Why Oil Price Weakness Is Not Really a Big Deal Anymore

The big story in June was crude oil price weakness and its limited impact on equities markets. As at July 3, 2017 Brent Crude Oil was trading at $48.98 per barrel, and WTI Crude Oil was trading at $46.33 per barrel. The 52-week range of Brent Crude Oil is $44.35 on the low end and $60.21 on the high end. With WTI Crude Oil, the 52-week trading range is $42.05 on the low end and $58.30 on the high end. The correlation between crude oil prices and Wall Street indices is an important one. Until around August 2016, the relationship between crude oil and indices was ironclad.

The positive correlation was evident in rising oil prices and rising indices levels. As oil prices weakened, so indices retreated accordingly. The fate of oil-producing economies also hinges on oil prices and that’s precisely why countries like Saudi Arabia, Qatar, Kuwait and Nigeria are feeling the pinch with historically low prices. Government coffers are being stretched to provide for basic services, and austerity measures are being implemented in these countries to make up for the shortfall in oil revenues.

Recent Trends with Crude Oil Prices

The election of Donald J. Trump to the highest office has been met with widespread optimism from the financial markets. This despite growing weakness in oil markets. OPEC has held multiple pow-wows to try and shore up oil prices by cutting production. Even Russia has signed on to OPECs proposals. However, increasing WTI Crude Oil production and high inventory levels of oil and petroleum products are making it difficult for markets to clear.

WTI Crude production has helped to boost the number of rigs in operation to new highs, according to the latest Baker Hughes reports. As at 23 June, the latest rig count in the US is 941, up 8 rigs since June 18. This represents an increase of 520 from the same period a year ago. As the number of US oil rigs increases, so too does production. This has a negative effect on oil prices and the profitability of energy companies like Shell, Exxon Mobil, Texaco and British Petroleum.

Decreasing Importance of Energy Companies on the S&P 500 Index

The impact of cheap fuel on the US economy is less obvious. While cheap oil is beneficial to motorists and households (in the form of savings on fuel) it also has a negative impact on inflation by preventing the US economy from reaching its 2% objective. The price of energy company stocks are also hindered by weakness in oil prices and this prevents further exploration and expansion. Fortunately, US oil producers are exceptionally efficient and provided prices remain above $40 they are profitable.

In June however, the price fluctuations in Crude Oil had a muted effect on US bourses. This represents a shift in market behaviour. In fact, the correlation has been near-zero in June, and well beneath the 5-year high levels last year. Falling Crude Oil prices have already negatively impacted the major energy companies in such a big way that their market capitalization has been eroded away to levels that cannot swing Wall Street bourses as much anymore. The efficiency of US oil producers means that break-even price points are much lower – this is another positive for US energy companies.