With OPEC poised to cut crude production by as much as 1.5 million barrels per day, investors are hopeful the cut might fuel the otherwise smoldering energy sector.
Organization of Petroleum Exporting Countries
reportedly will meet on Aug. 6 or Aug. 7 to cut its petroleum output. With OPEC's second-largest producer, Venezuela, already on record backing a production cut of 1.5 million barrels per day, the cartel is expected to have gathered enough member support to formally announce the emergency meeting today. The move comes in response to the recent swoon in demand for crude and a corresponding drop in price.
"Global oil demand is beginning to show signs of collapsing, as it did in 1998, under the combined pressures of a weakening global economy, a strengthening U.S. dollar and high oil prices," said Leo Drollas, chief economist at London's Centre for Global Energy Studies. "Each piece of new economic data that has become available over the past month has added to the gloom."
Oil prices recently breached OPEC's $25 per barrel target and fell toward the low end of the $22 to $28 price band OPEC uses to myopically guide production policy. "OPEC appears determined to defend its $25 per barrel price target, whatever the implications for oil demand growth or the world economy, and may cut output again to do so," concludes Drollas.
A Crude Tumble:
Source: TSC Research
News of a possible OPEC cut came in time to reverse last week's bearishness that took many energy stocks to new lows. Oil reacted positively: Friday, West Texas Intermediate closed at $25.90, up $1.19. Crude held its gains Monday, closing at $26.12.
Summer Doldrums, Winter Bounce?
Some analysts don't think an OPEC production cut will do enough, soon enough to stem the current trend toward lower crude prices. "The problem is timing," noted UBS Warburg's London energy research group in a note to clients on Monday. If OPEC waited until its regularly scheduled meeting in September to cut output, that would be "too slow for the cartel's best interests, since it means the U.S., for example, that imports from the Persian Gulf would not decline until mid-October."
Reducing supply isn't likely to hit prices quickly because "the primary cause of the current weakness in oil prices is poor demand rather than excess supply," notes Drollas.
That doesn't mean prices will stay down. "It is very possible to see a muted response initially with a bigger reaction into the fourth quarter and the start of winter," says Dan Pickering, director of research at Simmons & Co., a Houston energy investment boutique and a member of the
TSC Energy Roundtable
. "When you combine the initial impacts of an OPEC production cut with a seasonal increase in demand you could get a big move."
Not only that, says Drollas, but short-covering could add to the magnitude of an early winter rally. "Although OPEC is concerned about falling prices, the oil market will remain vulnerable to winter price spikes as industry stocks remain low globally," he notes. "Furthermore, speculators' huge net short positions will be quickly reversed as soon as the market shows any sign of recovery, exaggerating any rebound in prices."
Another OPEC production cut -- if cartel nations comply with the directive -- should provide a boost to exploration companies with a focus on oil around the world and the service companies that have large international operations. "Companies that stand to benefit the most will be internationally focused without a lot of refining exposure," suggests Pickering. "It's going to be more E&P oriented companies than integrated companies."
Analysts say exploration companies that could benefit from an increased focus on crude oil production include
, as well as a number of the oil-focused exploration and production companies based in Canada. "You are looking for E&P companies that don't have a lot of gas exposure which rules out many of the North American names as they tend to be at least 50% in natural gas," says Pickering.
And, you should see support for the international service names, companies that providing drilling services and equipment to oil producers around the world. That list includes names like
, which receives nearly two-thirds of its revenue from international operations. In addition, investors may focus on
Santa Fe International
, a smaller drilling company with an international oil focus.
Banc of America analyst Tyler Dann also says an OPEC production cut would help rally the sector. However, he cautions the rally may be short-lived. "In the short term we think the integrated oils and other stocks within the petroleum complex will rally," he says. "We'd consider it a bear market rally since we ultimately do not believe the fundamental environment supports high oil prices or inflated valuations on oil stocks."
One thing is for certain. Almost everyone expects OPEC to cut production to provide some price support. If the cartel doesn't cut, crude prices could fall fast.
And, if OPEC does cut, it is far from clear the move will be the panacea energy investors are hoping for.
Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, Edmonds was long Vintage Petroleum, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to