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 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 closed down on the week
Last week, West Texas Intermediate crude oil prices finished at $96.60 per barrel, compared to $97.65 per barrel the week prior. One possible reason for the bearish crude price movement was that the market expects that the Fed may begin to taper its open market asset purchases soon, which could dampen the U.S. economy and therefore U.S. demand for oil.
Note that WTI more represents the price producers receive in the U.S., 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 benchmarks, please see WTI-Brent spread neared $20 per barrel as US oil surge continues. 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.
Despite a recent slide, 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 oil 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 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.
This past week’s downward movement in prices was a short-term negative for the sector. Over the past few months, WTI crude oil fell ~$15 per barrel (before recovering about $5 per barrel of that fall back), a medium-term negative. However, the longer-term stable and elevated oil price has been positive, as crude prices have largely remained above $80 per barrel since late 2010. Investors with domestic energy holdings in names such as CHK, EOG, RRC, or PXD may find it prudent to track the movements of benchmarks like WTI crude.
© 2013 Market Realist, Inc.