Oil Prices And Oil Stock Prices

I see in the commodities markets that the price of oil has gotten into the mid 50s, after spending years it seems in the 40-50 Dollar range. Prices always fluctuate, but this uptick at least bears watching.

As with many resources, oil exploration and development takes years, so once the decision is made, the cost to produce oil from any particular well or oil field are known. Yes, costs also fluctuate for oil production, but in a very narrow band. So, what happens when prices fluctuate is that it is magnified when the bottom line is calculated.

Take a well for which the all-in costs are around $40 a barrel. If the price is $50 a barrel, then the company earns $10 profit per barrel. If the price goes up to $55 a barrel (as $WTIC is today), then this 10% rise in price has produced a 50% jump in profit. That’s some leverage. Since stock prices fundamentally are tied to profit, then oil stock prices also are leveraged to the price of oil. Today, compared to the price of oil, the price of the oil stocks is around as low as it’s been over the last 5 years.

If the $55 price of oil continues, then as oil companies start reporting earnings over the next few quarters, profits likely will be nicely higher than in previous quarters / years, and this should cause an oil stock rise. There is no way to tell if the $55 price will continue, but there also is no way to know whether the price may continue up to around $60, generating even higher profits and oil stock prices.

As I said, it bears watching.

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