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The Tariff War and Oil

by | published June 19th, 2018

President Trump’s recent threat to add an additional $200 billion in tariffs against Chinese imports hit the markets hard.

It has also catapulted oil price down in tandem.

Coming on the heels of already announced $50 billion in levees against steel and aluminum, along with U.S. fees on Chinese solar equipment, coined with a decision by Beijing to cut dramatically further domestic assistance to the solar industry, this is shaping up as a trade “perfect storm.”

But will anything approaching $200 billion in additional tariffs ever see the light of day?

For one thing, total Chinese imports to the U.S. only amounts to about $500 billion.

For another, the U.S. Trade Representative must be able to document specific trading abuses to justify the imposition.

Nonetheless, even if it turns out that $200 billion is unreasonably high, with much of the bravado never translating into any concrete action beyond being the latest Trump shakeup tweet, the uncertainty of White House intent moving forward is enough to chill investor sentiment.

The effect on oil, however, remains three-fold…

A Volatile Reign

First, one of the primary effects involves overall economic impact, that is, the idea that increased tariffs result in reduced economic activity translating into a declining demand for energy.

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There may not be any genuine statistical basis for rendering a judgment emerging for three months or more out from an “event.”

Nonetheless, oil traders will move well before that.

Remember, the folks who set futures contract prices (the “paper” barrels that drive the market price of “wet” barrels, the underlying oil consignments actually in trade) are betting on a forward curve. They will peg prices on the expected cost of the next available barrel.

In the current environment of trade uncertainty, that becomes the expected least expensive next available barrel.

That means they will overcompensate in whichever direction the curve predicts prices will move.

In the aftermath of a downward push by tariff concerns, futures will push downward even more, beyond what is warranted by market considerations.

Of course, once the underlying situation is resolved, the market price rebounds.

But until the rebalance occurs, volatility reigns.

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Second, the uncertain prospects place a new constraint on operating company commitments of forward working capital.

This certainly does not happen uniformly across the board.

Given the advantageous positioning of some well-placed companies, breakouts to the upside still occur.

But it is hardly a tide lifting all boats.

Currently, even with the pressures issuing for a burgeoning tariff war, average market prices allow most companies to remain profitable.

After all, crude oil prices are still more than double what they were 16 months ago.

But it is the negative nature of tariff scares that are depressing otherwise better indicators.

Finally, there is yet a third aspect that is unfolding.

This is a matter on which I have spent some time advising during the past week.

The American “Double Advantage”

China and others are beginning to target U.S. crude oil and oil product exports to other higher-priced global markets.

American producers have been using a double advantage for some time.

They benefit from huge domestic reserves, much of which is available for low cost and efficient extraction.

In addition, exports have now reached over two million barrels a day of U.S.-produced crude.

When it comes to processed oil products, American refiners have been the leading exporters worldwide.

Not being a member of the OPEC-Russia agreement, the U.S. shale and tight oil production space has been able to play both the internal and external markets without restraint – once prices recovered into the $50 a barrel and above range.

All of this may be ending.

I am now receiving intel from my global network indicating that China and certain European parties are prepared to use a combination of futures, contract swaps, and other derivatives to cut U.S. profitability in international sales.

Some of this may include support for Iranian crude exports in defiance of separate White House-inspired sanctions in the aftermath of the U.S. departing from JCPOA (the Joint Comprehensive Plan of Action), the nuclear agreement entered into by the five permanent members of the UN Security Council, Germany, and Iran.

When it comes to the reaction in London, Paris, Berlin, and Brussels (the EU), combined with Trump’s dismissal of allies at the recent G7 meetings in Canada, livid is an understatement.

That Europe also has been adversely affected by the U.S. steel and aluminum tariffs is an additional issue, as is the decided European interest in keeping JCPOA in some form absent Washington.

Make no mistake, the external reaction to Trump’s tariff adventures will cost U.S. export revenues and domestic jobs.

It will also (intentionally) target those segments of the American economy from which Trump received his strongest electoral support.

Unless cool heads prevail, that just may extend to include the oil patch.

Sincerely,


Kent

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