The Relationship between Oil, Drillers and Refiners

Considering this Memorial Day weekend officially kicked off the "driving season" I decided to do some research on the sky high oil prices that are behind the sky high prices at the pump. In particular, I did some tests on the relationship between the price of oil, the price of oil driller stocks, and the price of oil refiner stocks.

I'm sure most of you already know that when oil prices go up, oil driller stocks also tend to go up, and oil refiner stocks tend to go down. Just to double check this conventional wisdom, I ran some regression models. Using daily price data from the beginning of 2007 through this week, I ran five separate regressions models:

1) Oil versus Transocean (RIG): RIG is an oil driller, and there is a very strong positive relationship between the price of oil and the price of RIG. In fact, oil prices have explained 92% of the total variability in the price of RIG. Specifically, the price of RIG is positively impacted when oil prices go up, and negatively impacted when oil prices go down. For reference, during this time period, oil prices have increased 124% and RIG has increased 109% while the SP500 has actually fallen about 1%.

2) Oil versus Tesoro (TSO): TSO is an oil refiner, and there is a very strong negative relationship between oil prices and the price of TSO. Generally speaking, the price of TSO is negatively impacted on days when oil prices rise, and vice-versa. For reference, the price of oil explains 31% of the total variability in the price of TSO.

3) Oil versus Diamond Offshore Drilling (DO): DO is an oil driller, and there is a very strong positive relationship between oil prices and the price of DO. In fact, oil prices explain 86% of the total variability in the price of DO. The price of DO is positively impacted on days when oil prices go up, and negatively impacted on days when oil prices go down.

4) Oil versus Valero Energy (VLO). VLO is an oil refiner, and there is a very strong negative relationship between oil prices and the price of VLO. In fact, oil prices have explained about 14% of the total variability in the price of VLO during this time period. Generally speaking, VLO is negatively impacted when oil prices rise.

5) Oil versus the S&P500. There is a very strong negative relationship between oil prices and the price of the S&P500 (a proxy for the overall market). In fact, oil prices have explained 18% of the total variability in the price of the S&P500. This means that when oil prices go up it has a negative impact on the S&P500.

To summarize the above: If oil prices go up, oil driller stocks tend to go up, and oil refiner stocks tend to go down. Further, the positive correlation between oil prices and oil drillers is stronger than the negative correlation between oil prices and oil refiners. Further, rising oil prices negatively impact the overall stock market as measured by the S&P500.

Anyway, I've been further fiddling around with the data in attempt to find some way to use oil prices to predict future stock prices. I've tried lagged variables, autoregressive models, and moving average input variables, to name a few. Unfortunately, I haven't been able to come up with any good predictive models, so I'm giving up for now.

Comments

[nycDem:]

Thanks. This is a simple but useful article which corroborates what I have already observed. Appreciate you crunching the numbers.

I own long-term options on RIG and ATW...but I think oil is due for a correction (if we're not already in one). Wondering if I should just ride it out since I feel that RIG and ATW will continue to perform well in the long-term. But I'm not looking forward to seeing my options get cut in half if oil does get spanked.

I bought some DUG as a hedge...but it won't do much to offset my loss if the drillers take a beating.

Decisions, decisions...

- nyctrax

2008 May 28 12:35 AM

[ship shape ...:]

As long as oil doesn't collapse I think RIG and the rest of the sector will do better with oil between 90 and 105$, than oil at 135$.

2008 May 28 05:26 AM

[ChBobII:]

Unless you have options expiring soon it is a nice luxury to not do anything radical with energy stuff because any downturn will be short lived. We can count on energy bad guys like Iran & Venezuela to say something to reverse any slide in crude prices.

2008 May 28 10:19 AM

[MarkR:]

Would you be willing to provide a data file for your models?

2008 May 28 10:47 AM

[H.W.:]

Doing a research requires a good sampling with thorough diversification. I am not really convinced with a few samples experimented.

2008 May 28 11:02 AM

[Mark Hines:]

MarkR- I have access to some premium price data services that I cannot share, but you can get the same data for free all over the Internet. Try Yahoo!Finance for historical stock prices and try this link for historical oil prices:

tonto.eia.doe.gov/dnav...

Also, here is a link to my original article, which includes more detail on the regression results:
vestopia.com/Blogs/Mar...

2008 May 28 01:09 PM

[Mark Hines:]

Hi H.W. I agree with you. This is just a short sample period of data for only a few stocks. It was only meant to give folks (and myself) a rough confirmation of a general relationship that many people assume to be true. Obviously there are a lot more factors at play, and a lot more robust models can be built for those inclined to do so. Thanks for you comments.

2008 May 28 01:11 PM

[MarkR:]

Mark, thanks for the links to the data.

2008 May 28 01:58 PM

[MikeH:]

Nice, but a considerate commentator would have written this article before I bought VLO and FTO. Refiners will rise again!

2008 May 28 04:56 PM

[Mark:]

Mark, this is crisp and clear. I learned the hard way on WNR but have done very well on Halliburton (the more people hated on Cheney, the more I bought and the more it went up!), Apache, and finally Nabors!
Thanks!

2008 May 28 11:18 PM

[jwaydog:]

duh

2008 May 29 09:19 AM

[jwaydog:]

Actually, the summary that oil drillers greater upside relative to the price of oil vs refiners downside is very interesting and therefore I retract my previous statement. Nice work.

2008 May 29 09:25 AM

[jwaydog:]

It seems to me that conversely drillers are much,much more sensitive to a decline in oil than refiners. At this point the research on a decline may be in order. I have owned OIH for a long time but am out now due to this belief (though I like the drillers long term) just not at this level. Lost my a-- this year on the refiners waiting for the dollar to strengthen and oil to wane. Now I would like to get back into vlo,tso but am worried about gasoline demand. Ok, it feels better to talk about it.

2008 May 29 09:37 AM

[CBrown1818:]

One thing to bear in mind is the rate at which oil prices are climbing/dropping in comparison to gas prices rising/declining. As oil prices rise slowly this is great for refiners, because gas prices tend to rise too, increasing profit margins despite the slowly increasing costs of oil. However if oil prices rise too quickly vs gas prices, refiners are in for some tough times because the price of oil exceeds what they can make from selling the gasoline. If oil remains near its current price or goes higher over the next few months expect some bad quarterly reports from refiners in the near term. However those who are positioning themselves to and will be strong enough to weather these circumstances will make a great recovery once gas prices rise to meet oil. Valero and Tesoro are my top picks. I hate WNR.

2008 May 29 01:55 PM

[BrotherMaynard:]

Excellent stuff...and just to add, i did something similar to this. If you look at the correlation between oil and these stocks during the 90's (i used the XOI for drillers...i did not do this w/refiners, though)...there's almost none! That leads me to believe the second derivative of correlation seems to be positively correlated w/oil as well (that my sound circular, but its not). In other words, stock picking ability is less beneficial now, as investors do not discriminate between biz models.

2008 May 29 03:41 PM

[jwaydog:]

With regard to the refiners, we know the crack spread has not been favorable. Additionally (however often overlooked) the operating cost per barrel has risen significantly. For example Valero's 1st quarter operating cost per barrel was $4.69 as compared to $3.93 for year 2007 and $3.53 for 2006. I want to own the refiners but cannot bring myself to reenter.

2008 May 30 10:32 AM

[legmaker:]

Great job on the article, not only useful, but explains a great way to short oil without owning the commodity through the use of refiners. Thank you.

2008 May 31 09:28 AM