How Will Brexit Affect Oil Prices Going Forward?

| About: The United (USO)

Summary

Any speculation/ event that results in a drop in oil prices needs to be evaluated for its effect on the global supply- demand fundamentals.

Even If UK’s GDP falls by 2% post Brexit, its oil demand will only be reduced by around 1% which is around 16,000 barrels a day.

Supplies from Nigeria and Venezuela are not going to substantially increase anytime soon.

Based on the existing situation, I believe that oil will return back to its $50 level very soon as the current drop in oil price is mostly because of speculation.

As Britain shocked the world last week with its vote to exit the European Union, the global financial markets plunged with WTI (WTI) and Brent trading at $47.37 and $48.38 respectively at the time of writing this article. British Prime Minister - David Cameron even announced his exit later this year as the British pound touched its 31 year old low ($1.3228) last Friday. As investors in oil remain highly uncertain on the quantum of risk assets that they need to sell, I strongly believe that the oil market is over reacting on the entire Brexit situation and the current slump in oil prices has more to do with the strengthening of the US dollar and market speculations. Let me present some of the reasons why I feel that oil (NYSEARCA:USO) will appreciate in the coming time, even with Brexit in background.

The drop in oil prices was not that bad after all

Many analysts believed that oil prices might crash if Britain opted to leave the European Union. Oil prices did fall when the results came out, with WTI and Brent falling by 6.8% ($46.7) and 6.6% ($47.54) respectively. However, prices did not decline any further from those levels and appreciated a bit. This clearly shows that oil prices did not 'collapse' because of Brexit. It needs to be noted that any speculation or event that results in a drop in oil prices needs to be evaluated for its effect on the global supply- demand fundamentals. Looking at Brexit, we can easily see that it will not have any direct -major impact on supply- demand of oil. As per Goldman Sachs, even if UK's GDP falls by 2% post Brexit, its oil demand will only be reduced by around 1% which is around 16,000 barrels a day. This drop will hardly affect the global oil demand in the coming time. Moreover, future oil demand outlook of India and China (combined at around 16 million barrels a day) still looks very strong.

Oil Supply isn't stabilizing any time soon

It needs to be noted that supplies from Nigeria and Venezuela are not going to substantially increase anytime soon. Although it has been reported that Nigeria's oil production is rising, the threat from its militant group Niger Delta Avengers still looms large and it will still take months before the country starts producing close to its January 2016 -level of around 2 million barrels a day. Looking at Venezuela (whose oil production tumbled by 120,000 barrels a day in May this year ), we can see that its oil industry is now in trouble as companies like Schlumberger (NYSE:SLB) and Halliburton (NYSE:HAL) have started reducing their operations due to payment issues. In fact, I believe that Venezuela's situation can deteriorate even further as the state - owned PDVSA does not have the cash that is needed to keep its oil output steady. Even the U.S. crude oil production has fallen to its lowest levels since September 2014 (Figure) along with the US crude oil stocks (figure). All these factors clearly highlight that global oil supply will not stabilize any time soon and this factor will definitely support oil prices in the coming time.

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Source : oilprice.com

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Conclusion

As Britain's exit from European Union will take around two years, I expect the markets to remain volatile as speculations and uncertainty among investors and traders will not end very soon. However, I strongly believe that effect of Brexit on oil will not be as severe as predicted by many analysts and market experts, because it is not going to affect the supply- demand fundamentals of crude oil ( as explained above). However, if other European nations decided to follow Britain and leave EU, the situation can be different as it would lead to more uncertainty and market volatility. Based on the existing situation, I believe that oil will return back to its $50 level very soon . In fact, I feel that this is a great buying opportunity and oil prices will surely increase in the coming time.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.