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Oil prices are a major valuation driver for energy stocks
West Texas Intermediate (WTI) crude (priced at Cushing, Oklahoma) is the benchmark crude for U.S. oil. So movements in WTI oil prices are a major driver in the valuation of domestic oil producers. Higher oil prices also incentivize producers to spend more money on drilling, which results in increased revenues for oilfield service companies (companies that provide services such as drilling, fracking, and well servicing). Consequently, WTI prices are an important indicator to watch for investors who own domestic energy stocks.
Fears of China slowdown put downward pressure on WTI oil prices
Last week, West Texas Intermediate (WTI) crude oil prices were down, as WTI finished at $104.70 per barrel on Friday, July 26, compared to $108.05 per barrel a week earlier.
China’s Ministry of Industry and Information Technology released a statement noting that it would order capacity cutbacks in areas such as steel, ferroalloys, aluminum, copper smelting, cement, and paper. Traders feared that the cutbacks would create a slowdown in the economy and suppress China’s demand for oil, which weighed down WTI oil prices.
Additionally, crude prices fell during the week on news of surging production (for more information, please see Why surging crude supplies weigh down oil prices).
Note that WTI more represents the price that producers receive in the United States, and there’s another benchmark for crude called Brent that more represents the price that producers receive internationally. For more on the price difference between the two, please see WTI-Brent spread widens back out slightly but remains tight. As the domestic benchmark, WTI prices matter more for domestic companies such as Chesapeake Energy (CHK), Range Resources (RRC), EOG Resources (EOG), and Pioneer Natural Resources (PXD).
Oil prices have remained relatively high and stable, supporting energy company valuations
For most of this past year, WTI crude oil has been range-bound between ~$85 per barrel and ~$100 per barrel, but recent events such as unrest in the Middle East and large inventory draws have helped to push WTI upward to current levels of ~$105 per barrel. As we’ve seen, higher crude prices generally have a positive effect on stocks in the energy sector. The graph below shows WTI crude oil price movements compared to XLE and EOG on a percentage change basis from January 2007 onward. You can see that crude oil, the XLE ETF, and EOG (one of the largest U.S.-concentrated companies in the energy space) have largely moved in the same direction over the past several years.
Upward movement, positive outlook
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 consequently affect the amount of money oil producers are incentivized to spend on oilfield services. So this past week’s upward movement in prices was a short-term positive for the sector. Plus, the longer-term stable and elevated price of oil has generally been positive. Investors with domestic energy holdings in names such as CHK, EOG, RRC, or PXD may find it prudent to track the movements of benchmarks such as WTI crude.
© 2013 Market Realist, Inc.