Must-know: Why oil prices dropped on API inventory data

Oil prices are a major valuation driver for energy stocks

West Texas Intermediate (or WTI) crude (priced at Cushing, Oklahoma) is the benchmark crude for US 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.

2013.10.20 -WTI STEnlarge Graph

WTI crude dropped on the week due to API inventory data

Last week, West Texas Intermediate crude oil prices were lower, as WTI finished at $100.81 per barrel on Friday, October 18, compared to $102.02 per barrel a week earlier. Oil prices dropped on the week, as the market focused on inventory data released by the American Petroleum Institute (the API), a private group that also reports estimates on inventories. The usual report from the US Energy Information Administration had been indefinitely delayed due to the government shutdown. The API report stated that domestic oil inventories rose 5.9 million barrels for the week ended October 11, compared with estimates of 1.7 million barrels, implying more-than-expected supply, less-than-expected demand, or both. API also noted that the rate of processing crude oil by refineries was at its lowest level since April. The lower run rate of crude through refineries also implies less demand for the commodity.

Note that WTI more represents the price that producers receive in the US 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 WTI-Brent spread hits recent low, favoring international producers. 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) than for companies with significant international exposure, where Brent prices might be more relevant to watch.

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 ~$110 per barrel. 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 US-concentrated companies in the energy space) have largely moved in the same direction over the past several years.

2013.10.20 - WTI vs XLE vs EOGEnlarge Graph

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 downward movement in prices was a negative for the sector. However, oil prices over the past few months have largely remained elevated above $100 per barrel, which is a medium-term positive. Lastly, the longer-term stable and elevated price of oil has 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.