ENERGY stocks and energy-related bonds have had a rough ride over the past year after outperforming considerably over the last decade.

The reason for the decline is simple: the plunge in oil prices from over US$100 a barrel to just above US$40 currently. In fact, WTI crude which was at a level of US$95.83 in June 2014 is currently trading at US$45 a barrel for 53 per cent drop, while Brent crude which traded as high as US$107.75 in June 2014 fell 55 per cent to be trading around the US$48.00 level.

The slide began due to significantly increased supply of US oil production, as hydraulic fracturing was able to retrieve oil from previously difficult-to-get-at locations, as a result of improved drilling technology. The combination of high oil prices and low interest rates, emanating from Central Bank accommodative monetary policies, made such projects economically viable.

Consequently, US oil production increased 80 per cent from 2008 through 2014, according to one estimate. Crude oil inventories in storage at Cushing, Oklahoma, the largest storage hub in the US, increased from 20 million barrels in the middle of last year to just below 60 million presently.

In addition on the demand side, slower growth in demand from China played a significant role in declining prices.

Finally, there was quite a bit of feeling that the high price of oil merely reflected trading and speculation, and that the whole situation was a house of cards that would fall apart at some point as fundamentals declined. In this case, the catalyst was OPEC failing to reach an agreement in production cuts last November.

So what’s next for oil? While it’s difficult to predict the timing, a recovery in oil prices should begin as supply and demand come back into balance.

Oil demand tends to go up over time. According to economic estimates posted by an analyst, global demand for oil increased from 75.9 million barrels per day in 2000 to 92.6 million barrels per day in 2014. Additionally, according to the International Energy Association (IEA), further increases are expected to 94.2 million in 2015 and 95.6 million in 2016. The analyst also stated that although oil demand is widely regarded as cyclical, it’s worth noting that in the recession year of 2009, global demand fell to just 84.9 million from 86.2 million in 2008, then quickly recovered to 88.3 million in 2010.

On the supply side, US drilling activity is slowing, with the Baker-Hughes rig count currently at 877 (down from 1,914 a year ago), the analyst further stated. There will be a lag effect to reduce supply, as the remaining wells still being drilled are very efficient.

In addition, given the high fixed cost in oil drilling, once a well is operating at peak capacity, it is very profitable even at lower commodity prices. However, with the lack of new wells being drilled, supply will fall at some point, and given the steady rise in demand, equilibrium will eventually be reached. Supply would then tighten and prices should rise.

The analyst concluded with the view that oil prices were close to the bottom. I tend to agree, although we have had a few supposed floors already, so the exact timing of a rally is difficult to forecast. The analyst added that given the difference fracking has made in increasing available supply to the United States, we will not see US$100 a barrel for a long time — perhaps never again as we begin a slow but likely definite transition to cleaner fuels.

As we see a more definitive bottom reached in this sector, look out for more lucrative buying opportunities to emerge in once again beaten-down energy assets, similar to those presented in the first half of this year.

Eugene Stanley is Vice-President – Fixed Income and Foreign Exchange Trading at Sterling Asset Management. Sterling provides medium to long-term financial advice and investments in U.S. and other world market currencies to the corporate, individual and institutional investor. Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm. You may visit us on Facebook or follow us on Twitter and for more information please visit our website www.sterling.com.jm