Brexit Just One of Many Risks for Oil Prices

 

Once global financial markets stabilise after the referendum result, analysts say the most likely near-term outlook for oil is decline, either through dollar strength against the pound in the event of "Brexit", or through a renewed focus on oil supply and demand if Britain opts to stay in the EU.

 

The oil price has risen nearly 40 percent this year to around $50 a barrel, driven by unplanned outages around the world that have tempered a widely anticipated supply glut.

 

"Scenario A: there is 'Brexit', in which case we're likely to see the commodities complex dragged down through the channel of a stronger dollar," said BNP Paribas head of commodity strategy, Harry Tchilinguirian.

 

"Scenario B, there is a 'Bremain' outcome, in which case our scenario is basically an eventual shift in focus back to the fundamentals," he added.

 

"Either way...it may be interesting to take up some insurance and buy downside protection." BNP Paribas does not take a view on the likely outcome of the EU referendum.

 

Capital Economics chief economist and head of commodities research, Julian Jessop, says broader market reaction will depend on how much support a "leave" or a "remain" result has, but the response in oil is likely to be less nuanced.

 

"It's more black and white for (the oil market), whether it's a vote to leave, or a vote to stay," he said.

 

Optional Options

Investors may seek protection against price swings through put options that allow them to sell the underlying asset at above the current price.

 

Such options tend to be cheaper than calls, or options to buy below the current price, when investors believe the oil price is likely to rise over the longer term.

 

A put expiring in one week for one August Brent futures contract at a strike price of $45 a barrel costs 12 cents, while a call at the same strike price costs $5.77.

 

Buying protection through these "out-of-the-money" puts might seem like a bargain, but it is not for the faint-hearted, BNP Paribas's Tchilinguirian said.

 

"Should extreme price moves ensue, then getting out of your position may prove difficult. You need to evaluate if there is going to be sufficient market liquidity," he said.

 

Societe Generale oil analyst Michael Wittner expects oil to drop sharply in the event of Brexit, as risk aversion takes over, albeit temporarily.

 

"While a Brexit may result in further sentiment-driven price declines at the front of the crude forward curve of around 5 percent, we would expect any such weakness to be temporary," Wittner said.