BANKER'S TAKE
As Europe tries to contain populist movement’s within its member states in the wake of Brexit, the UK parliament will be trying to decipher how they will manage the mandate handed down to them from the referendum which has split the country more than the continent. The Conservative Party will need to clear its thoughts prior to discussion in the parliament as the result of the referendum does not reflect the manifesto of any political party but a group of politicians from multiple camps. The situation UK finds itself in is their own making and it highlights an important lesson in statesmanship; matters of such national importance should not be handed down to public rhetoric.
Oil industry in the meantime has continued its recovery on the side. There seems to have been method to the madness when Saudi Arabia claimed that oil production will continue to be the right of countries having the lowest cost base. The dichotomy Opec faces within its ranks is very difficult to manage and the disparity between oil producers is getting wider at the prevalent oil prices. Brexit will pose interesting challenges as US dollar strengthens and pushes commodity prices down.
The yellow brick road post-Brexit
Her Majesty’s Treasury had identified three detrimental possibilities citing contraction of economy ranging from 3.4% to 9.5% if Brexit was to become a reality. There was a flurry of diplomatic missions to London highlighting that they would be better off as part of the larger Union than being alone, however, the vote on Friday demonstrated that the people of the Island were determined to march ahead without the larger economic bloc and potentially also without Scotland, if Edinburgh also holds a plebiscite and gets unexpected results.
As a consequence of the vote, 10 Downing Street saw the prime minister resign, The FTSE 100 fell 8%, a big sell-off of bank shares caused key banks to lose more than 30% of their market cap; GBP fell more than 10% to levels not seen since 1985. Bank of England had to ensure market stability allocating GBP250bn of extra liquidity to support the banking sector. The remaining 27 members of the European Union realised that contagion populist movements in France and the Netherlands could become a reality.
The referendum in Britain has given a desired direction by the people; it is up to the British parliament to chart the road map to enable this. While no precedence exists, EU exit is unlikely to be an automated process; instead it will be a demonstration of complex diplomatic manoeuvring between Britain and the 27 EU states. Under article 50 of the Treaty of European Union, UK has to notify the European Council, which will be done post deliberations in a divided and confused Conservative Party who is not sure of the stance it needs to take in the UK parliament. Once this is done and UK has decided how to manage its European neighbourhood, its allies in Asia, Africa, Americas, Australia and Middle East; UK will have two years to secure 20 of the 27 votes to exit eurozone. The impact of Brexit therefore on the remaining world will depend on negotiations the office at 10 Downing Street can get done with its neighbours and global allies.
Oil, convergence of divergence
Across from the troubled Continent in the meantime, Opec courts countries with weak economic fundamentals even when oil was trading at USD 100 levels; with prices ranging between $35 and $50, this fragility has been amplified. The current range of oil price is in a comfort zone, it is not high enough for the weak economies in Opec to enable an attempt to rescue their fragile economies nor is it low enough for the world to take any dramatic steps.
In order to reach the current levels, production cuts were an essential move, which occurred in May 2016 not by Opec design but by chance. Combined oil production disruption was estimated at 3.6mn barrels a day. Venezuela, struggling with a serious financial crisis that includes commodity shortages and power cuts; Nigeria halved its production due to militancy, Iraq facing a never ending political and security vacuum and Algeria managing reduced oil output. Outside of Opec, Canada has also recorded decline in oil production due to wild fires in Alberta.
The oil market however benefited from this curtailment. This adversity of Opec’s ‘Feeble 5’ is advantageous for demand and supply of overall oil industry as it takes away part of the glut without any Opec action.
Brexit and the commotion around it will strengthen USD and weaken commodities especially oil and we will see correction in the coming weeks as currencies weaken against the green back.
Brexit courtship with GCC
Oil producers are still reeling under pressure from budgets that were tested with low oil prices and liquidity squeeze in the GCC banking sector. Current oil prices are better than the start of the year; however, the oil economies are far from being out of the woods. Brexit has further compounded matters with suppression of revenue streams from over USD 200B worth of real estate assets owned by GCC in UK. GBP weakness and S&P downgrade of UK will continue to deteriorate yields. In addition, property valuations are also expected to see a correction between 7% and 10% which will erode net worth over and above GBP weakness. Overall therefore, revenue streams from hydrocarbons and investments will come under pressure in 2016 owing to USD strength.
The uncertainty that has been caused by this referendum will settle soon with the exception of Federal Reserve and their desire to raise interest rates. It is likely, with Brexit in view; rate hikes will get stalled for a longer time, with a robust and strong pipeline for borrowing planned from the GCC; the sovereign and large rated corporate issuances will greatly benefit from suppressed interest rates and availability of term liquidity in the US and Europe. There will be a good time to tap these markets soon and bring home much needed liquidity to the corporates and sovereigns in the region. Valuation correction will also provide very interesting opportunities in the UK, it will remain to be seen how the GCC investors look at Britain without Europe and London without its status as a global financial hub.
* Salman Gulzar is head of corporate banking at Mashreq Qatar.
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