Brexit Impacts: What Could We Expect?

On June 23^rd, voters in the United Kingdom (UK) went to the polls to vote on whether to stay in the European Union (EU), a group of 28 member states that the UK has been a member of since 1973. To the surprise of financial markets, the final vote was in favor to leave the EU (52% to 48%). This vote triggers a new British government to come into office and start the process of leaving the EU.

The most direct Brexit impacts included a drop in the British Pound (GBP) against the U.S. Dollar (USD) of 10%, as well as a sell-off in equities and crude oil. Longer-term impacts on the UK, the fifth largest economy in the world, will be played out in the years to come.

While voters in the “leave” camp prevailed, the process of the UK withdrawing from the EU will likely take up to two years. This is outlined by Article 50 of the EU’s Treaty of Lisbon, which governs a member’s departure. No member has ever left the EU. Brexit will likely produce uncertainty as terms are negotiated and markets digest the change. As the second largest economy in Europe and the largest exporter of financial services, tariffs on goods as well as mobility of EU citizens to work in the UK will likely need to be negotiated. A new Prime Minister, Theresa May (formerly Home Secretary), will take on the task to arrange the exit of the UK from the EU.

Impacts on U.S. Energy Markets

The biggest impact to U.S. energy markets might be the boost in U.S. dollar value and Liquefied Natural Gas (LNG) imports. On the day of the vote, the GBP/USD exchange rate was 1.49. That declined to a recent low of 1.29 on July 7th. This is the lowest value of the GBP versus the USD since the early 1990’s. If the Pound and Euro should both weaken against the Dollar, oil prices could face downward pressure. It would take fewer dollars to buy the same barrel of oil since oil is traded in USD on the international market. U.S. crude oil (WTI) prices traded above $50/bbl in early June. The day after the Brexit vote, prices declined to $46.

So, what does this mean for U.S. natural gas markets? A decline in oil prices to below $40/bbl could hinder deployment of oil rigs. This could lead to a sustained decline in “associated” gas output, or gas that is recovered along with oil output. A longer-term effect of Brexit could be demand for imported LNG into the UK. According to the Federal Energy Regulatory Commission (FERC), global LNG is trading in the $4.25-4.75/MMBtu range as of May 2016. These are historically very low prices compared to the last few years when it traded in the $8-12/MMBtu range. Longer-term, a weaker Pound could make British imports of U.S. LNG more costly. This could impact UK industrial demand.

Impacts on the UK Economy

On a macro financial level, the Brexit crisis could present a challenge for central banks. The banks may be limited in the measures they can take to stimulate growth due to already low interest rates.

The fallout of Brexit on the UK economy is being monitored by the Bank of England (BOE) for any negative “shock”. The BOE’s Governor, Mark Carney, said in recent weeks that an interest rate cut may be needed to help bolster the UK economy. On July 14th, the BOE’s Monetary Policy Committee (MPC) announced they will wait until August to start stimulus programs as a result of Brexit. A severe recession in the UK could impact U.S. export levels and U.S. GDP (gross domestic product).

Since 2009, central banks have cut interest rates and used quantitative easing to help fuel economic demand. One concern now is that a negative “shock,” such as Brexit, could leave little room for central banks to maneuver. The U.S. Federal Reserve is one of the few central banks with guidance on raising rates in the next 12 months. Though, post-Brexit vote, any interest rate hike by the U.S. Federal Reserve is now not likely in the short-term. The key benchmark, German 10-Year Bonds, are negative (-0.90%) according to Citibank. This could imply that European Central Bank (ECB) policy makers may be limited as to measures they can take.

The prevailing “Leave” vote of Brexit caught many in the financial markets off guard. Still, the process of the UK actually leaving the EU over the next two years could be an uncertain, and at times, painful process. U.S. economic growth could be negatively impacted if both the UK and many EU countries fall into recession as a result of trade barriers being erected between the EU and UK.

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