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.
WTI crude prices slightly down on mixed trading through the week
Last week, West Texas Intermediate (WTI) crude oil prices were down, as WTI finished at $106.42 per barrel on Friday, August 23, compared to $107.10 per barrel a week earlier. Oil was weighed down earlier in the week as the market worried about an end to Fed stimulus measures. Media sources such as Bloomberg News and the Wall Street Journal reported that later in the week, crude advanced on stronger economic data out of China and continued unrest in the Middle East.
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 Why is there volatility in the WTI-Brent crude oil spread? 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 ~$105 per barrel. Plus, over the past month, oil has remained over $100 per barrel, helped by turmoil in the Middle East, as unrest in Egypt has caused fears of supply shocks (see Why Middle East and North Africa turmoil could cause an oil price spike).
As we’ve seen, 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 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 affect the amount of money oil producers are incentivized to spend on oilfield services. So this past week’s slight downward movement in prices was a negative for the sector. However, over the past few weeks, prices have remained elevated above $100 per barrel—which is a medium-term positive. Lastly, 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.