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Why oil prices finished down with Syria fears abating

Ingrid Pan, CFA

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 such as drilling, fracking, and well servicing). Consequently, WTI prices are an important indicator to watch for investors who own domestic energy stocks.

(Read more: Why ethane stopped trading like crude and started trading like nat gas (part II))

Crude prices finished down with talks to deal with Syria’s chemical weapons

Last week, West Texas Intermediate (WTI) crude oil prices were down slightly, as the oil benchmark finished at $108.21 per barrel on Friday, September 13, compared to $109.52 per barrel a week earlier. Oil prices continued to react to news out of Syria, as last Friday, it seemed that Russia and the United States were headed into talks to deal with Syria’s chemical weapons stocks. The country itself isn’t a major oil producer, but it’s surrounded by other major oil producers, and traders feared contagion throughout the Middle East as well as possible transportation disruptions through the Suez Canal in Egypt, another hotbed of geopolitical tension. See Why Syrian tensions led to sustained escalated crude prices for more information.

Note that WTI more represents the price that 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 to ~$105 per barrel. Plus, over the past month, oil has remained between $100 and $110 per barrel, in large part due to unrest in the Middle East and supply disruptions from Libya (see Why unrest in Libya has persistently disrupted oil production).

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 U.S.-concentrated companies in the energy space) have largely moved in the same direction over the past several years.

(Read more: Why ethane stopped trading like crude and started trading like nat gas (part III))

As you can see 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 slight downward movement in prices was a negative for the sector. However, over the past few weeks, prices have remained elevated above $100 per barrel. This is a medium-term positive. Lastly, the longer-term stable and elevated price of oil has generally 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.

(Read more: Natural gas continues to lose market share to coal year-over-year due to price gains)

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