Trader Talk

Oil near $40 again, but bulls insist recovery coming

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It's been exactly one year since OPEC announced it was not cutting production. So far, they have stuck to their word.

So there is a bit of nervousness going into Friday's OPEC meeting in Vienna.

Why? Because U.S. supply declines have been modest so far this year, and no one else in the world is cutting production.

Oil is again hovering just above the psychologically important $40 level.

Problem is, no one seems to think anything is going to come out of this meeting. The Saudis are still calling the shots—the betting is they will stick to their position of maintaining market share. No cuts.

Not only are they not cutting, they're overproducing. OPEC has a quote of 30 million barrels a day, about a third of world supply. But the group announced its output last month was 32.12 million barrels a day.

In other words, there is a market share battle going on within OPEC itself. That's putting a lot of pressure on the supply/demand balance.

Then there's Iran. They will start to come online soon, possibly January. How much? It's not clear, but even if it's just 500,000-1,000,000 barrels a day, that would add roughly one percent to world supply.

In a world awash in oil, one percent more is a lot.

And demand? On average, global demand has grown roughly one million barrels a day each year for the last several years. Oh sure, there's all sorts of rosy projections for 2016. We'll see.

My point: there is lots of additional marginal supply to swamp the normal demand. And we haven't even mentioned U.S. shale, which could easily capture the incremental demand.

Analysts, which have eaten crow all year about when to "buy the bottom," keep trying to pick that bottom (that's what they do). So Cannacord Genuity said this morning: "[W]e see more upside potential than downside risk in the current global oil market and think Canadian E&P stocks provide excellent exposure to a recovering oil price."

Guggenheim went even further. They upgraded the who oil services sector yesterday, arguing that a year from now, inventories will move from builds to draws because non-OPEC production (read: U.S. shale) will drop dramatically and oil prices will recover.

This is what the bullish crowd have been arguing all year: the frackers are going to collapse. Evercore ISI summarized it: "We continue to believe that approximately a third of the companies with commoditized service offerings will end in bankruptcy as a result of this downturn..."

And boy, now is the time to buy, the bulls argue: "We believe investors are beginning to look ahead to the upturn (which we envision in 2H16) and fund flows into energy may have begun - or will soon begin."

Stop me if you've heard this before. OK, I'll stop.