What Brexit holds for the European oil and gas industry

The unexpected result of the vote cast by the British in regard to the European Union has brought turmoil to the financial markets, strongly felt by the oil and gas industry as well, where both the oil prices and the sectoral indices registered significant variations. The impact was short-lived and actually was absorbed by the market in the next few days. Nevertheless, the Brexit leaves behind a series of possible complications, which raise important questions about the future of the continental industry on the medium and long term.

The decision of the British to say ‘yes’ to exit the EU has taken by surprise the markets, as seen in the movements of the main indicators in the following days: thus, the indices and the oil prices registered significant decreases and the British currency dramatically depreciated against the main reference currencies; in parallel, the USD and gold - considered ‘safe-haven assets’ in times of crisis, showed consistent appreciation, while the VIX index - which reflects the volatility (and therefore the risk!) on the markets, had an ascending movement of about 25% in just two days (see the ‘CBOE Volatility Index, United States, CBOE: VIX’ graph ‘Gold, oil evolution and VIX’).

More specifically, subsequent to the referendum results on June 23 the Brent oil price decreased by about 8% in the following two days (down from USD 50/barrel to a minimum of almost USD 46/barrel) and Stoxx 600 Oil & Gas index (reflecting the development of the top 20 European companies in the oil and gas industry) reached a minimum of about -9% against the June 23 level. In both cases the decreases did not last very long – as in following days the losses were absorbed: on July 1 the oil price was by only 1% lower against the level before the Brexit and the Stoxx 600 Oil & Gas index already exceeded by 1% the level against the same date (see the index ‘Brent oil (CFD): LCO’ in the graph ‘Gold, oil evolution and VIX’ for oil prices, respectively the index ‘STOXX Europe 600 Oil & Gas, Global Indices: SPEX’ in the graph ‘Stock indices development’- for the stock index on the European oil and gas sector).
The effects of the shock given by Brexit were also felt worldwide. Both the evolution of the Stoxx 1800 Oil & Gas index (stock index to reflect the evolution of large oil and gas companies in developed economies around the world), which lost about 4% following the Brexit, but also in the development of other world relevant indices. For example, the price of gold (considered a safe-haven asset in times of crisis) increased by 8% until June 27 and remained at these relatively high levels (against the one on June 23) until the end of the first week of July, when it started to draw back (see the index ‘Gold (CFD): GC’ in the graph ‘Gold, oil evolution and VIX’); the USD registered a significant appreciation against all relevant currencies: thus, immediately after Brexit, the GBP regitered a significant depreciation against the USD (within two days the GBP reached a 12% lower level against the USD) and similar developments - albeit less extensive, were registered by the EUR and CHF against USD (which in the same first two days after Brexit lost about 3% against USD), see the graph ‘GBP evolution against major currencies’).

It should be noted, however, that during the same interval, the GBP lost about 9% against EUR and CHF - increasing its loss in the coming days (at the end of the first week in July the GBP had a minus 12% against the two European currencies by reference to the values before the vote).

Very interesting in this context was the development of the FTSE 100 index by comparison to the main continental European major indices! Thus, the FTSE had a decrease of about 3% in the following days after the announcement of the vote results, subsequently recovered and marking an advance of 3.5% on July 1 (as compared to the level on June 23)... the representative continental European indices - namely DAX (representative for the German stock market and economy) and EuroStoxx (representative for the capital market and for the European economy as a whole), although the losses in the first two days have eased, DAX and EuroStoxx were still in the red on July 1 (against ante-Brexit level) by 4.7% and 5.1% respectively, see the graph ‘Evolution of stock exchanges indices’.

 

Gold oil evolution and vix

 

Therefore, gold, the USD and oil prices show on one hand that the Brexit is an element inducing serious risks on the markets (gold and the USD are safe-haven assets and the fall in oil price may be seen as an expectation of economic decline); on the other hand, the difference between the developments of the British capital market index and the developments of the European indices shows that markets see the Brexit as an event having the potential to negatively affect the European economy more than the British one.

The gbp development against major curencies

A possible argument to support this idea may be given by the fact that, despite the relatively alarmist declarations made by Bank of England officials immediately after the voting results – however it did not cut the key interest rate in its latest monetary policy meeting, as analysts expected; the markets interpreted that the BoE does not see risks for the UK economy that require additional measures for financial incentives.

LONG-TERM EFFECTS

The Brexit has thus turned upside down all financial markets, and European markets appear to be most affected by this event than the UK itself.

Stock exchange indices development

In such an extremely complicated context, more important than the day to day or week to week variations (not insignificant, but largely already recovered - as seen in the charts)... are the effects the UK exit may have on European oil and gas industry; effects not easy to quantify, as the Brexit implications are extremely complex and profound, which certainly will put the industry on other foundations.

Perhaps the greatest risk or negative effect, in this context, for the European oil and gas industry, is given by the significant increase of unpredictability. This obviously is obviously equally to other industries/fields! From taxation to regulation, from immigration to labour market and trade... this unpredictability can practically lead to anything: from freezing investment projects to actual withdrawals of certain players from certain areas; this could happen while the oil and gas industry is still struggling to overcome the problems caused by the falling oil prices. As the latest news show that the British political class tends to delay this approach, which may see the talks stretch during at least two years (period which the UK officials have in hand to conduct negotiations with the EU for drawing up another legal framework for the relationship), the European oil & gas industry could face a fairly long period of uncertainty.

By far the most important Brexit implications for the continental oil and gas industry are given by the fact that the UK will be absent from the negotiating table on the EU energy policies. Therefore, on long-term, in the absence of the UK (which was one of the strong ‘pro-market’ voices within the European Commission), in defining the European regulatory framework for energy policies, the countries with an ‘interventionist’ and ‘centralist’ view will have more power and influence.

The UK had often been discordant against the continental-European vision, supporting nuclear energy and shale gas exploitations, the need and the right of each Member State to independently set its needed energy mix; from this position as opponent to the dominant trend among the Brussels officials, the UK was a strong ally of the small states in Central and Eastern Europe.

The Brexit represents a loss for these countries because the UK was the only member who could have offset Germany’s, France’s and Italy’s influence in the Council. As a result, for the Central and Eastern Europe (CEE) countries losing this ally means lower chances to get a flexible system in order to reach the emissions targets, renewable energies and energy efficiency set by the EU for 2030; the CEE countries will find it difficult to cope with the rigidity of countries such as Germany, Denmark and Sweden, which support the sanctioning of the members who do not comply with the set limits.

In this context it should be recalled that the UK had an important part in the philosophy of the European energy policy, arguing that the EU should follow principles and not to impose patterns. The UK supported, along with the CEE countries, the Member States’ need to choose incorporating nuclear energy in the internal energy mix - unlike countries such as Austria and Germany which oppose this idea, supporting a unique approach at European level and have often influenced the decisions made at national level. An example in this regard is the British project at Hinkley Point to build a new nuclear reactor - a project which was given the Brussels’ OK on state aid (in 2014) but has been blocked by the opposition of Austria and Luxembourg, which appealed the Brussels decision to the European Court of Justice.

The UK contribution was extremely relevant and important, for example, in the issue of shale gas; the UK supported their exploitation, as the states of Central and Eastern Europe did... unlike some ‘hard core’ EU economies which opposed. It’s about those states which, unlike the CEE countries, have access to cheap Russian natural gas, on the basis of agreements that provide preferential prices and are strategically positioned on the market – the one of regional gas hubs (hence, the national companies get consistent royalties for the transport of imported gas from Russia to the rest of Europe).
UK’s absence from the decisions made at European level deprives the CEE countries of an ally in this ‘dispute’ apparently caused by a difference in terms of political vision and/or philosophical about the European project, which has a significant economic component (coloured as strongly nationalistic!). In this context, the Brexit has major implications in regard to the principle of solidarity at European level.
Such an issue is, for example, the debate regarding the Nord Stream 2 project (which brings Russian gas directly to Germany); a project that represents a threat to the process of integration of national energy markets at EU level and which, by giving the consortium the opportunity and tools to dictate the conditions of gas flows to CEE, can influence the economic competitiveness of the CEE countries at European level. These issues are likely to maintain tensions between Western and Eastern Europe - and the UK’s absence from discussions and negotiations at the European Commission level will increase these tensions.

Besides the question marks regarding the European energy policy’s direction in the absence of the UK’s voice, another important problem may appear given by the potential restrictions regarding the access of large British oil companies (operating in Northern Europe) to the EU labour force; In such a situation, on one hand these companies will face difficulties in hiring qualified (European) staff and, on the other hand, European experts will face difficulties in taking advantage of the employment offers in the North Sea - where most operations are conducted under the British legal system. This is an issue important enough to be considered, given that on the one hand the European oil and gas industry is affected by falling prices (not few European companies are still carrying out restructuring programmes), and on the other hand this region of the North Sea is by far one of the most attractive for the workforce in this sector.

Last but not least, the UK’s exit is relevant in energy terms as the UK has a good positioning (with appropriate diversification of the energy mix and an energy dependence below the European average), which granted it the status of balancing pole at European level; which means that, in its absence, the European energy system will be weakened. Since the largest European oil and gas companies have important operations in the UK and the North Sea – operating thus under British jurisdiction - which means that any strain relations between the UK and the EU can pose serious problems to the continental companies. The same things state, for example, the RWE’s officials, German company which operates as electricity and gas distributor in England (Npower), with 3.2 million customers in electricity and 2 million customers of natural gas.

LEGITIMATE QUESTION MARKS

The question marks about the future of the continental oil and gas companies are even more legitimate if we consider as unlikely that London be dislodged from the position of European financial centre – its financial, professional and institutional infrastructure is difficult, even impossible, to replicate. In this context, the tensioning of the EU-UK post Brexit relations can lead to difficulties for European companies traded on the London stock market in their access to capital and investors.

The all above mentioned issues are the results of a rather pessimistic analysis. From an optimistic perspective - shared by many analysts - Britain will remain virtually a part of the European Union and of the European energy market (electricity and natural gas) through an arrangement similar to the one making Norway a key participant to the European market of natural gas and/or making Switzerland an important pillar for the electricity transmission system.

Recent history - specifically the result of the vote to leave the EU, which was expected to be ‘remain’ - shows us that surprises are more possible/probable than ever.

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