Should Oil Investors Be Afraid Of Brexit?

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Includes: OIL, USO
by: Gary Bourgeault

Summary

The Brexit effect as the vote approaches.

Where the most economic impact could be.

Market will be increasingly volatile as uncertainty increases.

Workforce movement and Scotland remaining in UK.

How oil investors should respond in the short term.

source: express.co.uk

There's a growing amount of consternation and fear surrounding the upcoming Brexit vote, which for the few that may not know, would whether or not Great Britain leaves the European Union, with all the pros and cons associated with the decision, depending on which way the vote goes.

A lot has been said by those wanting Britain to remain in the EU concerning the economic fallout that would accompany leaving, specifically for multi-nationals doing business in the UK, which could result in having potential tariffs or trade barriers put in place that aren't there because of the UK being a part of the eurozone.

How I see it is if there is a significant negative effect on oil, it'll be as a result of conditions on the macro economic side of things, not a direct impact on the energy sector; although there are a couple of things we'll look at that could change some of the way the oil business is done if Brexit becomes a reality.

Workforce movement and Scotland

A couple of concerns that have been suggested as far as a potential direct impact on the UK oil industry are the free movement of workers and the potential fallout from Scotland - which feels strongly about remaining in the EU - in that it could call for another vote on whether to remain in the UK or not.

If the UK leaves the euro zone it could trigger more restrictions on the movement of workers to various basins that aren't in place at this time. Assuming that were to happen, it would require oversight, which would add to the costs of doing business. That in turn could possibly encourage energy companies to do business elsewhere.

In regard to Scotland, it would almost certainly push for a new referendum to determine if it would stay in the UK. If that were to come about it would definitely have an immediate impact on the companies operating in the North Sea.

These are possibilities that I'm not too concerned with, but they could come about over time if a Britain decides to go it alone.

What the overall battle is about

Obviously this is a referendum on what is believed is best for the British and what is perceived to be the best for large corporations and the EU.

Those wanting to leave say it costs the UK just under $500 million a week - money that could be used for British initiatives.

If there is a Brexit, it is believed by supporters it would give power back to Britain to engage in its own trade agreement negotiations; agreements that would be best for Britain and not interfered with from Brussels.

Also weighing on the British is the fact it has to allow citizens of the EU to work and live in the UK, which adds costs to the various social services programs offered by the government. Under a Brexit, a new system would be put in place that would remove the existing preferences afforded citizens of the EU.

The major impact on businesses would be the probable increase in tariffs or barriers for companies trading with the EU. This is why multi-national businesses in particular have gotten behind those wanting to stay in the euro-zone.

As for immigration concerns, those against a Brexit cite other European countries not part of the EU has having higher per capita immigration levels than those within the EU. They assert it is likely to increase after checkpoints are changed from France to Dover. That doesn't make a lot of sense to me because it would be a matter of will and enforcement, just like in the U.S. and other countries.

Where most of the financial impact would be

The most obvious economic impact would be how firms doing business in the UK would have to adjust if there were tariffs and other measures put in place against products and services coming from Britain.

For that reason, 54 percent of large businesses in Britain say they support staying, while 37 percent say they support the Brexit. The rest didn't vote or weren't decided yet, according to a poll conducted by the British Chambers of Commerce.

On the other hand, the majority of small businesses, as defined by those with 250 or less employees, want to leave the EU.

As for U.S. companies with operations in Europe, banking and manufacturing seem to be the most concerned over the disruption a Brexit would have. This is why giant banks like Citigroup, Goldman Sachs, J.P. Morgan and Morgan Stanley have contributed significantly to the opponents of a Brexit.

Manufacturers in the UK would be faced with new rules they would have to adapt to, including immigration, labor and trade laws.

While the market is all jittery about this, it would take about two years for the UK to negotiate its departure from the EU if that's how the vote goes. There would be a short-term response to an exit, but the reality would settle in that it will take at least 24 months to work out the details.

For the multi-nationals in particular, it would be waiting in limbo and the accompanying uncertainty that will probable force them to put some things on hold until it's clear what the new market and rules will be.

Implications for oil

Other than the North Sea challenges that may accompany a Brexit, the major concern is at the macro-economic level, where some believe a vote to leave would result in a recession in the UK and EU. If that were to happen, that is where oil would be impacted the most.

To me that suggests retaliatory implications, as a market is still a market, and if there is supply and demand going on, it should be reflected in the trading process. Leaving the EU should have no impact on that unless there are measures taken to punish the decision. That is a real possibility because of the strong pressure from powerful and wealthy interests to keep the EU intact.

Again, the market isn't taking into consideration the time frame it'll take to work an exit out. I think once that's understood, it won't have that much of an economic impact in the near term. Media outlets will temporarily imply it's the end of the world, but it won't be long before it'll be business as usual. Of course this is only conjecture until the vote actually takes place on Tuesday, June 23.

As it relates to oil, I would wait until the vote is confirmed and officially finalized before I took any more positions. The media are trying to make it look like the tide has turned against a Brexit, but that is only wishful thinking at this time - it's too close to call.

Further out, I don't see this being any different than any other economic slowdown. A recession, when it comes, isn't going to be primarily from a Brexit, it'll be from the already slowing global economy.

That said, oil will without a doubt drop in price if the vote is to leave the EU. It'll give substance to the existing fears, and the market will punish crude in response, as it will other sectors.

Once that reaction is over, things will settle down and the market will go back to analyzing data as it always does. Oil investors will do the same.

Conclusion

I believe the vote for a Brexit isn't that big of a deal at all. Those with a lot of skin in the EU game are playing it up to the media as the end of the world, but it wasn't that long ago there wasn't an EU, and the world got along just fine without it.

Whatever way it goes Tuesday, there'll be a market response to align with it. If the vote is to leave, there'll be a temporary downward move in the market because of the fear trade. If the vote is to remain, the same will happen on the upside.

That is evident as I write because oil moved up in response to the assumption the outlook for the UK to stay in the euro zone has been reinforced. That could change very quickly.

On Tuesday oil will move significantly one way or the other. For that reason I find no reason to take a new position in crude until the smoke clears. The vote is too close to call.

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.