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 owning domestic energy stocks.
WTI crude prices were lifted on positive U.S. economic data
Last week, West Texas Intermediate (WTI) crude oil prices were up, as WTI finished at $106.94 per barrel on Friday, August 2, compared to $104.70 per barrel a week earlier.
On Thursday, the Institute for Supply Management reported positive data on the U.S. manufacturing segment. For more on that, please see Positive U.S. manufacturing sector data boosts oil prices. Plus, initial jobless claims came in less than expected. For more on that development, please see Lower jobless claims: Positive for U.S. economy and oil demand. These data points indicated strength in the U.S. economy and so were positive signals for oil demand.
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 producers receive internationally. For more on the price difference between the two, please see Why the WTI-Brent spread 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, large inventory draws, and signals of strength in the U.S. economy 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.
As the graph above shows, 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. Moreover, 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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