Oil Is Fine With Wars, Just Not Trade Wars
It’s a sad, cold fact that, for some, war actually is good for more than absolutely nothing. Consider how sprightly oil can get at the mere rumor of stuff getting blown up.
Trade war is different, though, because that usually entails large parts of the economy taking flak. While President Donald Trump appears to have pulled back from an immediate confrontation with the EU, the impact of existing tariffs largely aimed at China is starting to be felt from auto plants to farms.
The oil market has suffered a mild dose of nerves, too, although it’s also been contending with other bearish factors, from higher Saudi Arabian output to a potential pre-midterms release from the Strategic Petroleum Reserve. It certainly hasn’t been hit as hard as metals such as copper or aluminum.
Escalation could change that. I say “could” because a trade war initiated by the country underwriting the post-World War II free-trade system is somewhat outside the old frame of reference.
China’s threat to levy tariffs on some U.S. energy exports springs from three things: the widening pool of tariff-targeted Chinese exports to the U.S.; the more limited pool of trade going the other way for China to hit; and (possibly) a desire to take a symbolic swipe at Trump’s stated desire for “energy dominance.”
China took 20 percent of U.S. crude-oil exports in the 12 months through April and has been the largest market for them this year, according to the International Energy Agency.
One line of thinking says China imposing tariffs on U.S. crude oil exports would have zero effect. China would buy less U.S. oil, but would then buy it from elsewhere. That would push other countries, in turn, to buy the U.S. barrels now going begging.
But oil isn’t quite as fungible as all that, because some barrels are heavier or dirtier than others, and refineries tend to have particular tastes. As energy economist Philip Verleger wrote in a recent report, a Chinese tariff would act like a tax on U.S. oil exports. American barrels would have to reprice lower in order to access China — with producers absorbing the “tax” — or compete for new buyers.
The light oil derived from U.S. tight-rock basins might find buyers in Asia, and European refiners might take conventional barrels if reimposed U.S. sanctions choke off Iranian exports, according to Kristine Petrosyan, a senior analyst at the IEA. Pricing would have to be right, though, “so the net effect is not quite zero.”
Petrosyan points out that even refineries configured to take other grades of crude oil will process lighter oil if the economics make sense, citing the example of refineries on the U.S. Gulf Coast. While these invested heavily in the past in order to run cheaper, heavier barrels from the Middle East and Venezuela, Petrosyan estimates their mix of crude oil has lightened up significantly amid the shale boom and Venezuela’s collapse. Such decisions are still, though, a function of price, so it’s unlikely refiners would pay high enough to offset the “tax” imposed by Chinese tariffs.
Indeed, refiners that could buy discounted U.S. barrels would be the real winners in this scenario, being able to sell their gasoline and diesel at global prices. Similar to what would likely happen if the SPR was tapped, don’t expect consumers to gain from any dislocation.
Any victory for China would be Pyrrhic. Bloodying the nose of America’s oil industry wouldn’t change the fact that China’s export-heavy economy has been built on the foundations of the free-trade system underwritten by the U.S. and now being undermined by it. This presents a broader threat to oil producers everywhere, not just in Texas.
China accounts for about 30 percent of expected global oil demand growth this year and next. And there are some causes for concern already, such as a marked pick-up in the country’s exports of diesel, a fuel tied most closely with industrial activity and freight:
This may reflect tighter credit in the first half of the year that will loosen in the back half, especially if trade battles bite. Yet a bigger trade war clearly would represent a threat to China of a different order from what’s come before. This adds further risk to China’s diesel demand at a time when gasoline demand growth is coming under pressure from prices around the world (including the U.S.). Oil watchers have become accustomed to focusing on supply — Oh, Vienna! — but demand is the other side of the equation.
For now, there is at least hope that a bigger war with Europe might be avoided. “For now” does a lot of work in that sentence, though. Wednesday’s talks at the White House represent a truce, not a final peace agreement. Meanwhile, antipathy to “unfair” trade and a propensity for sudden moves remain defining features of the Trump administration.
In any case, we have entered dangerous territory already when it comes to energy. Alongside Saudi Arabia, Russia, and Iran, the U.S. has reemerged as a more interventionist player, with sanctions, tariffs and maybe even that SPR in play. As OPEC could tell Washington, though, every action provokes a reaction; splash one corner of the oil market and the waves ripple out all over.
And yet, as that mooted $12 billion bailout for tariff-trampled farmers shows, this administration seems fine with acting first and trying to patch up the collateral damage afterwards. As we’ve seen already in America’s electricity and coal sectors, energy dominance comes with a hefty dose of that old-time state meddling. Oil will be no different.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal’s Heard on the Street column and wrote for the Financial Times’ Lex column. He was also an investment banker.