Oil prices are a major valuation driver for energy stocks
West Texas Intermediate (WTI) crude (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 on drilling, which results in increased revenues for oilfield service companies (companies that provide services such as drilling, fracking, and well servicing). So WTI prices are an important indicator to watch for investors who own domestic energy stocks.
(Read more: Crack Spread 101 (Part 1: What’s a crack spread?))
Crude prices traded down as the market focus moved from Syria to the US government
Last week, West Texas Intermediate (WTI) crude oil prices were down, as WTI finished at $102.87 per barrel on Friday, September 27, compared to $104.67 per barrel a week earlier. Oil prices declined as the market has shifted its attention away from Syria for the moment, given UN intervention, and towards the likelihood of US government shutdown. The specter of a government standstill caused bearish sentiment throughout the markets. See Why Middle East and North Africa turmoil could cause an oil price spike and Brief background on why the Syrian conflict affects oil prices for why actions in Syria affect oil prices.
Note that WTI more represents the price producers receive in the United States and there’s 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 closes tighter, but market keeps eye on Syria. 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).
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 ~$105 per barrel. Plus, over the past month, oil has remained at levels of $100 to $110 per barrel. This is in large part due to unrest in the Middle East and supply disruptions from Libya.
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 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.
So this past week’s downward movement in prices was a negative for the sector. However, oil prices over the past few months have remained elevated above $100 per barrel, which is a medium-term positive. Lastly, the longer-term stable and elevated price of oil has been positive. 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.
More From Market Realist