Coping with the downturn

THE 19-MONTH downturn in oil will go on record as one of the worst slumps the industry has ever faced, even rivaling the iconic price collapse of 1986. Looking back at the past year-and-a-half, it's easy to see why oil never really had a chance to maintain its robust triple-digit value it had enjoyed for the better part of four years. Waning international demand, peak OPEC production, a US shale boom, and a slowing Chinese economy created the perfect recipe for an oil crash.

At its lowest point in January 2015, NYMEX crude was down 75% from its June 2014 peak.

The reason investors may expect continued weakness in the price of oil boils down to one very crucial detail: supply is unlikely to drop any time soon now that OPEC has essentially waged a price war against global producers in an effort to maintain market share.

So while demand will rise and spending on new oil projects will fall, stock prices will remain low, and a persistent drop in global supplies is unlikely to transpire any time soon. In fact, the International Energy Agency (IEA), as reported by Bloomberg, recently announced that the global oil surplus will likely increase in 2016 despite a noticeable reduction in output among non-OPEC producers. The Paris-based organization believes that the oil surplus will average 1.75 million barrels per day in the first half of 2016, higher than an earlier estimate of 1.5 million. As one could imagine, this will likely only depress oil prices further in the short run.

Nation-states tied to oil exports have been hit especially hard by the oil price collapse. For example, Canada entered into a mild recession in 2015, while Russia fell deeper into contraction. Both are major energy producers. Even oil-rich Saudi Arabia, which relies on petroleum for 80% of budget revenues and 90% of export earnings, according to Forbes, posted a record deficit last year.

Oil-producing companies themselves have also come under fire. British oil giant BP recently reported its worst-ever annual loss. Royal Dutch Shell also registered staggering losses just days after acquiring BG Group Plc. Even in a cyclical industry such as energy, the nearly two-year rout in oil prices has been extremely costly.

To cope with the volatility, companies have scaled back capital investment plans, laid off tens of thousands from their global workforce, and sought strategic takeovers to increase proven reserves.

For investors, exposure to this industry has not been wise. The S&P 500's energy component is down 30% year-over-year and shows no signs of slowing down. Through the first six weeks of 2016, American energy shares are down more than 8%.

Savvy investors realize that with oil plumbing 13-year lows, energy stocks are probably undervalued right now. Still, they may not be willing to enter a market with so much uncertainty, especially with renewables being the current zeitgeist.

If you're thinking about entering into energy stocks at a time like this, your best bet is to go the technology route. Think of electricity as the main driver of innovation in the energy sector and consider researching companies that are increasing efficiency at a reduced cost. Try to be forward-looking without forgetting that the world still relies heavily on fossil fuels and that this dependence is unlikely to waver any time soon.

So while it might be enticing to completely diversify away from traditional forms of energy, this doesn't cohere with current market realities.

Nikolas Xenofontos is head of risk at easyMarkets.