Why oil prices have stabilized after two months of decreases

Market Realist

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 US 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 unchanged on the week, after two months of declines

Last week, West Texas Intermediate crude oil prices finished at $94.60 per barrel, compared to $94.61 per barrel the week prior. Oil prices have been falling since early September, when WTI reached levels of over $110 per barrel. Since then, tensions in the Middle East seem to have eased, production from Libya has started to recover, and flush supply continues to come from the US, causing prices to drop. This week, crude traded relatively flat, perhaps signaling an end to the bearish oil market.

Note that WTI more represents the price producers receive in the US, and there’s another benchmark for crude called Brent that more represents the price producers receive internationally. For more on the price difference between the two benchmarks, please see Why the WTI-Brent oil spread is at its widest level since March. 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 previously mentioned, 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 US-concentrated companies in the energy space) have largely moved in the same direction over the past several years.

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

This past week’s flat movement in prices was a short-term neutral for the sector. Over the past few months, oil has fallen about $15 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 such as WTI crude.

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