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.
WTI crude prices continued to rise last week and are up over 3% in the past two weeks
Last week, WTI crude oil prices finished at $97.40 per barrel, compared to $96.64 per barrel the week prior. Plus, WTI has been up 3.3% since the past two weeks. Last week, data was released that showed that the U.S. gross domestic product expanded at a seasonally adjusted annual rate of 3.2% in fourth quarter of 2013—one of the best three-month periods of growth in a decade. This indicator of solid U.S. economic growth indicates positively affected oil prices, as economic growth correlates to oil demand. The prior week showed that distillate inventories (a refined product of crude oil) had decreased much more than expected, which was also a positive driver for oil demand. For more on that development, please see Must-know: Why distillate inventories are driving up oil prices.
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.
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 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.
For more analysis on oil prices, see Why oil and natural gas prices seemed to ignore inventory figures.