During the past week, several economic factors worked in unison to push crude oil prices to an all-time high. The European Central Bank suggested that it might raise interest rates in response to inflation concerns in the European Union. This announcement pushed the euro up against the dollar and gave oil prices a boost as investors looked to hedge the falling dollar with an investment in a hard asset. The oil market got a further boost when Israel's transportation minister made less than flattering remarks about Iran. Iran is the second largest oil producer in OPEC and any supply disruptions from Iran would surely jolt the global oil market (a market in which oil production has been hardly growing over the past few years).
On top of this, emerging economies like China and India are still increasing their consumption of oil. Couple these developments in the oil market with the current economic situation in the United States (low interest rates, sluggish economic growth, rising inflation and rising unemployment) and it is not hard to see why oil is seen by many as the choice investment.
But are rising oil prices good for oil company stock prices? Normally, the answer to this question is yes, but, given the current economic situation, the answer is not so clear.
In order to get a better understanding of the current sensitivity of oil company stock prices to changes in oil prices, I collected daily closing data from January 2, 2008 to the present on two well known oil ETFs (the iShares Dow Jones US Energy (NYSEARCA:IYE), and the Energy Select SPDR (NYSEARCA:XLE)), the S&P 500, and the nearest contract on the NYMEX crude oil futures contract. For the year 2008 to date, IYE is up 7.35%, XLE is up 8.17%, and crude oil is up 32.9%.
I used a multiple regression model to separate out the effects of oil prices and general stock market movements on oil stock prices. So far this year, a one percent increase in the returns to the S&P 500 increased returns on IYE by 0.90% while a one percent increase in crude oil futures price returns increased returns on IYE by 0.47%.
In comparison, a one percent increase in the returns to the S&P 500 increased returns on XLE by 1.04% while a one percent increase in crude oil futures price returns increased returns on XLE by 0.53%. These results are useful in showing that oil ETFs have similar sensitivities to changes in oil prices (approximately half a percent increase in stock returns for each one percent increase in oil price returns) but that their market sensitivities are different.
XLE is much more sensitive to changes in the broad based stock market than is IYE. IYE and XLE are both more sensitive to movements in the stock market than movements in oil prices.
The current U.S. situation of low interest rates make fixed income investments look less attractive, especially since some of these investments are currently earning negative real returns. Sluggish economic growth, rising inflation and rising unemployment are not the signs that a strong stock market wants to see. In the long term, oil company stocks should do well, but in the short term, market corrections are likely to weigh heavier on oil stock prices than movements in oil prices.
Disclosure: Author is long IYE