Making the best of Brexit

Colin Welsh, CEO of Simmons & Co. International Ltd.

August 1, 2016

The big surprise over the last few weeks was of course the UK referendum decision to exit the European Union (EU). At first sight, it looks like a vote for independence over economics. While the first part of that is certainly true, the economic aspect should be measured in years, and not days or weeks.

 

None of the politicians on either side of the debate emerge with any credit, given the widespread scaremongering, misrepresentation and duplicitous conduct on show. That has now been extended post-referendum with calls for the EU vote to be re-run and Nicola Sturgeon proposing a second Scottish independence referendum. Both suggestions represent an affront to democracy. They are also a big negative from an economic perspective because they exacerbate the uncertainty around the consequences of Brexit, which in turn jeopardizes key investment decisions.

Like it or not the people have spoken and both politicians and the public should accept and respect that decision, and get on with it.

Another important consequence of the vote to leave is that it has shone a light on the fragility of the EU. Italian banks are on the brink of a crash, and Greece shows no signs of an economic recovery after seven years of recession and needs for a third bailout. Factions in France and the Netherlands want their own EU referendums. To compound matters, European Commission President Jean-Claude Juncker, an unelected bureaucrat, has reacted to the vote more like a petulant schoolboy than a respected statesman.

The fact is that there is a deep interdependence between the EU and the UK, so it is in the interests of both parties to come to a deal that minimizes the damage to both. Contrary to recent political and media rhetoric, when the time comes to negotiate its exit from the EU, the UK will be in a strong position given the extent of the UK’s trade deficit with the EU (£24 billion in the first three months of this year alone) and because the UK contributes 12% to the EU budget (filling the gap will be a headache to the remaining members unless a phasing out can be agreed). The big issue is “Freedom of movement v. Free trade.” Given the UK voted for controlled immigration, not no immigration, it’s reasonable to assume that skilled negotiators (rather than politicians) on both sides will find a compromise that affords the UK Associate Member status. This would preserve existing free trade benefits without having to negotiate multiple individual trade deals.

As for the threat of another Scottish referendum, as a Scottish resident the feeling I get is that there is little appetite for that on the part of a referendum weary population. Moreover, the economics simply do not add up. Leaving the UK would put the £50 billion of annual Scottish exports to the rest of the UK at risk (Scotland exports just £12 billion to Europe). It would also forego the extensive subsidies that Westminster pays to shore up the Scottish budget deficit. In that event a combination of reduced public spending and higher taxes would be required.

As the drama plays out, the US dollar’s value continues to rise. That will make it more difficult for crude prices to continue their upwards march even though the supply and demand balance is tightening. On the other hand, UK companies with US dollar revenues will find a welcome tailwind. The big risk is that Brexit jitters somehow trigger a global financial crisis that significantly impairs crude demand. In that event, crude prices will be well down the queue in our list of worries. In times of great uncertainty such as these it is always best to remember that things rarely turn out as bad as we feared or as well as we hoped.

Colin Welsh is head of international energy investment banking at Simmons & Company International, part of Piper Jaffray. He studied accountancy, economics and law at the University of Aberdeen and qualified as a Scottish Chartered Accountant with Ernst & Whinney (now EY).