Oil prices are a major valuation driver for energy stocks
West Texas Intermediate (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 like drilling, fracking, and well servicing). Consequently, WTI prices are an important indicator to watch for investors who own domestic energy stocks.
Last week, West Texas Intermediate (WTI) crude oil prices finished at $92.72 per barrel, compared to $94.84 per barrel the week prior. Oil prices have been falling since early September, when WTI reached over $110 per barrel. Since then, tensions in the Middle East seem to have eased, and flush supply continues from the U.S., causing prices to drop. This week, crude continued to fall as the U.S. Energy Information Administration released data that showed that U.S. crude inventories increased more than expected. For more background, please see Why crude oil prices continue to slide on inventory figures.
Note that WTI more represents the price producers receive in the U.S., and there is another benchmark for crude called Brent, which more represents the price producers receive internationally. For more on the price difference between the two benchmarks, please see WTI-Brent spread neared $20 per barrel, as US oil production continues to surge. As the domestic benchmark, WTI prices matter more for domestic companies like 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 the 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 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 ExxonMobil (the largest oil producer in the world) on a percentage change basis from January 2007 onward. You can see that crude oil, the XLE ETF, and ExxonMobil 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 they 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 has fallen nearly $20 per barrel—a medium-term negative. However, the longer-term stable and elevated price of oil 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.