Perhaps the biggest surprise of 2014 was the sharp decline in oil prices. Black gold fell almost 60% from its summer peak of $107 to a low of $44 in January, before enjoying a nice bounce to a recent $53. The reverberations—good and bad—are being felt around the world, from the oil kingdoms of the Middle East to Argentina, Russia, and here in the U.S.
The downturn will be the first big test of the U.S. oil-production renaissance. New technologies, such as horizontal drilling and the ability to draw oil from shale rock, have enabled companies to extract more oil from new places faster than anyone expected. In fact, they have led to a 41% reduction in U.S. imports since 2007.

But with the benefits have come some negatives. Increased production, coupled with slower-than-expected growth in demand has led to today’s sharply lower oil price. What’s good news for consumers, however, can be problematic for producers. Only companies that can slash expenses and were wise enough not to take on too much debt during the boom times stand a chance of prospering today. 

Barron’s recently asked a group of industry pros to walk us through the intricacies of pricing oil—and predict where prices will be a year from now. They also identified which companies could survive these turbulent times, and might even come out ahead. 

John Dowd, who manages $4.7 billion for Fidelity, provides an optimistic view of oil prices—and energy stocks—a year out. His largest fund, the $2 billion Fidelity Select Energy (ticker: FSENX), has outpaced the competition in the past five years by almost four percentage points annually, rising 6.2% a year in that period. Just as important, the fund outperformed during the tough market of the past year, falling 7%, versus the competition’s 13% decline. 

Jerry Swank brings wisdom accumulated over more than 40 years in the industry. In 2001, he founded his research firm, Swank Capital, and later launched Cushing Asset Management, known as a pioneer in master-limited-partnership, or MLP, investing. Cushing had $4.3 billion under management last July, including the $2 billion MainStay Cushing MLP Premier fund (CSHAX), when the firm’s open-end funds were purchased by New York Life’s MainStay Investment arm. 

Shaun Hong of Jennison Associates is the most skeptical about oil’s price recovery. He has co-managed the Prudential Jennison Utility fund (PRUAX) since 2000, which has crushed its peers by rising, on average, nearly 10% a year. He took over the Prudential Jennison Equity Income fund (JDEZX) in 2007. Both funds have a higher-than-average allocation to energy stocks.

Gibson Cooper, a high-yield-bond portfolio manager and senior energy analyst at Western Asset Management, provides a fixed-income expert’s perspective on the oil patch. Bonds sold by energy companies account for about 15%of the high-yield market, among the largest share ever, due to the more than $50 billion of new debt these companies sold each year from 2012 through 2014. The new-issue pipeline has since slowed to a trickle, and many bond prices have dropped sharply, which could spell good opportunities for careful investors.

Barron’s: Why have oil prices dropped so precipitously since last summer?
John Dowd: Demand for oil had been increasing by one million barrels a day, on average, from 2010 through 2013. But that growth slowed to about 700,000 barrels a day in 2014. At the same time, non-OPEC supply accelerated by more than 1.5 million barrels a day. A classic supply-and-demand imbalance emerged.

Which non-OPEC countries are producing more?
Dowd: Primarily the U.S. During 2012 and 2013, the growth in U.S. shale-oil production was partially offset by declines in Iran and Libya. But in 2014, Libya actually increased production, creating an imbalance in supply. 

How much excess oil is there?
Jerry Swank: We are not talking about massive oversupply. The world consumes 92 million barrels a day, and there’s an oversupply of 1.5 million to two million barrels a day. The price drop shows how precarious the market is when just a slight supply imbalance causes crazily violent swings. The market is telling us that oil was way overpriced last summer. 

Why did demand slow?
Swank: Economic growth in Europe and Asia has been slower than expected, and the strong dollar made oil more expensive for countries to purchase. That was especially true in emerging markets, which drove much of the demand growth in recent years.

How will the market return to balance?
Shaun Hong: You really need demand to grow at a decent pace in order to get oil back up to a $60-ish level. A production decline would also accelerate a price recovery. 

What is demand growth expected to be this year?
Dowd: The International Energy Agency, a government-supported research group, is estimating demand growth in 2015 at 900,000 barrels a day. That would be in line with the average over the past 10 years.
Hong: Do you believe that forecast, given how much China’s economy has slowed?
Dowd: Yes. When oil prices decline, demand generally picks up. We are already seeing a change in consumer behavior.

It sounds like you don’t believe that forecast, Shaun.
Hong: I’m skeptical. The U.S. has seen a pickup in gasoline demand. But international demand may not increase as much as people expect. So maybe demand growth is closer to 800,000 barrels. This whole rebound may take a little bit longer—an extra quarter or two—to play out.

Why would growth in demand be slower than expectations?
Hong: Gasoline is the biggest source of demand for oil. Europe’s economy is weak, and its high gasoline taxes mean that gas prices won’t fall, on a percentage basis, as much as crude prices do. Likewise, China’s economy may not grow as fast as expected. And demand could be weaker than predicted in countries like Indonesia or India, which have recently reduced their fuel subsidies because they can’t afford the cost. 

Beyond excess supply, what else caused oil prices to tumble?
Gibson Cooper: The real straw that broke the camel’s back was when Saudi Arabia discounted the price of its own crude in October; then other OPEC members also discounted. Around Thanksgiving, the market thought OPEC would cut production by 500,000 barrels to support the price of oil. But it didn’t, and oil prices fell further. 

Why do you think Saudi Arabia and OPEC allowed the price of oil to fall? Lower oil prices hurt their revenues and budgets.
Cooper: Some people think there’s a benefit to bringing prices down just to hurt Iran and Russia. But the Saudis see the increasing efficiency of U.S. shale-oil production, and see the writing on the wall: At some point, the U.S. will be exporting oil. A lower oil price is a way for Saudi Arabia to slow down U.S. production growth.
Swank: Yes, although the Saudis don’t have much market share left here—we barely import anything from them, 600,000 to 800,000 barrels a day. They don’t like seeing other OPEC members take market share in India and China. They are trying to defend their market share by allowing oil prices to drop. Saudi Arabia has a budget surplus and can withstand lower prices. That’s not the case for other OPEC countries....MUCH MORE
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