Oil, Energy Stocks Back in Their Sweet Spot

After a record-breaking rally between 2003 and 2007, followed by a disastrous 2008, crude oil prices appear to have finally settled down in a comfortable middle ground around $70 per barrel. That’s good news for oil companies. Why? Though they can generate income with oil at any price, their stocks tend to thrive when crude’s stable… simply because investors know what to expect.

Of course, a strong performance in the foreseeable future from the energy sector will largely depend on staving off wild price swings in the future. All the ingredients that drive crude’s price, however, do indeed seem to be tamed. Those ingredients are consistent demand, a stable U.S. dollar, and tempered inflation.

The demand part of the equation is a function of the average consumer’s ability to spend. Are they paying for gas to take trips to the mall, take vacations, etc.? The answer is yes. Over the past four weeks, gasoline usage in the U.S. averaged 9.2 million barrels a day, up 3.5% from the same period a year ago. Not too hot, not too cold - and the fears of further economic hardships are dwindling.

A stable greenback is also necessary for stable oil prices, since oil is priced in U.S. dollars. The dollar’s value, however, reflects U.S interest rates. Interest rates are already rock bottom though, so they can’t go lower. Raising rates, however, may quell the fragile economic recovery. So, interest rates aren’t apt to budge anytime soon either.

The wild card in the equation is inflation - if inflation swells, so too would crude oil prices. Though it’s the biggest threat to oil companies at this point, none of the aggressive predictions of inflation have materialized yet. Perhaps it’s not as big of a liability as first assumed.

However, the most encouraging factoid may simply be how nearly all the major oil companies are starting to invest in new wells and drilling projects. Chevron, ExxonMobil, and BP have all tapped new sites recently. In fact, BP’s total oil production was up 4% last quarter.