Looking at the shares of Suncor Energy Inc. (TSX: SU)(NYSE: SU), it’s easy to see why there was an increase in value over the past few weeks. Since September, shares have risen from approximately $34 per share to their current price of approximately $43.
When looking at the history of the company’s share price in relation to the price of oil, it is very clear there is a strong correlation. When oil increases in value, it is typically in tandem with an increase in price in the shares of the company. The same is true on the downside.
When looking at the price of oil in comparison to the share price, the price of oil is much more volatile. As a vertically integrated company present in all phases of the oil-production process, it is normal to see less volatility in the day-to-day movements of the share price of Suncor Energy Inc. than in the commodity itself.
Why the lag?
In late 2014, we saw a steep selloff in oil and a clear decline in price. Although it was almost two years ago, we have really only seen oil trade sideways since then. As oil is a commodity, it makes perfect sense to look at the pure supply and demand of the situation and ask why it takes so long to balance.
One of the reasons the supply/demand equation takes a long time to balance is because of the hedging relationship between the buyers and sellers of oil.
As a buyer of oil, it makes perfect sense to lock in the costs for a period of up to two years in the hopes of being able to plan out your costs and budget accordingly. The buyers of oil want to enter into a future of forward contracts in order to lock in their costs.
The seller will want to ensure an adequate amount of revenue to cover the costs of their new oil projects. The suppliers will often sell their production before even breaking ground in order to secure the cash flows. It makes perfect sense to take the risk off the table.
The result is a willing buyer and a willing seller entering into a contract for future production of oil for a given time frame, often within a two-year time frame. In certain instances, however, it can be for a longer time period, but most contracts are for a period of two years or less.
Looking again at the situation, we know it has been approximately two years since the major pullback in oil prices at the end of 2014.
Conclusion
As we move into 2017, the oil market should become much more exciting, but as with any other product, if the selling price is high enough to justify restarting production, we will see a gradual increase in supply no matter what the OPEC understanding is. The oil industry is simply too fragmented to monitor everyone. The result may lead to many disappointed investors.
