Correlation analysis: Impact of falling oil prices on energy stocks
In this part, we’ll examine the impact of falling crude oil prices on the stock performance of several companies. For this analysis, we have tested the correlation between energy sector stocks and Brent for the past five years.
Integrated energy company: Lower positive correlation
The correlation coefficient of ExxonMobil (XOM) versus Brent stands at 0.23. All other things being equal, a changing oil price inversely affects the upstream and downstream segments of the integrated energy company. This provides ExxonMobil with a degree of resistance to oil price volatility. This reflects in the lower correlation between oil prices and XOM’s stock prices.
Upstream company: Higher positive correlation
On analyzing a standalone upstream company like ConocoPhillips (COP), it’s observed that the correlation to oil price is even stronger than for an integrated energy company. The correlation coefficient of ConocoPhillips (COP) versus Brent stands at 0.45. This is higher than the correlation for an integrated energy company due to the full exposure to only upstream segment earnings, as they are are highly dependent on crude oil prices.
Downstream company: Strong inverse correlation
The correlation coefficient of Tesoro (TSO) versus Brent stands at -0.85, indicating an inverse relation between the TSO stock price and Brent. This means that around 85% of the movement in TSO’s stock prices can be explained by changes in Brent prices. This is similar to Valero Energy’s (VLO) -0.74 correlation to Brent.
Crude oil prices have varied effects on energy sector stocks. All other things being equal, for integrated energy and upstream stocks with a positive correlation, falling oil prices should translate into lower stock prices. How much lower? It depends on the strength of correlation. On the other hand, falling oil prices should translate into higher stock prices for downstream players with a strong negative correlation to crude oil’s price.
Additionally, falling oil prices are likely to impact the financial and operating performance of integrated energy, upstream, and downstream companies in a varied manner. While integrated energy companies will be impacted by falling oil prices, the downstream segment could be an earning savior for them. Upstream companies are likely to bear the highest brunt of falling oil prices.
On the other hand, the fate of downstream companies could depend on cracks and oil spreads. Plus, downstream companies need to be cautious about the market dynamics. That is, if refiners produce, stock up, and flood the market with refined products to take advantage of relatively higher product prices, then they could end up diminishing their own advantage.
For exposure to energy sector stocks, you can consider the Vanguard Energy ETF (VDE). The ETF has an exposure of ~38% to integrated energy, ~11% to downstream, ~25% to oil and gas exploration, and ~16% to oil field equipment and services sector stocks.