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Brexit: what impact for oil?

The UK’s vote has spooked crude, equity and currency markets. More volatility is likely

ON its own, Brexit's direct impact on oil prices might be negligible. Indirectly, the UK's vote to leave is another headwind for the oil market’s fragile recovery.

One of the world's biggest economies could contract, the US dollar is strengthening and political risk across the rest of the EU will inevitably rise. Thus, the wider macroeconomic impact of Brexit could stall the oil market’s delicate rebalancing.

In a tight race, the UK decided to end its 43-year membership of the EU on 23 June. It was a narrow - and unexpected - victory for the leave camp, with 52% of the 30m voters opting to leave the bloc.

The political bloodbath is underway. UK prime minister David Cameron has already resigned (he will leave office in October). Nicola Sturgeon, the first minister of Scotland – which voted heavily in favour of remain – now says it is “highly likely” that her country will hold a new independence referendum. The consequences for the North Sea are unpredictable.

It all comes just as oil prices were gathering steam. Eulogio Del Pino, Venezuela’s oil minister, reckoned prices would rise by $10 a barrel this summer. Not if the UK vote spreads panic in global markets.

Whatever happens to sterling and the UK economy, markets are worried by the wider macro-economic implications of Brexit – and they should be

Equity and commodities exchanges were already volatile in the days ahead of the vote. But those gyrations were nothing compared with the reaction when broad expectations of a remain majority were overturned. Sterling fell to a 30-year low in a matter of hours and the UK stock exchange plummeted. Equity markets in Asia slumped.

Brent fell about $3 a barrel, to $47.50 in London, as traders digested the news.

Whatever happens to sterling and the UK economy, markets are worried by the wider macro-economic implications of Brexit – and they should be.

US Federal Reserve boss Janet Yellen and Mario Draghi, the European Central Bank president, both said Brexit could be disastrous for the global economy, triggering capital flight from the world’s sixth-largest economy (it was fifth 24-hours before the results were announced) and threatening the eurozone’s fragile economic recovery.

Rising US dollar strength looks inevitable, providing another headwind for oil prices. But that could be short-lived, especially if the macro shock troubles the Fed sufficiently to postpone, again, its plan to lift US interest rates.

Provided the economic impact can be contained within the UK, though, the global oil market may prove relatively resilient once the shock has passed. The fundamentals remain positive: supply and demand are coming closer to balance, easing an 18-month-long glut.

Production outages in May took nearly 0.8m barrels a day of supply off the market, leaving global supply at 95.4m b/d, or 0.6m b/d lower than a year earlier. That is the first significant drop in supply since early 2013.

At the same time, global demand forecasts – made before the Brexit vote – expect consumption to rise by 1.3m b/d this year and the same in 2017.

On its own, the UK is too small a consumer – 1.6m b/d, or 2% of the world total – to ruin those forecasts. But bears will watch for signs of a wider macroeconomic weakening, across Europe or further afield, in the wake of the decision.

Other consequences for energy may be more difficult to predict, or take longer to be visible. Accountancy firm PwC says, for example, that Brexit is “a major setback” for global efforts to tackle climate change.

“The UK government has been a champion of climate action at home, within the EU, and in the Paris climate talks,” says Jonathan Grant, the firm’s director of sustainability and climate change. “However, this leadership is at risk, with many supporters of Brexit also opposed to climate policies such as carbon taxes and efficiency standards.” Further uncertainty will cause the price of EU carbon credits to tumble as well, he said.

It will take at least two years for the UK to leave the EU, and probably much longer for it to rebuild trade agreements with the bloc and other international markets.

That leaves plenty of scope for political and economic volatility, especially if – as Brexit cheerleaders claim – the UK vote sparks similar efforts from other nationalist movements to abandon the EU.

Oil prices will remain focused on the fundamentals, but the macroeconomic outlook is suddenly looking a lot less rosy than it was.

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