The economic conflict between the United States and China continues to ramp up. Earlier this week the Trump administration announced plans for tariffs on another $200 billion in Chinese exports to the United States. Barring (substantial) Chinese concessions the new tariffs will likely come into effect around the end of August. This is now the third volley in what has become a tit-for-tat trade war. I’m starting to think up snazzy names. “Pacific Pong” doesn’t have quite the right je ne sais quoi, but I’m working on it. Suggestions welcome.
The Americans’ imports from China are triple China’s imports from the United States (quadruple if you factor out services). The simple fact is the Chinese are already running out of American imports to penalize. Any effort to shift the dispute to something beyond goods trade will similarly end in colossal failure. The Americans control global trade routes, global energy, global security, and global finance — everything that makes the Chinese system possible. The Chinese simply can’t bring the fight to other fields without suffering immeasurably. (Which isn’t the same thing as me saying I’d like to be an American company operating in China right now.) Chinese holdings of American government debt don’t even give Beijing leverage as such “investments” in reality are capital flight from the Chinese system.
While Chinese state media continues to put on a brave face, the days of tone-deaf chest-beating are gone. Government censorship guidelines now regularly bar terms like “Trump tantrum” and “trade war” and in general discourage the discussing of any angle of the issue whatsoever. One of the problems with stoking nationalism is that it can be hard to turn off. With the Politburo realizing they have little ammo for this sort of fight, political consolidation at home is far more important than scoring points in a media firestorm.
But that’s not what I want to talk about today. I want to talk about one of the funniest things I’ve seen in months. On July 11 the Chinese floated the possibility of a 25% tariff on U.S. oil exports. Several media commentators immediately pounced on the trial balloon as evidence of something that would get Trump’s attention because of his stated interest in “achieving American energy dominance.” Maybe it will. The criteria for what attracts or doesn’t attract the American president’s attention continues to elude me.
But that doesn’t mean a tariff on American oil isn’t a fabulously stupid idea. It has to do with the nature of the oil market, and in particular the role of American crude within it.
First, demand for oil is inelastic. What you need, you need. If it takes ten gallons of gasoline to get your delivery truck from A to B and you only have nine gallons, you cannot make the run. You must have ten. So regardless of what the price of the gasoline is, you’re going to buy it. Applied to this situation, were the Chinese to levy the tariff they will simply have to buy oil from somewhere else, and America’s oil will (easily) fill that gap in that third market. Net effect on U.S. energy exporters: zero.
Second, American oil is different from the rest. Conventional crude percolates through rock formations over time, picking up impurities as it goes (sulfur being the most common). A big part of refining crude oil into finished product is removing those impurities. But American oil exports are not conventional. They come from shale formations. Shale isn’t as porous as most rock, so the oil never percolates. It is trapped. Shale technologies are all about cracking out these pure bits of petroleum out. Shale oil’s lack of exposure to impurities makes it the lightest, purest oil produced in the world, as well as the most valuable and easiest to refine. China likes shale oil because they can blend it with thicker, dirtier crude to make a cocktail that their refineries can use. American exporters will have zero problems finding alternative buyers, but since the United States produces more of this ultralight/ultrasweet crude than the rest of the world combined. China will find alternate supplies difficult to scrounge up.
So either China isn’t going to put this tariff on, or if it does it won’t have any meaningful impact on the American side of the equation. What the tariff trial balloon might do – what discussion of the topic is probably already doing – is pump up oil prices a touch. Markets – especially oil markets – hate anything that might even momentarily restrict oil’s availability. And this little China discussion is only one of four oil-related bits of news that oil markets are stressing about right now.
The second and third issues involve general civilizational breakdown in two major oil exporters: Libya and Venezuela. Ever since Colonel/President/Wacko Muammar Gaddafi was deposed and killed in 2011, Libya has not existed as a state. It is now a shifting series of warlord-run fiefdoms. Unfortunately for the oil markets, not only is Libya’s crude production not in the same area as the oil export facilities, oftentimes the connecting pipeline infrastructure is under a third party’s control. Libya’s larger oil export ports have switched hands twice already this month, with the expected impact upon export volumes – and global prices.
If anything, Venezuela is even worse. Government ineptitude combined with a slow slide towards one-man dictatorship cum anarchy has transformed what was once South America’s richest state to one of its poorest and condemned much of the population of this once-food exporter to famine. The government’s ability to perform basic maintenance on its oil industry is now collapsing. Venezuela’s oil output is already down to a 30-year low and will likely dip below 1.0 million bpd by year’s end… assuming the country doesn’t completely implode.
Needless to say, such civilizational breakdowns can only exert upward pressure on oil prices.
The fourth hit to the oil markets hasn’t quite landed yet: Iran. The Trump administration is pressuring, well, everyone, to eliminate their imports of Iranian crude by November. The expectation is for a two-thirds reduction in total exports. Countries that resist American pressure will find themselves subject to secondary sanctions that would bar their access to anything that touches the U.S. banking system. Since that is in essence anything that involves nouns it is sort of a big deal. The Indians and Japanese have already signaled they’re going to play ball, and the Europeans are rapidly coming around. That just leaves China.
While the pot-stirrer in me would love to see what would happen to a trade-dependent internationally-wired oil-importing economy like China’s under full financial embargo, I’m fairly sure the Chinese will blink on this one. Financial sanctions of the type the White House is preparing would hit China at least an order of magnitude harder than the tariffs they are staring down, and the Chinese are not suicidal. And while I firmly stand by my claim that no one can really claim to know what Trump is thinking I have to admit things are starting to look more than coincidental: a last-minute cave by the Chinese on Iran just as the third round of tit-for-tat tariffs really start to bite? I see some serious negotiating leverage there, useful in many theaters.
This – all of this – is quite possibly the best-case environment for U.S. shale oil producers. Chronic export outages in multiple countries for multiple reasons, a trade war that is both widening and deepening. All this pushes oil prices up. That helps whichever oil producers can bring new output online fastest. And with today’s shale tech American shale operators can bring on new oil output in half the time the Saudis can bring on their pre-existing spare capacity.
In the first half of 2018, before all this noise erupted, U.S. shale operators were already on course for increasing total U.S. oil output by the largest volume ever – in excess of a fresh 1.5 million bpd. Courtesy of China and Trump and Venezuela and Libya and Iran, that is now the low case estimate.
The concentration of power in the global system continues to gather in the Americans’ favor. Trump is demonstrating he doesn’t need to build an alliance to fight and win a trade war with multiple countries simultaneously. Trump is showing he can wield financial tools simultaneously with trade tools to crushing effect. Trump is showing an enthusiasm for standing up to the business community, something that resonates not just with his base, but also Bernie Sanders’. And in case you missed it, last week the United States became the world’s largest oil producer courtesy of shale, granting Trump even more leverage and autonomy in international relations.
As a guy who makes it his business to integrate context and data in to everything, I find Trump’s brash, details-be-damned approach to… everything a bit annoying. But that doesn’t mean he can’t get results.