy ETFs, such as XLE.