Brexit, the Turkish coup and oil prices By STEVE AUSTIN for OIL-PRICE.NET, 2016/07/22

We've been hearing a lot about Brexit. What is Brexit, by the way? Well, in June a referendum was held in Britain to decide whether the nation should remain with the European Union or not. The British people embraced uncertainty and voted to 'exit' the European Zone which is termed, Brexit. In a nutshell, Brexit, is the UK voting to exit from the European Union through a referendum. Frequent readers will recall how oil-price.net predicted Brexit nine months ago - as millions of welfare migrants flooding into Europe would exacerbate distrust between nations and trigger a breakdown of the EU.

If the stock markets were upbeat expecting a 'remain' vote, the euphoria evaporated quickly and immediately. The shock wave of Brexit spread to markets across the globe affecting almost all. Without exception, the US markets went down too. The pound slumped to its lowest since 1985. While gold prices rallied, oil prices fell. In the case of oil, Brexit pushed down the oil prices six percent in a single day to $48 per barrel. As markets expected demand for oil to slow down, investors moved to safer bets like gold and government bonds. When markets stabilized, the turmoil in Turkey threw cold water on investor confidence.

Effects of Brexit

In one stroke, Brexit has done; undone a lot and in the wake presenting a new Prime Minister for the UK in Theresa May. It's a typical case of- both- fear about immigration and nostalgia for a 'great' Britain pushing the UK out of the European Union. Pernicious calamity or a benign move? Only time will tell. However, in the resultant twirling vortex, the Pound fell to a thirty year low vis-à-vis the Dollar. More than £100 bn was knocked off from the FTSE 100. In simple terms, any shock, like the Brexit, on the pound and Euro makes dollar more expensive. Technically, when dollar gets strong, the crude prices slump. It's about weakening currencies like Pound, Euro and a strong Dollar. In the Brexit fallout, the oil prices slid by around $4 on various justified concerns. As pointed earlier, the pound hit a 31-year low and three UK property funds suspended. Markets stumped and slumped, Chinese commodities (mainly agriculture and iron ore) were sold off in a hurry. With the shift in dynamics, the Bank of England lowered the amount of capital banks should hold so that they can lend more.

Post Brexit, there were widespread fears of a domino effect across the world markets with annulled trade agreements, curbs in free movement of goods and services and panicked stock markets leading to recession. Wedged thus, in such cases, demand for oil naturally falls leading to weakened oil prices. In addition, a strong dollar means it's costlier to buy oil which depresses the prices further.

Were the fears realized? Well, that's debatable. For a start, unlike the Asian countries, many of the countries in Europe are pretty divested of oil and economic growth as of now. Yes, many oil companies have delayed projects waiting for the long term effects of Brexit to sink in. Yet, it hasn't been all 'crush' 'panic' and 'wrap up'.

The main point is that the immediate knee-jerk reactions are all short term volatility with trickled in uncertainty borne out of Brexit. Since then though, prices have recovered. If anything, the oil prices are back in the bracket of $45- 50. Specifically, Brent crude oil averaged $47 barrels a day in May. Indeed, this is the fourth consecutive monthly increase since January. A far cry from when oil prices bottomed at $26 last February. For the third quarter, oil-price.net raises its Brent forecast to $54 a barrel and WTI is $51 a barrel.

On the sidelines, many of the oil firms have actually performed better, that is after the initial fright. Deftly, the stocks of BP and Royal Dutch shell have gained in the wake of the referendum. The reason for this is simply that they have withdrawn funds from stocks exposed to the whims of UK economy and reinvested them in safer options. Also, these energy companies do business (revenue, dividends) mostly in US dollars and thus the present stronger dollar translate as better results for them. Essentially, the firms have grown in girth with the ingestion of British investors looking for better hosts. Asian stocks have rebound scaling new heights. For the US, Brexit means the Federal Reserve will shy away from raising the interest rates for now.

On the employment front, the news was good. According to the Labor Department, 287,000 jobs were added last month. In gasoline's case, historically, when prices go down usage increases. In March, American gasoline consumption was at an all time high of 9.25 million barrels a day. Still, as a matter of fact, there's a gasoline glut in the US at present. One reason, apart from Brexit for the brief fall in oil prices. The IEA predicts non - OPEC supplies to contract by 0.9 mbd in 2016. Taking the case of stocks, by July 15, the Dow Jones and the S&P 500 were scaling record highs.

Capital in oil

Let's look at the bigger picture. Among the cluster of facts, is also the whole story of 'investment'. Oil prices at $50 is still just about the manageable levels for the oil firms taking into account the high operating costs. Of course, this means lower investment in drilling and exploration. The old infrastructure has to be replaced, right? So, together with decline in output from existing fields, there may be a supply side deficit as the year moves on. Further, there's a certain level of uncertainty in the market which rules out investment in the oil sector. Even before Brexit, investors were wary of investing in oil because of stringent environmental policies, low price and returns and unrest in many parts of the oil producing countries. With Brexit, the oil industry would be further divested of capital. Delay in investment means a supply crunch in the future. For instance, the North Sea Basin is one of the major oil producing basins in the UK. However, production in the basin has been declining over the years. If there is no money for maintenance, the basin will eventually shut down.

UK and oil post Brexit

Before Brexit, British industrial growth was at its fastest in six years. Now, the situation has changed dramatically. With a falling Pound, technicians working in the oil industry will move out of the country to greener pastures like Canada, Australia and the US. Right now, there is a free travel arrangement between the UK and the EU. With this free movement off the equation, oil companies will have to pay more for people moving between the UK and the EU because of bureaucracy hurdles and other add-on costs, which will increase the cost of travel. Notably, many of the oil and gas firms will move to EU from the UK. This is hardly good news. It stands to reason that the oil companies will prefer to employ people in the EU to work there instead of spending to bring in employees from the UK. In the UK,demand for energy may fall because of decline in economic activities. Also, consumers in the UK will pay more for oil because of the mismatch between pound and dollar.

There have been talks of another Scottish referendum (IndyRef), not to mention similar moves from Northern Ireland. In fact, Scotland overwhelmly voted to stay in the European Union. If they elect to move off, then the ownership of North Sea Basin comes into focus. To be clear, this could lead to more uncertainty affecting investor confidence and Scotland secedes from the UK, taking its oil reserves along. Also, UK has shale oil that's waiting to be explored. Though estimates vary, it's put between 2.8 and 39.9 trillion cubic meters. We don't have any number as to 'proven reserves'. It's safe to say that gas that is actually extracted will be much lower than the estimates. And, you need higher investment to extract shale. With Brexit, UK will continue to import gas.

Turkey's failed coup

Before the dust settled on Brexit, Turkey reeled under military coup and rocked the oil prices.

Effectively, Turkey is the only Muslim country in the world that has been a democracy for any length of time... thanks to the Turkish military who enforces it. Much in a similar way US service members pledge to defend the US constitution, Turkey's millitary branch has the constitutional right (and responsibility) to act as a "reset button" against tyrants which muslim voters are prone to elect. This mechanism has worked well for Turkey in the past. Since the fifties, four military interventions in Turkey didn't deter the democratic process in play. In each instance the military, after every takeover, facilitated the continuation of the elected Government. This is because Turkish military enforces and respects democracy. Thanks to this balance Turkey has thrived, that is till the arrival of the present President.

President Recep Tayyip Erdogan's rule has been autocratic with a strong Islamic bent poisoning the secular country. A staunch rival of Syrian President Bashar al- Assad, Erdogan backed terrorist Islamists groups to wage war against Assad. Indeed, it was because of widespread Saudi-funded wahhabism in Turkish mosques that ultranationalist and ISIS-friendly Erdogan was elected to power with the collaboration of Saudi Arabia. Turkey under Erdogan devised a plan to build a gas pipeline from Qatar through Syria in a bid to displace Russia as the foremost provider of natural gas to Europe. Syria's Assad disagreed with Erdogan's plan, so Turkey helped funnel Islamic fighters into Syria through its border leading to the Syrian civil war.

The Turkish military took note and in application of the Turkish constitution acted swiftly to overthrow this dangerous dictator. However, in spite of thousands dead and more wounded, the coup attempt failed. Since then Erdogan has taken more alarming measures to gut its military, which prompted its NATO allies (friends of the Turkish military) to demand Turkey withdraw from NATO.

If history teaches us a lesson it's that gutting the Iraqi military caused a power vacuum which let Islamists (ISIS) establish themselves without opposition. The same is about to happen in Turkey, NATO's second largest military power after the US. European government are partly to blame for Erdogan's move. By demonstrating their inability to stem migration flows and terror attacks, then outsourcing Europe's eastern border control to Turkey, Europe has fueled the imperialist ambitions of Erdogan and his Islamist backers. Now Erdogan is taking more aggressive steps as he did with Syria and if he is not stopped, the situation will quickly deteriorate in Europe. Politically the situation is tense.

Now, to the question of oil: The Bosphorus Strait which handles about three percent of global oil shipments, chiefly from Russia and the Caspian Sea, has reopened. Turkey is also shipping oil from Caspian Sea and other countries directly to its exporting terminal bypassing Bosphorus. The Turkish straits, including Bosphorus and Dardanelles, are among the world's busiest and strategic choke points. That they are back in business is great news for oil. Besides, BP's 1768 kilometers long Baku-Tbilisi-Ceyhan pipeline which exported a staggering 740,000 million barrels of crude day in the first quarter continues nonstop. As for the ports, oil tankers are back to loading and unloading cargoes.

Limited impact of Brexit on oil

We are still wading through uncharted waters where the currents can change any moment. Still, as of now, the impact of Brexit has been lower than expected.

We at oil-price.net estimate that there would be excess supply at 1.5 million barrels per day until 2017. If, such a prediction holds true, oil prices should slump. However, look at the demand. In the first quarter of 2016, demand for oil has, in fact, increased 1.6 million barrels a day. And, according to the American Petroleum institute, crude inventories actually fell by 6.7 million barrels to July 1 to 520.9 million. Analysts were expecting a decrease of just 2 million barrels. OPEC, meanwhile, shares similar sentiments of whittled down oil inventories. It remains to be seen if the gains from Nigeria and Canada can offset the supply woes. Similarly, in its monthly report, OPEC has forecast world oil demand to whip up by 1. 2 million barrels per day in 2017, which is the same as its forecast for 2016.

After Brexit, the oil prices fell, rose, fell and increased. Sheer madness, as the wont of all stock markets. If you are wondering what might happens, don't. We predict that, together, higher demand from across the globe, supply disruptions and falling crude production will stabilize this wobble soon. Ultimately, the future for oil, as always, is bullish.