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How crude oil prices dropped drastically in four months

West Texas Intermediate (or 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 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.

2013.10.29 - WTI ST

WTI crude dropped on the week on inventory surge

Last week, WTI crude oil prices were lower, as WTI finished at $97.85 per barrel on Friday, October 25, compared to $100.81 per barrel a week earlier. Oil prices dropped on the week, as the US Energy Information Administration showed crude inventories rising 5,246 thousand barrels compared to expectations of 2,855 thousand barrels. Oil inventories rose as US oil production continues to grow, and refiners’ demand for crude recently has fallen due to regular seasonal maintenance as well as unplanned outages.

Note that WTI more represents the price producers receive in the US and there’s another benchmark for crude called Brent, which more represents the price that producers receive internationally. 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 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.

2013.10.29 - WTI vs XLE vs EOG

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.

So this past week’s downward movement in prices was a negative for the sector. Oil has also fallen about $10 per barrel since early September, which is 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.

Natural gas liquids, or NGLs, are a group of hydrocarbons (ethane, propane, butanes, and pentanes) that are often found alongside dry natural gas (methane). Many upstream companies (companies that produce crude oil and natural gas) garner much of their revenue from producing and selling NGLs—especially those that have a significant amount of “rich gas” assets, or natural gas assets “rich” in liquids. Some of these companies include Range Resources (RRC), Chesapeake Energy (CHK), SM Energy (SM), and Linn Energy (LINE). Price fluctuations in NGLs can affect the ultimate revenue and earnings of upstream companies, so NGL prices are an important indicator to track in the energy space.

2013.10.29 - NGL Composite ST

NGLs are made up of different compounds that receive different prices, and production streams are largely ethane and propane

According to a presentation by the Midstream Energy Group, the average NGL barrel composition in December 2011 was ~43% ethane, ~28% propane, ~7% normal butane, ~9% isobutane, and ~13% pentanes or heavier hydrocarbons. Using this representative composite barrel, NGL prices were down on the week, closing at $39.42 per barrel on October 25 compared to $40.42 per barrel for the week ended October 18.

The representative NGL barrel is up over 20% since lows in June, a medium-term positive catalyst. Natural gas liquids prices have largely been helped by strength in WTI crude prices, which shot up from ~$95 per barrel to up to $110 per barrel—though crude prices have retreated somewhat to ~$100 per barrel now.

Aside from elevated crude prices, the composite NGL barrel had also been helped by an increase in propane prices, which has likely been driven by higher propane exports.

NGLs have historically tracked movements in crude prices, but prices have fallen relative to crude lately

Natural gas liquids prices have largely tracked crude oil prices historically. However, over recent years, the composite barrel as a percentage of crude price has declined. This is because ethane and propane make up a large percentage of the average NGL barrel, but these two commodities especially have experienced a surge in supply due to the shale boom and have experienced a decline in prices. However, there’s still a correlation between NGL prices and crude, and movements in oil prices can cause NGL prices to move as well. Plus, the NGL barrel price relative to crude oil has recovered somewhat since June of this year.

 

2013.10.29 - Crude vs NGL

This week saw NGL prices trade down—a negative short-term indicator. Also, note that NGL prices are up significantly since late June—a positive medium-term indicator. From a longer-term perspective, many producers still find current price levels economic enough to continue to target and drill for NGLs, but they’ve suffered from NGL prices coming off highs (~$50 to $60 per barrel through much of 2011 versus ~$40 per barrel now). Major producers of NGLs include CHK, RRC, SM, and LINE—many of which are found in the Vanguard Energy ETF (VDE).

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