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.
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Crude prices continued to trade up on Syria fears
West Texas Intermediate (WTI) crude oil prices were up, as WTI finished at $110.53 per barrel on Friday, September 6, compared to $107.65 per barrel a week earlier. Oil prices continued to react to fears of supply disruptions given escalating tensions in Syria. The country itself isn’t a major oil producer, but it’s surrounded by major oil producers, and traders feared contagion throughout the Middle East as well as possible transportation disruptions through the Suez Canal in Egypt, another hotbed of geopolitical tension. See Why Middle East and North Africa turmoil could cause an oil price spike for more information.
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 benchmarks, please see Why the WTI-Brent spread closed slightly tighter. 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 between $100 and $110 per barrel, in large part due to unrest in the Middle East and supply disruptions from Libya.
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 upward movement in prices was a positive for the sector. Plus, 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 oil price 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.