The UK’s decision to leave the European Union sparked turmoil in financial markets around the world at the end of last week, but stocks rebounded on Tuesday in an early indication that the effects could be temporary. The surge in volatility seen in commodities, currencies and stock markets may not be over, but the massive sell off was probably a bit of an overreaction. Oil prices rose more than 2 percent on Tuesday, clawing back some lost ground.
Months from now, the effects of the Brexit may only appear to be blip on the radar for oil prices, a temporary downturn at the end of June that may sort itself out in short order.
But while the global effects will be muted, the Brexit is likely to have much greater effect on the domestic British oil and gas industry. The North Sea still represents a large source of oil output at roughly 1 million barrels per day, but the Brexit could compound an array of already existing challenges facing the oil-producing region.
Because the North Sea’s oil fields are decades old with most in decline, the region suffers from high-costs. For many companies, there are not large prospects for growth. North Sea oil production did actually increase in the past two years, but that new output came from projects planned years ago when oil prices were in triple-digit territory.
The reality is that today, many companies are abandoning the region, decommissioning oil rigs and platforms and shutting down infrastructure. Low oil prices could force the shutdown of a series of North Sea oil wells much earlier than expected, and some estimates project 150 platforms decommissioned over the next decade. That becomes a problem for oil companies that want to stick around – having fewer peers to share the cost of infrastructure makes it that much harder for firms that want to maintain a presence in the North Sea. Decommissioning infrastructure will be a much faster growing industry than oil exploration in the North Sea in the coming years. Related: Did Brexit Kill The Oil Price Rally?
That was all before the Brexit. The UK leaving the European Union could make things worse. On the one hand, London sets a lot of rules, regulations and levels of taxation. Brussels had less control over offshore oil drilling than some other sectors of the European economy. The regulatory regime may not change much.
On the other hand, the Brexit could spark a chain of events that quickly starts to change the North Sea operating environment. Scotland’s First Minister Nicola Sturgeon has already announced plans to pursue a second independence bid in an effort to keep Scotland within Europe. There is quite a deal of momentum for independence at this point with so many Scottish voters opting for “Remain” in the Brexit vote. That makes Scotland’s second bid for independence a very real possibility.
Many oil fields in the North Sea are actually off of the coast of Scotland, so Scottish independence would force a change in sovereignty over those resources. Some of the assets would be split, possibly along existing maritime borders used for fishing, which Bloomberg says would hand Scotland 96 percent of annual oil production and 47 percent of natural gas production.
The UK would lose out bigtime, and oil companies in the North Sea would face a different sovereignty structure. Of course, the Scottish independence movement has gone to lengths to describe the North Sea oil sector as a crucial pillar to the country’s potential independent economy, so there would be little incentive for the Scottish government to scare away investment. But in a region that is already losing its competitiveness, an independence vote – which could take years to pull off – creates another layer of uncertainty. Related: Does The U.S. Really Need A Strategic Petroleum Reserve?
"Many of the operators and service companies with Scottish operations are global by nature and the most important thing is Scotland remains an easy and profitable place to do business,” Andrew Speers, CEO of oil and gas recruiter Petroplan, told CNBC.
British oil companies are on alert after the Brexit vote. “The U.K. oil and gas industry is at a critical juncture and we need to ensure the U.K. continental shelf continues to attract investment,” Oil & Gas U.K., an industry trade group, said in a statement on June 24.
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The one upside to a Brexit could be a weaker British pound, lowering the costs for North Sea oil producers. While that may be comforting, it may not be enough to compensate for years of political and legal uncertainty.
By Nick Cunningham of Oilprice.com
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