The latest worry for oil bulls: Brexit, which has already sent the price of crude tumbling. What does last week’s vote mean for energy prices on this side of the pond?
As with most financial markets, the oil market seemed to be betting that British voters would reject a referendum to leave the European Union. In the days leading up to the vote, when bookies were heavily favoring a “remain” outcome, U.S. benchmark West Texas Intermediate was on the rise. By the eve of the vote, WTI had crested $50 per barrel, having nearly doubled from its February low of $26.21 per barrel. Traders must have been figuring a remain vote would put the long-simmering issue of the U.K.’s membership in the EU to rest, allowing markets to focus on the fundamentals of supply and demand.
Some further modest price increases looked like a good bet. Prior to the vote, we were figuring that WTI could move a few dollars per barrel higher this summer. After all, this is shaping up to be one of the busiest travel seasons on record, and Americans continue to snap up new SUVs and pickup trucks instead of hybrids and other gas misers. Heavy demand at the pump normally means refineries are running nonstop and buying plenty of crude oil.
And then, suddenly, things changed. To the surprise of almost everyone, the final tally showed the Brexit campaign coming out on top with nearly 52% of the vote. Markets everywhere tanked, with the notable exceptions of safe sovereign debt, certain safe-haven currencies such as the yen, and precious metals. Oil, being a risky asset that buyers flock to when times seem good and flee when signs of trouble emerge, joined stocks in the sharp, post-Brexit sell-off. After briefly breaching the $50 mark, WTI promptly slid to $46 per barrel by the Monday after the referendum, only to soar again on Tuesday and Wednesday as financial markets rebounded.
Where do things go from here? First, an easy forecast: Oil prices will remain volatile. After prices slid to that February low of $26.21 and then rocketed to $50 four months later, investors should expect the big swings to continue, for the simple reason that there are so many forces trying to push or pull crude prices in different directions.
Supply outages from Canada to Nigeria helped fuel the big spring rally, and new cutbacks can never be ruled out in a world beset by terrorist threats and political instability. But at the same time, global stockpiles of oil and refined fuels are bulging, and big exporters such as Russia and Saudi Arabia are pumping flat-out. So supply could continue to swamp demand. Meanwhile, concerns about the health of the global economy are mounting, especially in light of the latest EU crisis. Plus, any further weakening in currencies such as the British pound and the euro means a relatively stronger dollar, which makes dollar-denominated crude oil more expensive for foreign buyers and tends to suppress consumption.
Our best guess as to the direction of oil prices in the near term: A bit lower than crude had been trading recently, followed by the possibility of a modest midsummer rally. Barring a financial crisis or a nasty slide in the global economy, $45 per barrel seems like a reasonable floor for oil prices. As the season progresses and gasoline demand heats up, a return to $50 or a bit higher wouldn’t be surprising, though we would expect any such rally to be fleeting. By the end of September, when the summer driving season is over and demand cools off, we look for WTI to trade from $40 to $45.
In the longer run, crude could push higher because of today’s relatively low prices. Drilling activity continues to weaken and oil companies are nixing the sort of big projects that are needed to keep future supply in line with demand. If investment falls further, warns Prestige Economics President Jason Schenker, “the medium-term upside risks for oil prices are significant — especially in the 18- to 24-month window.” So for long-term oil investors, the more pain they absorb now because of Brexit, the more gain they could eventually reap down the road.
Natural Gas: “Brexit? What Brexit?”
Looking for an investment that won’t be buffeted by the aftershocks of the Brexit vote? Consider natural gas, the price of which barely budged after last week’s referendum. Unlike oil, which flows freely around the world and sells for similar prices in most countries, U.S. natural gas is still largely locked within the lower 48. A trickle of liquefied natural gas is starting to reach overseas markets, and more gas reaches Mexico and Canada by pipeline. But the vast majority stays within U.S. borders, making America its own unique gas market.
Natural gas has been enjoying a sizzling rally lately. The benchmark gas futures contract fell to a multidecade low of $1.64 per million British thermal units (MMBtu) this winter because of unseasonably warm weather and weak heating demand. Even as recently as mid-May, gas traded for about $2 per MMBtu. But since then, it has soared to $2.80 as hot weather in the western U.S. has ramped up electricity demand. Gas-fired power plants, which now account for more of the nation’s electricity than any other source, are working hard to keep up.
But this looks like one rally that may be running out of steam. Stephen Schork, editor of the energy trading newsletter The Schork Report, says he was not surprised by the late-spring rally, noting that summer weather forecasts calling for continued heat are “as bullish as it gets” for natural gas. Still, he predicts that gas held in storage will grow to a new record high by the end of the autumn, which should curb further price gains. And the downturn in manufacturing means that factories and other industrial customers are burning less gas this year than they did in 2015. The bottom line: If natural gas prices haven’t peaked already, they will soon, he reckons.