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Commodities Week Ahead: Trump & The Oil Market - Part 1

Investing.com’s Commodities Week Ahead typically looks at the prospects for oil and gold prices in the upcoming trading week. In the first of this two-part series, we examine the Trump administration's attempts to save the U.S. oil industry amid the collapse in demand for crude from the coronavirus crisis and the production-and-price war between market titans Saudi Arabia and Russia. Read part 2 here.

By Barani Krishnan

Investing.com - Should Donald Trump tax the import of Saudi and selective foreign crude as a last resort to save U.S. oil producers?

The president threatened on Saturday to “do whatever I have to do” in order “to protect … tens of thousands of energy workers and our great companies”. Just a day ago, he denied any plans to impose tariffs on any imported oil although he acknowledged it “is certainly a tool in the toolbox”.

Trump’s shifting stance is understandable. Within the same 24 hours, both Saudi Arabia and Russia have turned into a joke his tweets from earlier in the week that they were ready for a truce in their oil production-and-price warfare and go back to output cuts with other producers under the OPEC+ alliance that could even include U.S. companies. 

The only saving grace for Trump is that the OPEC video conference that Saudi King Salman agreed to host at the president’s request is still on. But instead of Monday, it might now be held on Friday, an OPEC source told CNN, although there was no certainty that wouldn’t be scrapped too.

It was prospects of that meeting - and Trump’s tweets that the Saudis and Russians were ready to lead the world in cutting 10-15% from global supply — that gave U.S. West Texas Intermediate crude a record 32% gain last week and U.K. Brent an even higher 37%, after 18-years lows for both in the $20s. 

With doom and gloom hanging over the market again, crude prices could see a renewed dive in Asian trading later today. Yet, Trump’s warning that he might use the tax wrench in his toolkit to fix imported barrels could prevent a freefall. The House of Saud will be rather eager to call the president on his bluff — if that’s what it is — though the Kremlin will be keen too. The variance in their interest is based on the fact that the United States imports 95% more Saudi crude than Russian.

The question of whether Trump should go ahead with tariffs leads one into a deeper debate: i.e. Is it right to save U.S. oil producers and hurt the country’s refiners, who depend critically on Saudi and other foreign-sourced crude to make the kind of fuel products that gasoline-friendly American shale oil isn’t capable of?; Will U.S. import taxes be a big enough deal to force the Saudis and Russians to back down from their production-and-price standoff and negotiate a reduced output deal? 

Shale Might Want Trump’s Intervention, Not Broader Industry

From Oklahoma to Texas, the clarion call for federal intervention in the oil market comes from the drillers working the prolific U.S. shale basins that have turned the country into a 13-million barrels-per-day behemoth surpassing even Saudi Arabia and Russia — whose production typically peak at 12 million and 11 million bpd, respectively. 

The U.S. oil industry is now a critical component of the domestic economy, supporting 10.9 million jobs.

The so-called fracking boom has provided gasoline at under $3 per gallon to most Americans for the past six years. It has also given U.S. crude a 3.5-million-barrel export advantage in markets that the Saudis and Russians couldn’t fill because they were too busy cutting output to keep global prices supported — while their American rivals were busy producing and marketing their oil without any care other than profit.

This “drill baby, drill!” phenomenon in U.S. oil can be easily understood once one learns of the industry’s makeup.

Some 91% of the oil wells in the United States  are owned by independent producers who produce 83% of the country’s crude and 90% of its natural gas. 

And who are these independents? They can be publicly traded companies or even small family companies. Under U.S. law, an independent energy producer is one who does not have more than $5 million in retail sales of oil and gas in a year or who does not refine more than an average of 75,000 barrels per day of crude oil during a given year. There are about 9,000 independent oil and natural gas producers in the United States. These companies operate in 33 states and the offshore and employ an average of just 12 people.

It explains why it has been virtually impossible all these years to bring such a diverse bunch of wildcatters to a table with a collective-minded group like the Organization of the Petroleum Exporting Countries to strike a deal that will benefit oil producers throughout the world. 

It’s not just the diversity and sheer mass of participants that have stood in the way of an U.S.-OPEC deal. It’s also the American antitrust law that prohibits any kind of coordination and control in oil production. It was a law that interestingly became the basis for the NOPEC - or No Oil Producing and Exporting Cartels Act - that the Trump administration was toying with two years ago, then to sue OPEC for cutting production. 

The antitrust law has been there for years. But it has surfaced in the news lately as talk emerged for the first time of coordinated production cuts by U.S. oil companies fearing  they have no chance of surviving the present crisis unless they do what OPEC has been doing all this while. Two of the companies, Pioneer Natural Resources (NYSE:PXD) Co. and Parsley Energy Inc, have written to regulators in their home state of Texas to ensure that all oil producers contribute to cuts in the state — which produces about 4 million bpd or a third of U.S. output. 

Ryan Sitton, an aggressive and vocal member of the Texas Railroad Commission, which regulates the state’s oil industry, has dived passionately into the shale-saving mission. Sitton has chatted on the phone with OPEC Secretary General Mohammad Barkindo and Russian Energy Minister Alexander Novak, offering a cut of 500,000 bpd on behalf of the TRC. Sitton says he hopes to have a conversation next with Saudi Crown Prince Mohammad bin Salman. He even has the backing of the premier of Canada’s Alberta region for cuts (more on Canada’s role in U.S. energy to follow)

Sitton’s enthusiasm for cuts, however, is not shared by everyone at his TRC office or the wider petroleum industry.

“One commissioner does not speak” for the commission, TRC member Christi Craddick tweeted, adding that “Texas operators will be heard” at a hearing scheduled on April 14.

TRC Chairman Wayne Christian tweeted his initial disagreement too: “If a release or tweet comes from an individual commish, it does not signal consensus from the agency.”

There’s more. On Friday, Trump met with the CEOs of Exxonmobil, Chevron (NYSE:CVX), Occidental Petroleum (NYSE:OXY), Devon Energy (NYSE:DVN), Phillips 66 (NYSE:PSX), Energy Transfer Partners and Continental Resources — all top names in the U.S. energy business. American Petroleum Institute CEO Mike Sommers, who represents the broader industry, was there too. Production cuts were never discussed, say those who attended the meeting. 

The American Petroleum Institute and another trade group, the American Fuel&Petrochemical Manufacturers, have actually counseled the president against intervention.

“We are not seeking any government subsidies or industry-specific intervention to address the recent market downturn at this time,” they argued in a letter to Trump. “Imposing supply constraints, such as quotas, tariffs, or bans on foreign crude oil would exacerbate this already difficult situation, jeopardize the short and long-term competitiveness of our refining sector world-wide, and could jeopardize the benefits Americans experience as a result of our increasing energy dominance.”

Why Taxes Won’t Work for Oil Refiners Or Lead to Output Cuts

And then there’s the refiners. There are 11 main companies behind the 68 refineries in the United States - namely Marathon Petroleum (NYSE:MPC), Valero Energy (NYSE:VLO), Phillips 66, Exxon Mobil (NYSE:XOM), Chevron, PBF Energy, Shell (LON:RDSa), BP (LON:BP), PDV, Koch and Motiva.

None of them ostensibly want taxes on oil imports because such tariffs will hurt a very major component part of their business: refining the heavier, or sour, crude that is typically not produced in the United States and which is critical for making the diesel for trucks and trains, jet kerosene for planes and heavy fuel oil for ships. The decades-old U.S. Gulf Coast refinery system is mainly configured to run on a healthy dose of lower quality heavy crude.

“Any import tax on crude is going to be so harmful to U.S. Gulf Coast refiners,” said John Kilduff, founding partner at New York energy hedge fund Again Capital.  “You’re not going to be lashing out at Saudi Arabia. You’re going to drive up the cost of diesel. It’s the last thing the U.S. economy needs at this time.”

In 2019, the United States imported about 9.1 million bpd of petroleum from nearly 90 countries.

Aside from the Saudi Arabia and the Middle East, the sour and heavy oils are largely found in Venezuela, Mexico and Canada.

Due to U.S. sanctions on Venezuela, not one barrel of oil from that South American country now lands in the United States.

Mexico's oil output has been in a steady decline for years. About 650,000 barrels of Mexican oil is imported into the United States each day.  

As for Canada, it is the largest provider of crude to the United States, channeling 4.42 million barrels daily, or 49% of U.S. needs. Canada can and wants to do a lot more for America. But it has run out of pipelines used to transport crude to its southern neighbor, limiting production.  

U.S. President Donald Trump on Friday signed a new permission for TransCanada Corp to build the long-delayed Keystone pipeline for imports of Canadian oil, replacing his previous permits in a fresh attempt to get around the blocking of the $8 billion project by a court in Montana. Still, that’s a project literally in the pipeline and won’t immediately solve U.S. needs in the event of a sudden supply crunch.

Which brings us to Saudi imports.  For the week ended Jan 24, U.S. crude oil imports averaged 6.7 million barrels per day and Saudi oil accounted for 407,000 bpd. That’s just about 6% of the total. Yet, it’s a very significant component due to scarcity in the supply of such heavier oils.

As for Russian oil imports, they stood at 18,637 barrels per day in June, just under 5% of the Saudi volumes.

The bottom line is this: The Saudis and Russians can always find markets for their oil. If America wants to tax their oil, they can take their crude elsewhere. Also, if their plan is to destroy U.S. shale and divvy up that 3.5 million barrels held by American exporters  between themselves, there should be no reason for any retreat on their part.

Trump does not have much love for Putin, and he can expect the Russian leader to respond in kind. 

But with Saudi Arabia, the president and his son-in-law Jared Kushner have invested time and energy in developing their relationship with Crown Prince MBS. They have defended the kingdom through the controversial Yemen war and the horrible murder of the journalist Jamal Khashoggi. Washington also provides military protection for the Saudis in the Gulf and has profited as well from Riyadh by selling the kingdom billions of dollars of U.S. arms. Trump seems ready to forsake those ties now if necessary, though the Saudis also seem prepared to do so, to get the market share they want for their oil.

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