Which Stocks Follow Oil Prices? Can XLE Grow Regardless of Crude Oil Prices?
Trading and Investing
An Overview of Recent Activities
In the Energy Annual Outlook 2022 (AEO2022), the U.S. Energy Information Administration (EIA short) addressed that “short-term oil price is subject to heightened uncertainty resulting from a variety of factors such as sanctions on Russia, production decision of OPEC+, etc.” Meanwhile, in Mid-June, they made the price forecast for the third quarter of 2022 will be an average of $4.05 for regular gasoline and $4.73 for diesel. However, according to the latest published August Short-Term Energy Outlook, EIA adjusted the target to be $4.29 in gasoline and $5.02 in diesel. The forecasted price increase in just one and a half months was caused mainly by the “uncertainty” mentioned earlier.
What Caused the Energy Sector to Soar Again?
In earlier August, the Saudi-led Organization of Petroleum Exporting Countries and a coalition of producers led by Russia (OPEC+) agreed to increase production smaller-than-expected. The energy minister of Saudi Arabia and other OPEC officials said: “OPEC+ has the commitment, the flexibility, and the means to deal with such challenges and provide guidance including cutting production at any time and in different forms….”
On August 12nd, Jeff Currie, an analyst at Goldman Sachs, agreed that commodity markets were behaving irrationally and warned of “unsustainable prices.”
On August 24, Saudi Prince Abdelaziz bin Salman said Saudi Arabia is considering cuts to OPEC+ productions, and the suggestions drove Brent crude oil by nearly 4%. The effects last until now.
An Alternative Way: Could XLE be profitable regardless of Crude Oil Price?
The previous two sections are not aimed at making investment suggestions in XLE but to display the high volatility of the energy sector. The price, again, is determined by many factors, such as the negotiation of OPEC+. However, one might think: Can investors still profit from the high volatility regardless of Oil price changes?
The intuition would be that XLE consists of 90.7% oil, gas & consumption fuels, while the other 9.3% are energy equipment & service, as shown below.
Furthermore, the EIA shows that roughly 30% of the price is related to marketing, refining, and profit. So, could investors benefit from the growth of companies’ services, excluding the influence of oil price changes?
We first obtained crude oil (denoted by WTI Crude) and XLE daily price from Yahoo Finance and then read it into Python to preprocess. By plotting the two prices, we have the following charts:
The two prices tend to move together to a greater extent. By examining the correlation, we got a 0.93002491 correlation coefficient.
To exclude the effect of oil price, for example, in practice, one might want to go long for XLE and short crude oil. In this way, the underlying spread of two assets can generate a profit. Therefore, we calculated the difference in prices and the daily percentage change of contrast.
The third column exhibited the difference in price between XLE and crude oil, while the last column calculated the percentage change between adjacent rows. The sum of the last column gives an approximate return of our strategy. That is, by simply holding two equal amounts but opposite positions in one year, the profit is about 0.557% with an average of 0.00227% daily. The mean also passed the t-test. It’s better than nothing but certainly not satisfying to most investors.
We then plotted the last column as follows, which is the first difference from the third column. By plotting the auto-correlation plot of the third column, we observed auto-correlation decreasing with time. The plot of percentage change, or the first difference of the price difference, looks stationary. Next, we try to determine if applying time series could lead to an improvement.
Before constructing the time-series model, we first applied the Augmented Dickey-Fuller Test for the existing unit root, which might lead to spurious regression. Luckily, we passed the ADF test with a p-value of -15.35, less than 0.05. It means we rejected the null hypothesis of the existence of a unit root.
The next step is to test if the data is white noise. To achieve this, we look at the autocorrelation plot and partial autocorrelation plot below:
No matter for ACF or PACF, we cannot decide the parameters of the ARMA model since all the points lie inside the blue area. To further prove this, we employed the Ljung-Box test. The test makes the null hypothesis of the original data (the percentage change in our case) white noise. We have the following results by printing the lags for up to 24 days.
The results show that all P-values (last column) are greater than 0.05 to a great extent.
Thus, we cannot reject the null. The percentage change is a white noise process. It also means the model construction could stop here since the time-series model cannot handle the spread very well.
To wrap up, we showed the volatile characteristics of the energy sector from several perspectives, including the annual outlook published by EIA and opinions from professionals. Then, we tried to construct a two-asset portfolio by holding two opposite directions of assets: long XLE and short crude oil futures, aiming to exclude the influence of oil price fluctuations. However, although the profit is predicted to be positive, the returns are barely satisfying. We next tried to build a time-series model on the percentage changes.
However, our test statistics showed that the percentage changes are white noise. It terminates the model construction since no further information could be possibly extracted from a white noise process. A possible improvement could be looking at data with higher frequency. The spread might be larger in those datasets. Moreover, no matter in the short run or even in the long run, the uncertain geopolitical conflicts will continue to drive and further impact the energy sectors. It’s worth it for investors to stay focused on and analyze this market.
Written By Yu Zhang
Works Cited : Which Stocks Follow Oil Prices? Can XLE Grow Regardless of Crude Oil Prices?
EIA, Short-Term Energy Outlook, https://www.eia.gov/outlooks/steo/pdf/steo_full.pdf,
published August 4.
Saudis, Allies Open Door to Oil-Output Cut to Keep Prices High, WSJ,
https://www.wsj.com/articles/saudis-allies-open-door-to-oil-output-cut-to-keep-prices-high-11661268794?mod=article_inline, August 23, 2022.
Goldman Says Commodity Prices Are ‘Irrational’ –After Slicing Oil Forecast,
https://www.wsj.com/livecoverage/stock-market-news-today-08-12-2022/card/goldman-says-commodity-prices-are-irrational–jq5oHmn6FSrUrlNGmKZD?mod=article_inline, August 12, 2022.
Big Oil’s Message to Investors: You’re Too Pessimistic,
The Energy Select Sector SPDR Fund, https://www.ssga.com/us/en/intermediary/etfs/resources/doc-viewer#xle&annual-report
Which Stocks Follow Oil Prices? Can XLE Grow Regardless of Crude Oil Prices?
