Last year, 'Energy' was the strongest S&P sector performer with a market-thumping 24% return. In particular, November's historic OPEC-led production cut deal to alleviate a supple glut managed to buoy oil prices and stabilize them around the psychologically important $50 per barrel threshold. The commodity was on a stellar run on optimism surrounding the agreement, and the outlook for oil stocks was getting better.

The seemingly positive developments encouraged investors to bet on firming prices for 2017 with the oil industry finally hoping that 'this would be the year.' True to the strong sentiments, U.S. oil prices reached around $55 per barrel in late February, the highest level in 19 months.

However, the situation is drastically different now, with the commodity having floundered in recent weeks. By June 21, crude had cratered more than 20% from its February highs and officially plunged into bear territory. In fact, prices ended down 14.3% for the first half of the year – the worst performance since 1998.

Apparently, there was one small thing that the bullish speculators didn’t account for – the spectacular boom in U.S. shale production. Arguably, the biggest development in global oil markets over the last few years, the relentless increase in North American shale output has undermined efforts by OPEC and other major producers to ‘rebalance’ the market and prop up prices.

Supply Side Woes Plague Oil Market

Apart from the much-discussed shale production issue, there are some other reasons as well why oil markets remain oversupplied.

At the crux of the matter is the rising flood of U.S. shale-driven production. Now at a financial equilibrium, the shale firms are putting more rigs and employees back to work. Throughout the downturn, producers worked tirelessly to cut costs down to a bare minimum and look for innovative ways to churn out more oil from rock. And they managed to do just that by improving drilling techniques.

With these efforts, many upstream companies have repositioned themselves to adapt to the new $50 oil reality and even thrive at those prices. In other words, while OPEC's moves to trim output and rebalance the demand-supply situation has stabilized the market to a large extent, in the process it has incentivized shale drillers to churn out more. As per EIA's latest inventory release, crude production over the last 4 weeks averaged about 9.31 million barrels per day, up 7.2% from the same 4-week period last year.

The extension of supply curbs by top producers led by OPEC also disappointed markets. At a meeting in Vienna in May, the cartel (plus non-members led by Russia) decided to roll over their output cuts of 1.8 million barrels per day (bpd) to reduce global oil inventories until Mar 2018. The move, though widely expected, spooked some oil market investors who hoped that the cuts would be deepened/lengthened further.

Meanwhile, the producer cartel pumped more oil last month than in May – the second successive monthly rise in 2017 – on increasing output from Nigeria and Libya, which are exempt from the deal. The production boost offset improved compliance by other members.

OPEC Fails to Curb Oil Glut

It’s quite clearly evident that the output-cap agreement spearheaded by OPEC has failed to achieve its stated goal of bringing global crude stockpiles down to five-year averages. Even the various energy-monitoring bodies – EIA, IEA, and OPEC – have of late projected that U.S. crude production will continue to ramp up through 2018, thereby leading to slower-than-expected market rebalancing.

To sum it up, oil’s future direction will depend on the battle between the OPEC-led output cuts and the increase in U.S. shale production. But as of now, it seems that the ‘lower for longer’ oil is there to stay well into next year.

A Rebound in the Cards?

Some analysts believe that oil prices have bottomed out following the recent selloff. While a significant rebound is out of question due to the lingering supply-demand imbalance, one could expect some short-term price gains.

Investors have pinned hopes of crude recovery over the latest U.S. Energy Department's inventory release that showed a fall in domestic oil production and a reduction in the U.S. rig count (number of rigs searching for oil and gas in the country) for the first time in 6 months – both pointing to a slowdown in shale output.

Yes, production is still climbing but growth might have tempered. According to the U.S. Energy Information Administration (EIA), domestic crude volumes have declined thrice in the last 8 weeks. Per the most recent report, U.S. output decreased 100,000 barrels per day – the largest fall since July 2016. As a proof, crude inventories have tumbled over 26 million barrels during the past 3 months. And with it, the pace of new rig addition has slowed down as well.  

Even as we cannot run down the chances of the market moving sideways and seeing high volatility, many analysts are not too bearish about oil in the remainder of 2017.

Look for Bargain Buys with Strong Fundamentals

If investors are eager to lap up opportunities in this notoriously volatile market, a prudent move would be to buy the beaten-down stocks with encouraging fundamentals. Stressed valuations do not always indicate that the stock has lost all potential. In fact, some could actually make a great buy. But prospective investors need to do adequate research before betting one’s hard-earned money on such stocks.

To guide investors to the right picks, we highlight 5 stocks that carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The Zacks Rank is a reliable tool that helps you to trade with confidence regardless of your trading style and risk tolerance. To learn more about how you can use this proven system for market-beating gains, visit Zacks Rank Education.

The stocks, which we shall cherry-pick, currently come at a bargain price after declining at least 15% in the first 6 months of the year (as compared to oil’s 14.3% fall), but have the potential to turn around in the third quarter.

5 Stocks to Invest In

SeaDrill Ltd. (SDRL - Free Report): Headquartered in London, SeaDrill is one of the leading offshore drilling contractors in the world with a fleet of floaters (semi-submersibles and drillships), jackup rigs and tender rigs.

Zacks Rank: #2

% Price Change (YTD): -89.4%

Bonanza Creek Energy Inc. (BCEI - Free Report) : Established in 2006, Denver, CO-based Bonanza Creek Energy is an independent exploration and production company with core operations in the in the Rocky Mountain and Mid-Continent regions.

Zacks Rank: #2

% Price Change (YTD): -72.3%

Pioneer Energy Services Corp. (PES - Free Report): Headquartered in San Antonio, TX, Pioneer Energy Services provides contract land drilling services to oil and gas operators in the U.S. and Colombia.

Zacks Rank: #2

% Price Change (YTD): -70.1%

W&T Offshore Inc. (WTI - Free Report): An exploration and production company headquartered in Houston, TX, W&T Offshore focuses primarily in U.S. Gulf of Mexico’s shallow water shelf.

Zacks Rank: #2

% Price Change (YTD): -29.2%

Emerge Energy Services L.P. (EMES - Free Report): Emerge Energy Services, based in Fort Worth, TX, is engaged in owning, operation, acquisition and development of energy service assets primarily in the U.S.

Zacks Rank: #2

% Price Change (YTD): -26.8%

Bottom Line

The greatest opportunities could be found by buying fundamentally sound stocks when everyone is selling them.