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US economic strength is a major determinant of oil demand and therefore oil prices
Oil prices are ultimately determined by supply and demand forces, and oil consumption is one factor in the demand equation. US employment figures affect US 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 US employment figures as one indicator of the demand for oil, and consequently oil prices which affect 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.
Unemployment rate was flat month-over-month; non-farm payrolls increased more than expected
On July 5, the Bureau of Labor Statistics reported that the unemployment rate for June 2013 was 7.6%, more than economists’ expectations of 7.5%. This was also unchanged compared to the prior month’s reported figure of 7.6%.
Additionally, the change in nonfarm payrolls was 195,000 for the month of June, compared to survey estimates of 165,000, which was a significant surprise to the upside. Oil (WTI Cushing benchmark) finished up on the day at $103.22/barrel compared to $101.24/barrel the day prior.
The relationship between jobs and oil demand
The below chart demonstrates the relationship between the number of US jobs and US 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 US jobs and oil demand appear to be closely linked.
Therefore, market participants watch the US 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 US 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.
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.
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.
© 2013 Market Realist, Inc.