Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

To rioting Venezuelans and militant Nigerians, the oil market can add another group of malcontents: Brexiteers.

The first thing to say about how Britain's decision to leave the EU will impact oil prices, beyond what you can see on your screen right now, is that nobody has a clue. We're in "here be dragons" territory. To understand why, look at this FX chart -- which, I assure you, isn't yet another snapshot of the pound face-planting:

Goin' South
One of Brexit's immediate side effects was a drop in the Mexican peso against the U.S. dollar
Bloomberg

That Mexico's peso, like many currencies, is having a bad day just because 17 million-odd Brits cast a vote about their relationship with Europe tells you there are no simple correlations here. Oil fell sharply on Friday, along with most other risk assets, and in keeping with the typical response of commodities to a stronger U.S. dollar. But after that knee-jerk reaction, the next move is harder to forecast.

That's because Brexit's fallout for oil will have feedback loops that can both support and squash oil prices.

On the positive side, fundamentally nothing has changed since Thursday. Oil supply and demand continue to rebalance toward the point when the global glut of inventories will start to retreat meaningfully, either later this year or sometime in 2017. Yes, the U.K. and the EU are about to undergo a vast experiment unlikely to stoke much confidence for the foreseeable future. But they've been cutting their oil demand for years now, so it wasn't like anyone was banking on Europe to provide oomph to the market.

Crude Awakening
Brexit triggered an abrupt selloff in crude oil overnight
Bloomberg

And oil's sudden move back down to the mid-$40s will also likely deter at least some U.S. operators from pulling more of it out of the ground. Lower prices will also keep money tight in places such as Venezuela and Nigeria, prolonging and perhaps intensifying their instability. Yes, the logic is grim; but given the primary role supply disruptions have played in the recent oil rally, this could support oil prices in the months ahead.

Yet the same damage to sentiment -- and thereby access to capital and business confidence -- could also be oil's undoing. Emerging markets don't just produce a lot of oil, they are also the center of gravity when it comes to demand growth, likely accounting for 96 percent of it in 2017, the International Energy Agency forecasts.

For many months leading up to this week's debacle, global economic forecasts from the likes of the IMF and the World Bank have been steadily trimmed, with much of the concern centered on emerging markets. Apart from the immediate volatility sparked by the U.K.'s referendum, there are further risks to consider, not least in politics. The victory of a populist, anti-establishment campaign in one of the world's biggest, and supposedly most stable, economies injects further uncertainty into not just a fractious Europe but also, of course, November's U.S. election.

How will that play out? Again, nobody knows. Taking a longer-term view, though, here's one observation.

The last oil boom lasted roughly through the decade leading up to the end of 2014, and it was especially steep in the run-up to 2008. It resulted from a Chinese economy booming on the back of healthy growth in global trade, which in turn rested on growing or, at times, vibrant European and U.S. economies. On the supply side, it reflected a growing fear of Peak Oil. 

Where are we now? Peak Oil fears have given way to an oil glut. China is no longer booming quite as much and has built up enormous debt in an effort to maintain growth. The U.S. economy has recovered but bears heavy scars that occasionally come to the fore in the form of weak jobs numbers and sentiment indicators. And now Europe has taken a plunge into the unknown.

This doesn't guarantee lower oil prices. It certainly suggests another boom is off the table.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net