What are we looking at?
Large cap Canadian oil stocks and domestic oil services companies are much more sensitive to United States oil prices than West Canada Select crude. Investors should not look for the relative strength in domestic oil prices to support their equity holdings in the oil patch's biggest firms.
The trend
The two accompanying charts compare the performance of the S&P/TSX Energy Index with both the Canadian and West Texas Intermediate (WTI) crude commodity price. Correlation analysis (not shown) confirms what the naked eye sees – the relationship between Canadian oil stocks and the U.S. commodity price is far closer than with domestic oil prices.
In terms of individual equities, oil services companies and oil-producing large caps have been the most sensitive to changes in the WTI crude price in the past 36 months. According to Bloomberg data, Canyon Services Group Inc. and Precision Drilling Corp. are the two stocks with the highest correlation to the U.S. oil price. Calfrac Well Services Ltd. and Trinidad Drilling Ltd. are not far behind.
Similarly, the stock prices for Canadian Natural Resources Ltd., Imperial Oil Ltd., Suncor Energy Inc. and Canadian Oil Sands Ltd. have also closely tracked U.S. oil prices.
Conclusion
To be sure, the WTI commodity price is not the only major factor behind domestic energy stock performance. Production increases, for example, can help insulate stocks such as MEG Energy Corp. from the worst effects of the falling commodity price. Andrew Leach, University of Alberta economics professor, also writes in Maclean's magazine that production costs in the oil sands are falling because such non-energy inputs as diluents for bitumen transport have become cheaper.
In general, however, a recovery in domestic energy stocks – particularly large caps and services companies – is dependent on stronger WTI prices. And, since there are no signs of a slowdown in either of the two factors pushing the crude price lower – surging U.S. oil production or the rapidly rising U.S. dollar – Canadian investors that are overweight in the domestic energy sector should reduce their holdings.
Scott Barlow writes for Inside the Market, which offers up-to-the-minute analysis of stock trends and market-moving news throughout the trading day. Subscribe to Globe Unlimited at globeandmail.com/globeunlimited