What If Steel And Aluminum Import Tariffs Are Extended To The Oil Industry?

Summary

• This week President Trump’s announcement of a 25% tariff on steel imports and a 10% tariff on aluminum imports caught the market by surprise.
• Crude oil is as strategic (if not more) to the US as steel and aluminum are and this further move cannot be completely ruled out.
• U.S. crude oil imports are rapidly decreasing every year and even more so from outside the NAFTA region.
• Any tariff on crude oil imports would spark a rally in WTI prices and move it significantly higher than Brent which would hurt US refineries and benefit oil producing companies.
• A 10% tariff on crude oil imports can make the WTI-Brent Arb go above +$5 while a 25% tariff can make it go above +$10.

This week President Trump’s announcement of a 25% tariff on steel imports and 10% imports on aluminum caught the market by surprise. It was widely criticised in the international media and leaders from Canada and the European Union (EU) threatened to retaliate. EU’s Jean Claude-Junker told German television "We will put tariffs on Harley-Davidson, on bourbon and on blue jeans — Levi's,".

(Source: EU threatens Trump with Harley-Davidson, bourbon and Levi's tariffs)

Since this topic is just a few days old, we don’t know the full extent and depth of how far these trade wars can go. U.S. tariffs on the steel sector is not new. President George W. Bush had implemented them in March 2002. The tariffs were lifted in December 2003 as research showed it caused adverse effect on U.S. employment and growth. (Source: 2002 United States steel tariff - Wikipedia)

The tariff then excluded NAFTA nations such as Canada and Mexico as it would have violated the rules of that organization.

This time around, we are unsure of whether NAFTA countries will be excluded. The impact of these tariffs would significantly harm Canada as it exports 90% of its steel to the U.S. (Source: Trump's steel and aluminum tariffs last thing 'kicked when down' Canadian economy needed now).

The proposed tariffs on steel and aluminum imports have already rattled the U.S. Energy industry. Executives worry that the cost of producing and moving oil will only increase if these tariffs get approved. If these tariffs do eventually get approved, it will lift the cost of oil production in the U.S. and reduce the oil production growth forecast for shale oil producers.

(Source: U.S. energy industry slams Trump's 'job-killing' steel tariffs)

With President Trump, anything is possible and there is no point looking at historical comparisons. If these trade tariffs are passed into law, we should expect retaliation from other countries and further industries can be included. Crude oil is one such sector given the strategic importance and every President’s dream to make U.S. energy independent.

Declining Crude Imports

US crude oil imports have continued to steadily decrease in the last 7 years. They averaged around 9-10 million barrels per day in 2011 and has recently reached a low of 7 million barrels per day.

Source: EIA

If you exclude imports from the NAFTA nations such as Mexico and Canada, the speed of decline in imports looks even more impressive. The imports excluding Mexico and Canada have halved from around 6 million barrels per day in 2011 to 3 million barrels per day according to the latest weekly data from the EIA. U.S. refineries consume around 17.5 million barrels per day, so that makes imports from non-NAFTA nations less than 20% of total crude oil demand. This number is a lot lower when looking at overall imports and President Trump might think tariffs can make this number go down to zero.

Source: EIA

Impact on the oil market

Any tariffs on U.S. oil imports would have a huge impact on crude oil flows and pricing benchmarks such as WTI and Brent. In the last 7 years, WTI has been positive over Brent only briefly in 2010 and then again in 2016. Most of the time it has traded at huge discounts vs Brent due to rampant shale oil production growth and pipeline constraints in Cushing, Oklahoma. A 10% tariff can make WTI easily trade $5 over Brent and a 25% tariff can make the WTI-Brent arb over $10.

Source: CME

This would severely harm Valero (NYSE: VLO), Phillips 66 (NYSE: PSX) and other independent refiners whose biggest cost is the cost of crude oil. U.S. refiners such as Valero and Phillips 66 have upgraded their refineries and used cheap U.S. crude oil linked to WTI to rapidly increase their refined product exports. Companies like them have turned the U.S. into a huge refined products exporting nation.

An increase in WTI price would kill their refining margins and reduce their competitiveness to export outlets such as South America. European, Middle Eastern, and Asian refineries will be able to price their refined products more competitively as their barrels are more linked to the international marker Brent.

Source: EIA.

On the other hand, oil producing companies such as Continental Resources (NYSE: CLR) and other U.S. domestic producers would greatly benefit from higher WTI prices. The recent decision to allow U.S. crude exports has lifted WTI prices relative to Brent and a future potential ban on imports will help these producer companies even further.

Second guessing President Trump’s next move is an impossible task and the likelihood of putting on tariffs on the oil industry seems low for now. However, if trade wars do escalate the oil industry will be very likely to get included.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[arbitguy]

David:

Oil tariffs would do no good; that is why they will not be proposed. The function of tariffs is to protect a high-cost industry. WTI sells for less than world crude so it needs no price protection. And, as you point out, even with increasing production, we still need to import millions of barrels a day that we cannot produce here in sufficient quantity.

This article is just a silly fulmination by the author based on his own imagination and nothing else.

[OILytics]

Hello David,
Thanks for reading the article. Tariffs on oil imports is an unlikely event but should be kept in mind in case the situation gets out of control due to retaliation by other countries. To answer your questions:
1) Yes, they did do that with the steel tariffs in 2002.
2) Not wise, but possible. Saudi imports into US have dwindled in the recent years (0.69mmbd as of latest monthly data). Saudi's major export market is Asia.
3) Will not be popular but can be seen as an alternative to oil consumption tax. Europe heavily taxes consumers on gasoline and diesel. An import tariff would be an alternative tax. There have already been some talks of some kind of gasoline tax to help fund roads/highways.
4) US import less than half of their crude requirements now. But even less so for non-NAFTA.
5) Agree, no good would come out of this. Same thing can be said for steel and aluminum yet here we are.

[David de los Ángeles Buendía]

Hello Oil Unhedged,

1) The question is could the United States create tariffs that only apply to non-NAFTA countries?

2) Forgetting the above, think of this as a practical matter, two can play the tariff game. Is it really a wise strategy to enter into a tariff war with Saudi Arabia? They are an important strategic ally in the oil producing regions of the world.

3) Forgetting all of the above, can you really see the United States Congress passing such a tariff, basically increasing the price of petrol in the United States? How popular would that be in an mid-term election year?

4) Forgetting all of the above, the United States still imports the majority of its petroleum. In what way is it a good idea to hinder the import of oil at this time?

5) Forgetting all of the above, what good would it really do?

[Flacobob]

I just don’t see any compelling reason for tariffs