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 were volatile during the week, ultimately finished flat to last week
On Friday, WTI crude oil prices finished at $102.58 per barrel, compared to $102.59 per barrel the week prior. Crude prices were volatile during the week as the markets tried to discern how escalating tension between Russia and Ukraine would affect world oil supply. This caused crude to rally and fall early in the week, while a bearish oil inventories report (see Why inventory figures helped natural gas prices but hurt oil prices) pushed prices down, then a positive U.S. economic indicators drove prices up. Ultimately, prices finished relatively unchanged.
WTI oil prices are up 7% since year-end 2013. This increase in prices was partly due to the market’s expectation of greater demand for heating fuels, which are refined products of crude oil, as the cold weather has persisted. Plus, the southern portion of the Keystone XL pipeline was put into service earlier this year, which has helped to transport crude oil away from Cushing (where WTI is priced), toward end markets. The drop in inventories at Cushing has helped to elevate WTI crude prices.
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. 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 may be more relevant to watch.
Oil prices have remained relatively high and stable, supporting energy company valuations
For most of the 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 graph below 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 trading action in prices was a short-term neutral 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.