The U.K. has chosen to leave the European Union (EU). The news caused major disruptions in the world’s stock market and currency markets. But let’s take a look at the Brexit’s impact on oil.
Oil prices have been recovering since hitting their 13-year lows in the first quarter of 2016. However, the Brexit news just put a sharp stop to that trend. On Friday, West Texas Intermediate (WTI) crude dropped 4.7% to $47.77 a barrel, while Brent crude also dropped 4.7% to $48.52 a barrel.
One of the reasons behind oil’s sharp drop is the Brexit’s implication for the global economy. After results of the referendum showed a 52–48 win for leaving the EU, the Brexit is now more than just a small possibility. Based on the market’s reaction, Britain leaving the EU could cause major disruptions to Europe’s politics, as well as economic growth.
If Europe’s economic growth slows down, it could weaken the demand for oil. Also, since world economies are interconnected these days, economic downturns in the U.K. and Europe could cause a domino effect on other continents, further impacting the demand for oil.
Moreover, right now, “flight to safety” seems to be the overwhelming mentality in the financial markets and there’s a good reason for it. In the currency market, the British pound plunged as much as 10% against the U.S. dollar, hitting the lowest level in 31 years. Even the euro dropped more than four percent against the dollar before recovering, an unusual move for the largest currency pair.
And when you look at the stock market, things are just as bad. In Europe, the FTSE 100 slipped 2.8%, the DAX was down 5.8%, and the CAC40 plunged an even eight percent. Shockwaves from the Brexit also traveled across the Atlantic. In the U.S., both the Dow and the S&P 500 dropped 2.6%, while NASDAQ plunged 3.2%.
When the global stock market is crashing, investors often go to safe haven assets. That happens to be the case this time, too. Gold, for instance, shot up 4.6%. However, for assets that are known for their volatility and sensitivity to business cycles—like oil—the news of the Brexit does not bode well.
This “flight to safety” mentality could also lead traders who were previously betting on oil’s rebound to close their positions. When the market turns to “risk off” mode, oil is probably not the place you want to put your money.