CORRELATIONS BETWEEN ENERGY STOCKS AND CRUDE OIL

CORRELATIONS BETWEEN ENERGY STOCKS AND CRUDE OIL

Year 2014 and 2015 were definitely depressing for investors and energy investor got bigger shock due to latest oil prices drop. Crude oil prices are down nearly 35% from 2014 and 145% from 2013 till Dec 2015. Crude oil prices starts dropping in July 2014 and found bottom in Mar 2015. It again broke low in Aug 15 and falling continuously and nobody really knows where oil prices are headed in 2016.

There are correlations between energy prices and equity markets that should factor into your 2016 investment decisions. The seven year Correlation Coefficient between Nifty and Crude Oil is 0.11 on monthly closing that reflects slightly positive correlation. In general, anything above .50 shows a strong positive correlation.

Above mentioned chart clearly indicates slight positive relationship between crude oil and nifty. Recent drop in crude oil starts from July 2014 but nifty starts falling from Jan 2015. Since Jan 2014 Crude Oil and Nifty dropped more than 32% and 14% respectively.

Oil stocks and oil prices are positively correlated most of the time and also negatively to some stocks. The degree of correlation is likely to vary over time. Market technicians know that equities lead the underlying commodity. This is partly because equities (or stocks) are widely held whereas commodities tend to be tightly traded. Just as falling gold stocks foreshadowed falling gold prices, high energy stock prices might be signaling a breakout in the price of crude. Here we tried to find some correlation between Crude Oil and Indian Energy Stocks.

Positive and Negative Correlation of oil stocks with crude oil

SCRIPT	CORRELATION COEFFICIENT	BETA
Cairn	0.75	0.42
ONGC	0.39	0.19
Hind Petro	0.21	0.44
GAIL	0.12	0.05
Tata Power	-0.01	0.15
Reliance	-0.08	0.17
BPCL	-0.14	-0.24
Power Grid	-0.16	0.00
IOC	-0.34	-0.04
NTPC	-0.39	-0.02

            (Calculated from period between Oct 2007 to Jan 2016 on monthly closing)

Positively Correlated Stocks with Crude Oil:

Positive correlation indicates that two securities move in the same direction, up or down. Higher the degree of correlation means higher possibilities to move in same direction. For example, Cairn India has strong positive correlation with crude oil along with ONGC, Hind Petro and GAIL. 

Cairn India has higher positive correlation with crude oil but lower beta as compared to Hind Petro which has less positive correlation with crude oil but has higher beta. There is very slight difference between beta of Cairn India and Hind Petro as beta of both securities are 0.42 and 0.44 respectively which is almost same but correlation coefficient of both securities 0.75 and 0.21 has big difference. It indicates that Hind Petro shows less movement with crude oil compared to Cairn India but carry same level of volatility.

According to above discussed relationship hind petro can be a choice for higher short term return and Cairn India for the longer term.

Negatively Correlated Stocks with Crude Oil:

Negative correlation (0 to -1) indicates that two securities move in opposite direction, up and down. It is very important to know that when crude oil prices are in the trend of falling, negatively correlated and negative beta stocks’ investment will provide a hedge because theses stocks’ will increase in value. Some oil Negatively Correlated Stocks are NTPC and IOC (-0.39&-0.34) has stronger negative correlation with crude oil as compared to other oil stocks such as Reliance, BPCL and power grid.

NTPC and IOC are negatively correlated with the Crude Oil and correlation coefficients of both securities are highest among other negatively correlated oil securities. Both securities have almost same correlation coefficient (-0.39 & -0.34) and beta (-0.02 & -0.04) which means that both securities shows opposite movement with the crude oil but did not show volatility in prices because beta of both securities are negative but almost equal to the zero.

Apart from NTPC and IOC there is also a security BPCL which is less correlated with the crude oil but has higher negative beta. BPCL has correlation coefficient of -0.14 and beta of -0.24 which indicates that BPCL moved opposite to crude oil and shows higher volatility as compared to other oil stocks.

According to above discussed relationship BPCL can be smart choice for the investment when crude oil is trend of falling.

Relationship between Cairn India and BPCL

Cairn India and BPCL are two oil securities which have higher correlation (positive and negative respectively) with crude oil and also have higher beta (positive and negative respectively) which shows some volatility as well. Positive correlation of Cairn India and Negative correlation of BPCL provide hedging opportunity for long term and short term investors.

CAIRN INDIA			BPCL
YEAR	PRICE	% RETURN	YEAR	PRICE	% RETURN
Jan-12	337.15		Jan-12	289.85
Jan-13	323.35	-4.09%	Jan-13	410.05	29%
Jan-14	326.45	0.96%	Jan-14	363.9	-13%
Jan-15	234.35	-28.21%	Jan-15	750.4	52%
Jan-16	113.05	-51.76%	Jan-16	884.95	15%
SINCE 2012	-66.47%		SINCE 2012	205%

Recent drop in price of crude oil has been started since Aug 2013 when crude oil price were on it peak and BPCL also started rally from the same month. Crude oil price fell more than 70% since Aug 2013 to Jan 2016 and Price of Cairn India fell by 65% but BPCL rose 236% at the same time. So price rise in BPCL was faster than falling prices in cairn India Crude Oil.

So we can say that there is possibility of risk diversification within oil stocks, when we include negatively correlated stocks in our portfolio. Cairn India and BPCL are two stocks which are negatively correlated and can give positive return in falling market of crude oil.