The energy arena has been anything but boring, and revisiting bombastic statements from the past has been a hallmark of the oil market for decades.

“Even taking into account the discovery of new fields in frontier areas…sometime between 2010 and 2020 the gush of oil from wells around the world will peak…then begin a steady, inevitable decline” The International Energy Agency as reported by Science Magazine—August 21, 1998. (Wall Street Journal)

The International Energy Agency warned the world could “drown in oversupply” of oil in 2016. Reuters

While entertaining at times, digging through all the noise can be difficult and can make investment decisions tough to frame. In fact, more patience and discipline may be required with the energy sector than any other—sentiment tends to play a large role in short-term performance of the group.

Given that backdrop, what’s going on with the group now? Are crude oil prices at or near a bottom? To answer the latter, timing a bottom for something as volatile as oil is next to impossible. Sentiment can drive prices lower than may be justified by the fundamentals. What we will say is that the basic law of economics—supply and demand—seems to be taking hold. Demand is actually rising as crude prices fall. In fact, according to the U.S. Energy Information Agency (EIA), global liquid fuel consumption (including crude oil and natural gas liquid) gained an average of 1.5% over the previous 12 months. Meanwhile, U.S. drivers are on pace to make 2015 the most heavily traveled year in history, according to the U.S. Department of Transportation. Also, despite the stories of a dramatic slowdown in China, the country’s oil imports increased 9.3% year-over-year in December 2015.

However, we are seeing the more dramatic response in the supply market, especially in the non-OPEC regions of the world.

According to the EIA, non-OPEC oil production fell precipitously in the fourth quarter of 2015, moving close to a -2% annualized rate and continuing to fall. Specifically in the U.S., the EIA estimates that the 9.4 million barrels per day (MBD) produced in 2015 will fall to 8.7 MBD in 2016. And with the decrease in U.S. rig count, it seems supplies will continue to wane.

Supply and demand is asserting itself in the oil patch

Going forward, we are likely to see more bankruptcies in the energy space, which will take some supply off the market. Investment in Canada’s oil and gas industry is expected to be 13% less in 2016 compared with 2015.3 While the reduced sanctions on Iran will put more oil onto the market, there are still major infrastructure issues in Iran that will limit the amount of oil it can pump. Rumors that OPEC could limit production also exist. Also, Iraq’s oil minister recently stated he was seeing more flexibility from Russia and Saudi Arabia with regard to potential production cuts. And in fact, Russian President Vladimir Putin has said Russia’s 2016 budget was calculated with an assumed $50/barrel oil price.

So what does all this mean for investors? To us, it means that investors who are underweight to the energy sector should start to add to positions to bring their portfolios up to market weight. Interestingly enough, the weight of the energy sector within the S&P 500® Index has fallen to near its lowest level in at least the past 40 years. This leads us to believe there may not be more downside to go, and an oil price reversion could mean upside potential for those investors who are patient.

Mean reversion could boost energy shares

There are still substantial risks in the group, however. Investors that go the individual stock route should be diligent, as there likely will be bankruptcies within the group. In short, the bumpy ride will continue, and we don’t expect a sustained sharp move back to previous highs. However, given the long-term view, investors willing to hang on in the near term should benefit within the next year or two.

Schwab Sector Views: Our current outlook

What is Schwab Sector Views?

Schwab Sector Views is our three- to six-month outlook for 10 stock market sectors, which are based on the 10 broad sectors of the economy.

The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:

Outperform: Likely to perform better than the rest of the market.
Underperform: Likely to perform worse than the rest of the market.
Marketperform: Likely to track the broad market.
How should I use Schwab Sector Views?

Investors should generally be well-diversified across all stock market sectors. You can use the Standard & Poor's 500 allocations to each sector, listed in the chart above, as a guideline.

Investors who want to make tactical shifts in their portfolio can use Schwab Sector Views' outperform, underperform and marketperform ratings as a resource. These ratings can be helpful in evaluating and monitoring the domestic equity portion of your portfolio.

Schwab Sector Views can also be useful in identifying stocks by sector for potential purchase or sale. When it's time to make adjustments, Schwab clients can use the Stock Screener or Mutual Fund Screener to help identify buy or sell candidates in particular sectors. Schwab Equity Ratings also can provide an objective and powerful approach for helping you select and monitor stocks.