Contemplating OPEC's latest market pondering

SUPPLY, DEMAND, speculation, and regulation are all part of the oil price equation. OPEC, too, remains a part of the discussion. On August 8, an OPEC press release about the oil market and its current path to rebalancing stated: "OPEC continues to monitor developments closely, and is in constant deliberations with all member states on ways and means to help restore stability and order to the oil market. An informal meeting of OPEC member countries is scheduled to take place on the sidelines of the 15th International Energy Forum which will take place in Algeria from 26 to 28 September 2016."

Whether or not you believe OPEC will take steps to affect change in the not-so-distant-future, if your conversations involve the price of oil, they likely contain a healthy dose of speculation on the matter. Here, some views from various industry thought-leaders to add to the discussion.

Speaking on factors currently influencing the oil price, Ole Hansen, Saxo Bank's Head of Commodity Strategy, noted that daily trade inspiration "has been provided by the current tug of war between challenging near-term fundamentals and OPEC members pondering how to support the market."

The big question, he said, is "whether a deal can be struck given that key players such as Iran still reserve the right to continue to increase production. If a deal were to be struck it would initially be taken positively as the first sign that OPEC members are actually able to support the price by more than verbal intervention."

In an August 22 note, Cowen and Company analysts said signs "continue to point to OPEC production discipline, although we see a freeze owing as much to commercial constraints as any other factor. In our view, a September freeze is priced into oil currently with a potential November cut offering material upside to the entire energy equity complex, given the likely capital inflow and upward revision to NAM drilling/completion activity and production."

Much has been said about OPEC's action/inaction in recent years. What would be different now?

For one, Cowen and Company analysts said, is its view that OPEC "would more easily form a consensus to suspend the policy of untethered production once the global oil market had visibility toward structural balance, as at that point a supply reduction would have a more certain impact. A change in leadership at Saudi Arabia's oil ministry underpins that view, and we see over 50% probability of at least a production freeze before YE16. The US oil and gas industry has shown significantly more resilience than OPEC leaders likely expected, and given the broad range of negative repercussions from the oil downturn among OPEC members themselves, only some form of quota enforcement in 2H16 could justify the organization's existence at this point. A freeze at current levels would bring balance to the market by 1H17, setting the stage for $60 oil price by next year, and appease distressed members of the organization that have called for stricter production quotas since early 2015." That said, expectations are somewhat tempered as "countervailing forces against a policy shift remain" given "the low likelihood of accord between Saudi Arabia and Iran with respect to production targets, as well as the fact that rival production (US, Brazil, Russia) remains robust (only China has seen declines up to expectations among OPEC-sized non-OPEC producers)."

Another factor, and possibly the most significant, Cowen and Company analysts noted, is commercial limitations of max production.

"Excluding steadier rising sales to the US, it is possible that OPEC producers see a commercial constraint to production above a certain level (the current level), with a production freeze underpinning what OPEC sees as max capacity without additional demand growth," they commented.

Also looking at the impact of OPEC's verbal intervention is Jefferies. Like others, the firm doesn't expect a production freeze from the informal meeting, and certainly not a production cut. However, in a note August 25, the analysts said "the timing of the meeting could in and of itself keep prices supported until the market nears balance in the fourth quarter."

Of course, a production freeze from the organization is possible. But, as Jefferies analysts see it, "the effects on the physical market would appear to be minimal. Saudi production was at a record level in July, and that record seems likely to stand only until the release of August data; Iranian production has returned to pre-sanction levels and likely has little remaining upside; if Iraq resumes NOC production around Kirkuk it will be near capacity. The only OPEC countries that would not be at full productive capacity by the end of September (excepting the Saudis who would merely be at record levels) would be Nigeria and Libya, who would likely seek exemption to return to pre-conflict levels."

Perhaps most notable is the expectation that "commercial inventories will begin to draw in 4Q as supply and demand rebalance," said Jefferies analysts, and with that, the stage is set for a "fundamentally-based price recovery" with or without an OPEC freeze.