Oil prices are a major valuation driver for energy stocks
West Texas Intermediate (or WTI) crude (priced at Cushing, Oklahoma) is the benchmark crude for U.S. oil. Therefore, 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 $93.84 per barrel, compared to $94.60 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, while crude production in the U.S. continues to surge, causing oil prices to drift downwards.
Note that WTI more represents the price producers receive in the U.S., 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 WTI-Brent spread now at widest point since February.
Despite a 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 (XOM) on a percentage change basis from January 2007 onward. You can see that crude oil, the XLE ETF, and Exxon 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 affect the amount of money oil producers are incentivized to spend on oilfield services.
This past week’s downward movement in prices was a negative short-term indicator 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 oil price has been positive, as crude prices have largely remained above $80 per barrel since late 2010. Investors with oil-weighted energy holdings such as ExxonMobil (XOM), Oasis Petroleum (OAS), Pioneer Natural Resources (PXD) or energy ETFs such as the Energy Select SPDR Fund (XLE) and iShares Dow Jones U.S. Energy Sector (IYE) may find it prudent track the movements of benchmarks such as WTI crude.
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