Why Oil Traders Are Rooting Against a Brexit
Money + Markets

Why Oil Traders Are Rooting Against a Brexit

© Luke MacGregor / Reuters

British voters are set to vote this week on whether to stay within the European Union or to break up and go it alone. Although the vote and the campaign largely focuses on highly controversial issues like immigration, the result could have profound implications for the global oil markets.

The connection between the Brexit vote and oil prices is not obvious on its face, but some oil analysts see the UK leaving the EU as a huge threat to the faltering oil price rally. There are several reasons for this.

Related: Which US Companies Would Be Hurt Most by a Brexit?

First, a Brexit creates an enormous cloud of uncertainty over global financial markets, particularly for higher risk classes. Second, the European economy has limped along for years, but a political fracturing could dent economic growth, putting pressure on oil demand.

Third, a Brexit will also have currency implications. The uncertainty surrounding the British and European economies will depress the pound and the euro. That will push capital flows into the dollar, strengthening the greenback, which as always, has a depressing effect on oil prices. “If it’s Brexit, then the macro picture would be quite bearish for oil and the dollar will strengthen—that’s a recipe for a correction” for crude oil, Doug King, chief investment officer at RCMA Asset Management, told The Wall Street Journal in an interview. In short, a “Leave” vote will likely cause oil prices to fall this week.

Related: Brexit: Who's Really to Blame for Europe's Mess

For evidence of this view, look no further than the horrific events last week in the UK, when a British MP was slain by an attacker who reportedly yelled “Britain First.” Following the shocking event, both sides of the Brexit debate suspended the campaign, and the markets responded by bidding up global equities and commodities on the belief that British voters would be revolted by the news and vote to remain within the EU. Oil prices surged by 4 percent on June 17.

But the events are highly fluid and the outcome is far from assured. That makes the June 23 vote an important catalyst for short-term crude movements. A vote to remain would strengthen the sterling at the expense of the dollar, pushing up oil prices. A Brexit would have the opposite effect.

There are also some long-term, if vague, implications for crude oil if the UK leaves. A Brexit increases the political instability in Europe, which is bearish for commodity demand. “If the Brits vote to leave, other nationalistic voices in Europe could grow louder, leading to more referendums across Europe—and that is a negative scenario for oil demand in the longer term,” Tamas Varga, an analyst at London oil brokerage PVM, told the WSJ.

The debate on whether or not the UK should leave is highly divided, but for oil bulls, the preference should be clear.

This article originally appeared on OilPrice.com. Read more from OilPrice.com:

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