Brexit implications for North Sea oil and gas

The UK’s referendum vote to exit the European Union (EU) leaves huge uncertainty over the country’s economic outloook and its trade relations with its continental European neighbours. Here, analysts at S&P Global Platts, give their view on what the Brexit vote and its accompanying uncertainty mean for the North Sea and the Dated Brent benchmark.

The Brent benchmark relies on all parts of the North Sea industry, from the oil field to the refinery, being able to interact freely. As a result, the UK and the EU have many reasons for finding a way to maintain the status quo around the North Sea. Europe’s reliance on oil produced in Norway and the UK means the EU has little reason to raise barriers against UK crude. The EU has shown flexibility in the past, when it suited it, waiving tariffs on jet fuel imports for example. Meanwhile, the UK oil industry has grown reliant on EU labour and to some extent EU fabrication yards to make up for a lack of domestic capacity.

North Sea crude production outlook is unlikely to be materially affected by Brexit, and remains unchanged from S&P Global Platts’ December 2015 outlook.

The UK oil and gas industry is a large and mature business play, and as such, its development in the years ahead will be decided by oil price developments established by global market circumstances. With the pound at its lowest value to the dollar in decades, smaller UK-based production companies may face financing challenges, influencing output negatively. There is a ‘silver lining’ to the weaker pound in that ongoing operating costs largely will be in sterling, while oil revenues are in dollars, improving overall economics.

Fears that Scotland could split from the UK and take with it the lion’s share of the UK’s North Sea industry may prove overdone, but a significant issue facing the UK is the prospect of a second independence vote in Scotland. According to various sources, almost all the oil fields and more than half the gas production would fall on the Scottish side of any likely maritime boundary line. Uncertainty alone could lead to years of delay to new development projects, and put more weight behind any planned closures.

Brent-related Brexit discussions will revolve around issues such as tariffs on refined products and the future of UK crude exports to South Korea, a trade that has been enabled by the EU’s 2011 free trade agreement with Seoul and has in turn spurred shipments to East Asia generally. A regular flow of Forties – often the lowest-valued grade of the four in the Dated Brent benchmark – to Asia has kept the grade’s value, and in turn, that of Dated Brent supported in times of low demand. Brexit could change all that.

The UK’s 40-year dependence on the European single market would probably see it having to sign up to the European regulatory authority in order to get a foothold in trading with the EU. Many in the trading community feel that the status quo will likely remain regardless of a UK exit.

UK-based refineries, all of which are owned by companies based overseas, have voiced confidence that they can adapt to a UK outside the EU, following the dramatic referendum result. In terms of current product flows, the UK has long-established trading relationships with non-EU countries that would not be substantially affected by leaving the EU, but also trades with other EU countries. The main export of refined products from UK refineries is gasoline to the US and West Africa.

The Brexit vote has already led to a S&P Global Ratings downgrade of the AAA ratings on the UK and the Bank of England by two notches to AA. The ratings agency believes the ‘leave’ result will weaken the predictability, stability, and effectiveness of policymaking in the UK. But for the companies rated by S&P Global Ratings, the downgrade of the sovereign rating and country risk assessment doesn’t have a direct impact. This is mostly because the ratings on the companies are lower than either AAA or AA and the government is not a material shareholder. It is considered that Brexit could have a bigger negative credit impact for the smaller UK oil and gas E&P companies and also the oilfield service companies focused on the North Sea.

The market analysts at S&P Global Ratings see oil traders as relatively unaffected by Brexit, unless caught out as a result of market volatility and basic risk mismatches or as result of counterparty risk. This largely reflects the view that large traders, whether at oil majors or independent houses, need to have robust risk management and mitigation in place as an entry ticket.

From a financial perspective, there are also some less obviously possible consequences for oil company ratings. As economic and fiscal realities and forecasts change as a result of Brexit, there is an impact on companies’ other obligations such as pensions.