Sentiment in the oil market may start turning positive as prices begin reflecting expectations of tighter supply in the second-half, but lingering worries of a global economic slowdown still present a downside risk, according to CNBC's weekly survey of oil market sentiment.
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"We really saw inventories go from below the 5-year average for the OECD countries at the start of the year to really high supply in the second-quarter to above that range. That was what fundamentally cut the legs off the price of oil. Going forward though, we think these factors should ease," Jeremy Friesen, Asia Commodity Strategist at Societe Generale told CNBC's 'Squawk Box' on Monday.
The Organization of Petroleum Exporting Countries (OPEC), which produces a third of global oil, may throttle back on production, Friesen said. OPEC price hawks called for production cuts during the group's last meeting in mid-June, claiming Saudi Arabia had over-produced and risked collapsing the oil price.
Latest OPEC data suggests partial cutbacks are already starting to materialize. Supply from OPEC’s 12 members hit a daily average of 31.36 million barrels a day last month, a decrease of about 100,000 barrels from May's levels. OPEC agreed to a production ceiling of 30 million barrels a day last December but has been pumping above that level since then.
"At these prices though I think OPEC is back in the driver's seat," Friesen said. "OPEC could jawbone up the price (and) could bring down some of their supply. Importantly, I guess the dove in the market, Saudi Arabia, is more comfortable with the price and certainly geopolitically it helps them to keep prices around this level so we don't see them continue to supply a lot."
Politically, Saudi Arabia and other Gulf Cooperation Council (GCC) countries need a high oil price to support social programs to avoid the upheaval seen during last year’s Arab Spring uprisings.
Anti-government protests have become more common in Saudi Arabia's oil-rich Eastern Province since uprisings in neighboring states in late 2010 and early 2011. The current demonstrations are more severe and appear to be more coordinated than previous incidents, Crispin Hawes and Riccardo Fabiani, analysts at political risk consultancy Eurasia Group wrote on July 13. "The immediate implications for state stability and crude oil production are limited, but the repercussions for the stability of the province in the longer-term are potentially significant."
Returning to the supply side, inventories in the U.S. fell during the week ended July 06, government data showed last Wednesday. The U.S. Energy Information Administration in its weekly crude oil report said U.S. commercial crude oil inventories decreased by 4.70 million barrels to 378.20 million barrels, but are above the upper limit of the average range for this time of year.
Four out of ten respondents expect oil prices to rise this week; two expect prices to fall while the remaining four believe prices will remain around current levels, CNBC's weekly survey of oil market sentiment shows. This week's results contrast with the prior week's findings where bearish respondents were in the majority, with nine out of the ten respondents expecting prices to soften.
Dollar Index Rises
But last week's price action confounded survey expectations as front-month Brent crude oil futures rose $4.21, or 4.29 percent, for the week, gaining for the third consecutive week. In London, August Brent crude settled at $102.40 a barrel on Friday, rising $1.33, or 1.32 percent.
"Strength in Brent stays limited to $102.50/$105.00 area," said Dhiren Sarin, Chief Technical Strategist for Asia-Pacific at Barclays Capital. "We are largely neutral/bearish for the coming week as Asian rates markets catch a safety bid and equities threaten to weaken further. The U.S. dollar index itself is testing year-to-date highs, which is also a potential negative catalyst for energy."
Constraints on spare oil production capacity, both amongst OPEC producers and outside the group, may also drive prices higher, analysts said.
Spare world oil production capacity is tight even though output from OPEC and North America has grown over the past year, the U.S. government said on June 26.
"Global spare capacity remains relatively tight by historical standards," the Energy Information Administration said in a report on global oil supply and prices required by the Iran sanctions law President Barack Obama signed in December. The report, obtained by Reuters ahead of publication, said spare oil capacity is estimated at less than 3 percent of total world consumption.
"It is quite evident that the structural underlying problems in the oil market (very limited OPEC spare capacity and significant delays and cost over runs in non-OPEC) are not going to be resolved anytime soon," said Aiden Bradley, Managing Director and Head of Asian Oil & Gas at CIMB Research in Singapore.
"So as seen recently and in 2008/2009, weakening economic conditions can lead to a significant sell off. But it tends to be short term as the underlying structural problems continue to exert a very powerful upward force."
Johannes Benigni, Managing Director of JBC Energy, agreed that the supply cushion in the third-quarter "is not there, thus we will see a stock draw," adding this explains why "the Saudis were pushing barrels especially in Q2 into storage and "why the U.S. gave waivers to buy Iranian oil to Asian buyers including China."
"Downside potential is therefore very much limited. Oil prices will go up and show less correlation to economic sentiment," Benigni added.
Outside the supply-side issues, Tuesday's semi-annual testimony by Fed Chief Ben Bernanke could be crucial for markets with some expecting Bernanke may lay the groundwork for additional stimulus, possibly fueling a risk-on bounce in global financial markets.
"If Bernanke makes a play for time" at Tuesday's testimony, markets "could be prone to a major dose of the vapors," said Ray Attrill, Co-Head of FX Strategy at National Australia Bank.
Excel Futures' Mark Waggoner, however, didn't expect much substance from Bernanke's testimony outside the familiar reiteration that the door is open to further stimulus if the economy deteriorates.
"China is slowing and oil will go lower as Europe plays out," Waggoner said. "Bernanke will say virtually nothing new. That being said oil fundamental will turn around later in the year but for now lower."
—By CNBC's Sri Jegarajah