Even if you only pay cursory attention to the news, you are likely aware of the geopolitical conflict unfolding in the Middle East. Given the region’s importance to the energy sector, it shouldn’t be surprising that oil prices have become very volatile, rising and falling in dramatic fashion. If oil prices stick at or around $100 per barrel, there’s a strong likelihood that energy producers are big winners.
The energy sector’s winners and losers
There are three segments in the energy sector: the upstream, the midstream, and the downstream. The upstream is where oil and natural gas are produced. The midstream essentially moves oil and natural gas around the world. The downstream sector is filled with chemical companies and refineries that transform oil and natural gas into usable products like gasoline. Each segment reacts differently to rising oil prices.
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The midstream is largely fee-driven, so oil prices aren’t all that important. The volume of energy flowing through a company’s portfolio of infrastructure assets is the key driver of financial performance. Performance in the downstream is generally hampered by high oil prices because oil is a key input and thus a key cost of doing business.
The segment that benefits is the upstream, with pure-play energy producers like Devon Energy (DVN +2.81%) likely to see the biggest upside. However, even integrated giants like ExxonMobil (XOM +2.18%) and Chevron (CVX +2.06%), which are vertically integrated across the industry, will see earnings improve, though to a lesser degree, thanks to high oil prices.
What goes up also comes back down
As the chart above shows, Devon Energy’s stock price performance more closely tracks energy price swings than Exxon’s, which is larger and more diversified. So if oil prices rise and linger at higher levels, Devon is likely to be a big winner because it can sell oil at higher prices, boosting its earnings. Investors are already anticipating that, but if energy prices remain elevated, the earnings benefit will be sustained even as geopolitical uncertainty makes investors more fearful in other areas of the market.
That’s not actually a shocking prediction. Here’s the prediction that really matters: When oil prices fall back down, as they always have historically, Exxon and Chevron will hold up better than a pure-play producer like Devon Energy. Tread carefully in the historically volatile energy sector, because high oil prices are great while they last, but they rarely do.