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. Therefore, 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 (that is, 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.
Oil prices spiked on a positive inventory figure
Last week, WTI crude oil prices were up, as WTI finished at $105.95 per barrel on Friday, July 12, compared to $103.22 per barrel a week earlier. A larger than expected inventory draw implied increased demand and caused prices to spike. For more on this, please see Must-know: Oil prices rise to new highs on supportive inventory report.
Note that WTI more represents the price that producers receive in the United States, and there’s another benchmark for crude called Brent, which more represents the price that producers receive internationally. For more on the price difference between the two benchmarks, please see Spread between WTI and Brent vanishes, lower relative U.S. oil prices. 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. 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.
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 also 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.
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