Why higher oil and gas prices are helping energy company valuations

Why higher oil and gas prices are helping energy company valuations (Part 1 of 4)

Must-know: Why oil prices finally rallied last week

Oil prices are a major valuation driver for energy stocks

West Texas Intermediate (or WTI) crude oil (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.

2014.01.21-WTI Crude Oil PricesEnlarge Graph

WTI crude prices grew $1.65 per barrel on the week

Last week, WTI crude oil prices finished at $94.37 per barrel, compared to $92.72 per barrel the week prior. Last Wednesday, the U.S. Energy Information Administration (EIA) released the weekly data on crude oil stocks. EIA data showed a sharper-than-expected drop in crude oil inventories, which can indicate stronger demand or weaker supply than expected. For more on crude oil inventories, see Why oil inventory data sent crude prices up.

Note that WTI more represents the price that producers receive in the U.S., and there’s another benchmark for crude called Brent, which more represents the price producers receive internationally. 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 U.S.-concentrated companies in the energy space) have largely moved in the same direction over the past several years.

2014.01.21-WTI Crude Oil vs. XLE vs. EOGEnlarge Graph

As shown 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 the amount of money oil producers are incentivized to spend on oilfield services.

This past week’s upward movement in prices was a short-term positive for the sector. 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 such as WTI crude.

The Realist Discussions

  • dubb II

    Well.. You have the basic facts correct, but your logic is misguided. It’s true, the U.S producers can’t export their crude oil, but refiners can, which should balance supply and demand on a global basis price wise. The ‘gap’ in Brent vs. WTI shouldn’t exist because Brent demand (due to its higher price) will slow or be capped as refineries in Europe continue to shut down, losing out to U.S. refineries whose price’s are lower. U.S. gasoline demand is actually down year over year, refinery utilization is up because of exporting and the fact that more than a few refineries were closed down in the past due to poor economics. The only reason why WTI and Brent are priced as such is speculation.