Syed Rashid Husain
BREXIT generated the biggest global financial shock since the 2008 crisis.
Crude oil markets sunk to a seven-week low early last week as markets gripped with the Britain’s decision to leave the European Union and the accompanied concerns of a possible slowdown in the global energy demand. In the immediate aftermath, markets plummeted - losing some eight percent in the wake. The two-week old rally was checkmated.
However, within days, markets appeared were getting used to the new reality, taking and interpreting cues, in their own peculiar ways.
Markets initially appeared in a state of 'shock and awe' over the 'divorce' decision. For, it carried consequences. In an era of globalization, the UK and the EU, remained a significant part of the existing global economic order. The world and especially the Euro zone could enter recession.
Economic growth in the zone could easily be a casualty, many stressed. And as Pound got an initial battering, concerns about other currencies too gained momentum.
As the US dollar gained in strength, it also meant that the dollar-priced commodities such as oil became less appealing to foreign investors. Further, concerns were also cited about the United Kingdom and EU’s oil consumption, as markets became uncertain about growth prospects in both the EU and the United Kingdom. This was a recipe for oil markets to slide deep.
However, as concerns began mellowing, oil prices began climbing Tuesday.
And the process continued until the weekend. A potential oil workers’ strike in Norway and a crisis in Venezuela's energy sector also provided support to crude futures. More than anticipated drawdown in US stockpiles too contributed to the firming up process. The US Energy Information Administration reported early Wednesday that domestic crude supplies fell by 4.1 million barrels for the week ending June 24. This definitely helped, especially since, the American Petroleum Institute late Tuesday had reported a 3.9 million-barrel drop, while analysts polled by S&P Global Platts expected a decline of 2.4 million barrels. "The larger-than-expected crude stock draw per the API gave the market an added boost overnight," Jim Ritterbusch of Chicago-based oil markets consultancy Ritterbusch & Associates said in a commentary.
The ghost of Brexit seems getting over. The benchmarks gained 3 percent last Tuesday, recovering from an 8 percent drop over two previous sessions after the referendum.
Analysts began getting easy. "But we still view the larger price motivator as a strong reacceptance of global risk following a 2-session plunge across the financial/commodity spaces related to the Brexit situation," Ritterbusch wrote.
Standard Chartered said it expected oil prices to return to $50 per barrel rapidly as the Brexit impact on energy markets appeared limited.
Although it generated a healthy debate, yet, for the time being at least, there has not been any major change in crude market fundamentals. Although the UK ranks as a top five global economy, Brexit won’t materially affect the supply/demand balance for crude oil, even if a withdrawal from Europe turns out to be hugely negative for economic growth. Goldman Sachs said after looking at the numbers: "If we assume a 2 percent drop in UK GDP in response to the exit vote, which is on the high end of our economists' estimates, then UK oil demand would likely be reduced by 1 percent or 16,000 barrels per day, which is a 0.016 percent hit to global demand. This is extremely small on any measure,” the investment bank added.
But despite the turnaround, the debate though is far from over. Indeed Brexit is much more significant for the financial and currency markets than it is for oil supply and demand.
But there are ominous signals too. Following the Brexit, the UK’s North Sea oil and gas industry, already reeling from low prices and high costs, is faced with a worsening investment drought, especially since the decision to quit the European Union looks set to trigger a second independence vote in Scotland. This leaves the North Sea oil and gas industry, the bulk of which is in Scottish waters, potentially facing years of uncertainty and political paralysis.
The North Sea has been battered by the slump in oil prices because of its high costs and dwindling resources. Oil and gas producers in the region will spend 40 percent less this year than in 2014 and by the end of the year an estimated 120,000 jobs will have been lost because of the downturn.
Brexit only adds to the pressure. There may be a pause in investment while companies assess uncertainties, including the possibility of another Scottish referendum,Ian Thom, senior research manager at Wood Mackenzie Ltd told Bloomberg, estimating that North Sea investment will decline by 79 percent from 2015 to 2020.
The industry could thus face a longer period of turmoil if the UK’s EU exit is followed by a split with Scotland. That would probably mean reserves of oil and gas would be split, possibly along the so-called median line already used to allocate fishing rights. The division would hand the Scots about 96 percent of annual oil production and 47 percent of natural gas, according to estimates for 2012 by the University of Aberdeen’s Alex Kemp and Linda Stephen cited by the Scottish government at the time of the 2014 referendum campaign. And this could be disastrous for the British economy too.
And hence despite the turnaround, some are still not sure. Confusion persists. "We were calling for $44 oil in 2016 on average, now we expect it in the low $40s, roughly $41," Michael D. Cohen, an analyst at Barclays Plc, told Bloomberg. The gloomier assessment continues into next year. “The 2017 forecast has been reduced by $3, from $60 to $57."
Bank of America Merrill Lynch agrees. “A vote for Brexit is a vote against globalization, against the free mobility of people and goods,” Francisco Blanch, head of commodities research at BofA Merrill Lynch, added. “Any reversal in the growth of trade and mobility is bad for the commodities, except gold.”
Concerns are also growing that a looming glut in refined oil products, especially in Asia, could also spill into crude.
The road ahead could still be bumpy!
