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Why German industry should fear a no-deal Brexit

The outlook for carmakers has worsened dramatically since the UK’s EU referendum

Some events intrude. And some fail to intrude. The promised reassertion of parliamentary control over Brexit was one of the latter. The House of Commons has rejected a cunning mechanism that might have procured a Brexit reversal.

Then there is the category of events that did manage to intrude, but not in an obvious way. An example would be Donald Trump’s threat to impose tariffs on car imports. But what has that got to with Brexit? The anticipation of the US president’s tariffs has the potential to change the way the EU will look at its future trading relationship with the UK.

To understand this, let us imagine that the Brexit talks were to break down. The UK would crash out of the EU in March next year with no transitional deal in place. British goods entering the EU would be subject to EU tariffs, and vice versa. The EU levies a 10 per cent tax on car imports. The UK could levy reciprocal tariffs.

Now consider the position of German carmakers. According to the German association of the automotive industry, the country last year exported 769,000 cars to the UK, its single largest export market. The US came second with 494,000 cars. German carmakers also export 258,000 German-made vehicles to China, plus those produced in US and Chinese factories.

If the UK were forced into a cliff-edge Brexit in March, the German car industry would face tariffs in its two largest export markets within a few months of each other. Daimler-Benz issued a profit warning last week, and this only in relationship to the expected rise in Chinese tariffs on Mercedes cars made in the US.

Just imagine what might happen once the US levies tariffs on European cars sometime in 2019, and possibly only a few months after Brexit. If the UK were to join in a tariff war, the industry would suffer the commercial equivalent of a cardiac arrest.

This would come on top of an escalating diesel emission scandal. Mercedes may need to recall 774,000 cars to remove software-cheating devices. Add to this the long-term commercial impact of diesel bans in cities, the surge in sales of electric cars and the complex impact of artificial intelligence, and the outlook for the German industry has worsened dramatically since the Brexit referendum.

Of course, the EU is not negotiating Brexit for the benefit of German industry. Nor should it. Angela Merkel said after the 2016 Brexit referendum that she does not want industry bosses to intervene in these delicate negotiations. But the German chancellor does not have the political room for manoeuvre she needs to persevere with a stance that could risk the loss of hundreds of thousands of jobs. The last thing she needs is an intra-European trade war.

Geopolitics have also changed since the Brexit referendum. Mr Trump poses a dual challenge for Germany and the EU — both on trade and foreign policy. His withdrawal of the US from the Iran nuclear deal and the Paris climate agreement have brought the EU and the UK closer together. Meanwhile, UK prime minister Theresa May has turned out to be a reliable ally for the EU. The interests of the UK and the EU are more aligned now than they were two years ago.

A customs union with a single market access for goods only would go a long way to serve the mutual interest, more than any of the other Brexit blueprints that carry the names of the countries with whom they were negotiated: Norway, Switzerland or Canada. It would minimise the economic effects on both sides, respect the commitments on the Irish border, and maintain the integrity of the single market.

For a deep customs union to work, manufactured goods would remain subject to the rules of the EU’s internal market. The UK would formally become a member of the single market. That said, the EU is in a position to offer a tailor-made customs union agreement, for goods but not services, with the various rights and obligations that come with this arrangement.

Would this turn the UK into a vassal state as some of the Brexiters are claiming? Of course not. The UK would not be subject to the European treaties. The customs union would set clear but finite limitations on sovereignty: no third-country trade agreements in respect of manufactured goods; acceptance of the EU’s product standards; and a minimum commitment on freedom of movement but well short of the obligations that apply today.

This is no comparison to the constraints on sovereignty that come with full EU membership. And these concessions are trivial compared to the crippling economic, social and political costs of a cliff-edge, no-deal Brexit.

The decisive argument in favour of a customs union is that important events have intruded since the referendum, for the UK and the EU too.

Weatherford International targeted by activist investor

Q hits at ‘woefully inadequate’ attempts to turn round oilfield services group

Weatherford International, one of the world’s largest oilfield services groups, is being targeted by an activist investor after a decade of underperformance. 

Q Investments, a Texas-based hedge fund, has taken a small stake in Weatherford and urged the board to sell its assets or the entire company, before its “over-levered capital structure” destroyed “what remaining value the shareholders have left”.

Weatherford was often described as one of the “big four” international oilfield services companies, along with Schlumberger, Halliburton and Baker Hughes, but its performance has lagged far behind its peers since then.

In 2008 Weatherford’s net income was about $1.4bn, close to that of Baker Hughes at $1.6bn. Today its market capitalisation is about $3.3bn, while the equity in Baker Hughes, which last year merged with the oil and gas division of General Electric, is worth about $40bn.

Weatherford’s shares have continued to underperform the leading companies in the sector as crude prices have rebounded. Over the past 12 months, Halliburton’s shares have risen 10 per cent, while Schlumberger’s have risen 2 per cent. Weatherford’s have fallen by 16 per cent. 

Mark McCollum, a former chief financial officer of Halliburton, was appointed chief executive of Weatherford last year to turn the company round. In November he launched a “transformation programme” intended to improve operating earnings by $1bn a year, but analysts say investors have yet to be convinced that Mr McCollum can succeed.

Kurt Hallead of RBC Capital Markets in a note this month described the shares as “a special situations stock”, that investors would buy only if they believed the company could achieve the $1bn improvement in earnings, generate free cash flow and reduce net debt, which stood at $7.3bn at the end of March.

Brad Handler of Jefferies said: “Mark McCollum has a good track record, and is well respected in the industry. But it’s going to take a while to achieve the results he wants to see.”

Q, which specialises in distressed debt as well as activism, has previously targeted companies including Jones Energy, Citadel Broadcasting, Quorum Health and Houghton Mifflin Harcourt, pushing for moves including share buybacks, board changes and a takeover. 

Its stake in Weatherford is just 0.02 per cent, but the fund believes that other investors are also unhappy about the company’s performance and will join its campaign for change. It has invested in a mix of equity and debt as a hedge against a possible restructuring. 

In a letter to Weatherford’s board, the fund criticised the efforts by Mr McCollum to turn round the company’s performance as “woefully inadequate”.

Q wrote in its letter that if Mr McCollum failed to deliver his projected improvements in performance, “we believe the status quo would be unsustainable”.

In that case, the fund said, it would call for “a process to explore all strategic alternatives, including a focus on selling the company through an equity transaction”. It added: “We believe the most viable path would be to sell the entire company; however, we would be open to any and all alternatives”.

Weatherford declined to comment.

Investors’ faith in the company took a blow at the end of last year, when it announced that a promising-looking joint venture with Schlumberger in hydraulic fracturing in the US had been abandoned. Instead Weatherford sold its operations in that business to Schlumberger for $430m. 

Q argued in its letter that what it called “the current dilapidated financial condition of the company” masked its “underlying strong portfolio of businesses and technologies”. It pointed to the company’s pumps and other services as “crown jewel assets” that could fetch buyers. 

The fund is not calling for new board members yet, but said it was “incomprehensible” that six directors who were in place during the tenure of the previous chief executive Bernard Duroc-Danner were still on the board.