What Drives Oil and Gas Company Stock Prices?

Volatility in oil and gas company stocks has skyrocketed since the market crash in 2008, on the back of even more volatile oil and gas prices. Over the same period, concerns over the availability and negative environmental consequences of nonrenewable energy resources have compounded on the price volatility to elevate the opinions of critics of the oil and gas industry into a national discussion about the sustainability of the industry. As such, many states have passed policies that promote the use of alternative energy, including state Renewable Portfolio Standards (RPS), which require that a fraction of energy consumption must come from renewable energy sources, and the Production Tax Credit, a federal subsidy for wind farm production. The recent changes in our attitudes towards oil and gas companies raises the question of whether changes have introduced new risk to the value of these companies, such that it impacts the stock price of nonrenewable energy companies.

The study, “Risk Factors and Value at Risk in Public Traded Companies of the Nonrenewable Energy Sector,” analyzed daily observations from a sample of 64 oil and gas companies from July 15, 2003 to August 14, 2012 to determine the factors affecting equity returns for publicly traded nonrenewable energy companies, and the effect of these factors on value at risk (a technique to assess the level of financial risk of a specific portfolio over a defined period) for those companies.

Daily value at risk in the oil and gas sector increased significantly during the 2008 financial crisis, but notably, it has also remained larger in magnitude since then. The elevated value at risk implies an increase in the expected maximum loss in a given oil and gas portfolio over the same period of time, and is indicative of a drop in market confidence in the oil and gas sector. Interestingly, though, when policymakers moved to limit CO2 concentration to 450 parts per million in November 2012, value at risk increased for a given oil and gas portfolio. As such, energy and environmental policy initiatives increase value at risk in the oil and gas sector.

And yet, changing energy policy initiatives alone are not sufficient to account for the volatility in companies’ stock returns. Idiosyncratic factors (debt-to-equity and company size), as well as systematic risks (market oil prices, foreign exchange rates, and actual and expected stock market indexes) also affect the return to equity for oil and gas companies.

In particular perceptions about debt-to-equity relative to stock prices appeared to shift after the financial crisis. Debt-to-equity, a measure of financial leverage, was found to have an insignificant impact on stock value in the full model, indicating that firms in this sector are relatively credit insensitive in general. But specifically after the financial crisis, debt-to-equity became significantly correlated negatively with returns. This suggested that companies with more debt after the financial crisis potentially became more exposed to credit concerns than before, thus impacting stock values.

The results also showed that size, quantified as the value of total assets scaled by the market value of equity, also showed to negatively impact company returns.

More often, companies have studied the impact of oil prices on oil and gas company stock returns. The study looked at US WTI crude oil prices, showing that company stock prices are very robustly exposed to the price of oil, with higher oil prices strongly correlating with the firm’s net income as well as the stock value, for companies across the sector.

This study added to the conversation by shedding light on how markets price company risk to foreign exchange values in addition to the US price of crude oil. The study compared the effects of foreign currency rates relative to the US dollar on each company stock price. The foreign exchange effects uncovered suggested that markets are valuing cost more than revenues for companies in China and Brazil, while revenues are more valued than costs for British and Japanese companies. As such, Chinese yuan, and Brazilian real, and additionally, the Euro, affect company stock prices negatively. This indicates that when any of these currencies devalue relative to the US dollar, company return on equity increases. On the other hand, the Japanese yen and British pound have a positive impact on company returns, suggesting that when either of the currencies appreciates, company stock prices go up. The difference in the direction of correlation may be the fact that in the nonrenewable energy sector, Chinese and Brazilian companies tend to realize revenues in domestic currency and costs in foreign currency.

The researchers also observed more common risks remain: namely, that a higher excess return of Dow Jones’ component stocks increases oil and gas company returns on equity. And, the Vix, which gauges the market’s expectation of S&P 500 index’s volatility over the next 30-day period, negatively correlates with company returns. That is, company stock prices drop when investors expect a riskier future market.

In addition to changing energy policy initiatives, this research offers insight into the factors that major nonrenewable energy companies tackle at present. Since these factors have correlated with the value of the stock price over the past decade, it is a useful tool for policy analysts hoping to understand how to manage a transition to a renewable-based economy without shuttering the stability of the current energy economy.

Feature Photo: cc/(Reto Fetz)

yxie@uchicago.edu'
Yiren Xie
Yiren Xie is a staff writer for The Review and is an MPP student at the Harris School of Public Policy. She is interested in public finance and energy and environmental policy.

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