Beyond the North Sea - How did the energy sector dodge the Brexit fallout?

Feature | 22 August 2016

As a result of the Leave vote in the UK, volatility in financial markets has increased. Political uncertainty and risk aversion triggered strong movements on equity and currency markets. Nevertheless, the effect on oil and gas prices seems to be limited for the moment. This is not very strange as the UK is not a major oil producer. In fact, while producing about 900,000/bpd, the UK contributes less than 1% of the global oil production.

After Brexit, we revised our macroeconomic forecasts. The new forecasts can be found in our Global Macro View update.1 If the lower growth projections are translated into global oil demand potential, the impact proves to be limited as well. Growth expectations for the UK were revised downwards to 2%, the eurozone at 0.6% and the US at 0.3%.

This would roughly be a net effect of oil demand decreasing by about 160,000/bpd globally. This is a drop of 0.17%. The expected demand growth was forecaste at 1.5% per year. After Brexit, this could ease towards 1.3%. However, the effect can be smaller as, especially in the US, oil demand increases as a result of the driving season, especially in combination with the relatively low oil prices.



Brexit could threaten the North Sea's energy sector

During the last two years, oil prices were mainly driven by supply related events. The main reason for the price gains that started in January was some shifts in speculative positions, but they were mainly temporary production disruptions in Libya, Nigeria, Canada and Kuwait. Nevertheless, the effects of the global oversupply are still hanging above the market. This was a main cause of the immense drop in prices which started in the summer of 2014.

Despite the recent price rally, the downside risks for prices have increased after Brexit. However, upside risks have also increased. Investments in energy related projects (oil and gas) at the North Sea were already under severe pressure as a result of limited available budgets due to low oil prices. Furthermore, oil and gas production is under pressure as a result of the depletion of wells. Since Brent oil is the benchmark for North Sea oil it is very sensitive to developments in this region.

On top of the existing difficulties for the sector, the political uncertainty surrounding the future of UK politics is creating more risks. These risks are related to support for new energy related projects, not only oil and gas, but also for offshore wind projects. A new political landscape also increases the risks around the willingness of the government to provide these projects with subsidies. On top of that, there is the question of whether European trading partners are still interested in participating in such oil, gas, and/or offshore wind projects.



Currently, investors will probably take a wait-and-see approach before they agree to enter long-term investments. This could possibly delay projects which are strongly needed to reach the ambitious targets set by the EU for the reduction of carbon emissions and increase of renewable energy in the energy mix. These risks could also form a threat to the expected cost price reduction for offshore wind.

However, Dutch offshore wind farms Borssele one and two (both 350MW) were awarded by DONG Energy with an average bid strike price (excluding transmission costs) of €72.70/MWh during the first 15 years of the contract. The total net cost, including transmission costs, will be €87/MWh - the lowest price ever for an offshore wind farm. With this price, the governments' goal to achieve a 40% cost reduction before 2023 was already reached this week.

There is an adverse scenario in which Brexit has a stronger impact on global economic growth. In this risk-scenario, oil prices would be more affected and investment in the energy sector would face even more downside. In such a scenario, the US dollar would find strong support and the overall interest of investors in risky assets like commodities - including oil - would deteriorate. However, this is not our base case scenario. For more details about our current oil price forecast, refer to our recent Energy Monitor2 in which we raised our oil price forecasts. We still expect more sideways trading in Q3 2016.

Gas price volatility

Henry Hub natural gas spot prices jumped by more than 50% during recent weeks. This rally was the result of warm weather which lead to a rise in power demand, mainly for air-conditioning usage. Market expectations suggest that demand may remain strong during the coming weeks. However, as soon as temperatures start to normalise, the US gas price is likely to ease somewhat.



The transfer title facility gas price in the Netherlands also showed some increased volatility. This was based on the downward adjustment of the production ceiling for the Groningen gas field to 24 billion cubic meters (bcm) in 2016-2017. The Dutch government followed the advice of the Staatstoezicht op de Mijnen (SodM). SodM advised to lower production to a maximum level of 24 bcm and not even lower as production shifts could become too strong during extreme cold winters. The possibility to produce 6bcm on top of the agreed production ceiling during extreme cold winters remains in place. The Dutch government will review this policy again within five years from now and till then, it will keep production flat at the agreed production level.

As a result of the rising gas price, which rallied more strongly than European gas prices, the difference dropped to a factor of 1.6. This means that gas in Europe is 'only' 1.6 times more expensive than gas in the US. This is positive for the competition between European and US business. Since liquefied natural gas (LNG) prices also fell under pressure, this development could be beneficial for LNG shipments towards Europe. LNG prices are under pressure as a result of rising supply (mainly from Qatar, Australia, and the US), as well as a drop in demand from the top-consumer, Japan. Japan restarted some of its nuclear power plants to become less dependent on LNG-imports, which are more expensive than nuclear.

Hans van Cleef is senior energy economist



1. See ABN AMRO's Global Macro View:

2. June energy monitor:

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