Energy Trading – Background

There is so much attention on oil prices that it seems like CNBC has become the Energy Channel.  It is not surprising.  The energy "sector" is up over 20% on the year and also accounts for the largest segment of earnings growth.  The S&P uses the term "sector" as it is defined in Morgan Stanley Capital International’s Global Industry Classification Standard (GICS).

Many — perhaps most — of those in the parade of talking heads on CNBC, and online pundits as well, talk about energy in this same broad fashion.  Everyone wants to act informed, including those who paid little attention to energy stocks before this year.  The result is that nearly everyone says things like "You have to own energy," or "We like the energy names," or "We have been doing well in energy."

Our own sector definitions are much narrower, more like the sub-industries in the GICS system.  For trading purposes these definitions are much sharper.  Here’s why.

The broad energy sector as defined in the GICS system includes a wide range of companies including the following:

  • Companies that own oil reserves
  • Companies that explore for oil
  • Companies that build exploration equipment
  • Natural gas and pipeline companies
  • Refiners – who buy oil from others and sell a finished product
  • Shippers – who transport either crude or refined products
  • Large integrated oil companies who do most or all of these things

The S&P 500 includes 28 companies covering the gamut listed above.

These companies do not all benefit in the same way from changes in oil prices.  Those that have large reserves will benefit from higher long-term prices when they sell the reserves.  More important for stock valuation is the impact on earnings.  A spike in prices may be good for the integrated companies, but have no real implications for the drillers or oil services companies.

More later..

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