The Next Trade War Escalation Will Hit U.S. Oil

The Trump administration is considering another ramp up of the trade war with China, a move that could begin to rattle the global economy.

The Wall Street Journal reports that the Trump administration is considering ratcheting up the tariffs on $200 billion of Chinese imports from the proposed 10 percent levy to as much as 25 percent. Hiking the tariff, Trump’s advisers seem to think, will force Beijing to back down and offer major concessions. Whether or not those tariffs move forward remains to be seen, and the administration reportedly won’t make a decision until later this month.

The tariffs are justified, the Trump administration says, because the Chinese yuan continues to depreciate, undercutting U.S. competitiveness. “Once you go down the road of using tariffs to disrupt the Chinese, you have to say 25% compared to 10%,” Derek Scissors, a China expert at the American Enterprise Institute and adviser to the administration on trade, told the WSJ.

The problem with that logic is that the tariffs are part of the reason why China’s currency is under pressure. To be sure, China’s economy is showing other signs of trouble, from slowing growth to a rise in corporate defaults. But the yuan, which is fixed against the dollar, recently ran into rocky waters, at least in part driven by fears of the U.S.-China trade war.

Moreover, the rate tightening by the U.S. Federal Reserve is also putting pressure on Beijing.

Morgan Stanley estimates U.S. GDP would lose a percentage point if the Trump administration imposed a 25 percent tariff on all imports from China and Europe, while China would lose 1.5 percentage points. “Growth overall is still there, and while there are risks, it’s holding up. The big picture of a trade war and protectionism is that it is a slow death - a death by a thousand paper cuts instead of anything sudden and shocking,” Richard Kelly, head of global strategy at TD Securities, said in a Reuters interview. Related: Russia’s High Risk Global Oil Strategy

China said on Wednesday that it would respond with quick retaliation if the U.S. moves forward with higher tariffs.

As the trade war escalates, there is a good chance that China retaliates by slapping a tariff on U.S. crude oil imports. “From the U.S. perspective, China is a significant market, but [U.S. shipments are] just 3% of Chinese imports,” Suresh Sivanandam, Asia refining senior manager at Wood Mackenzie, told the WSJ. “There’s more of the U.S. losing out here than China.” China has emerged as the largest buyer of U.S. crude, but that would quickly change with a tariff.

That doesn’t mean that U.S. crude exports would be shut in – far from it. Some analysts argue it wouldn’t even make much of a difference in terms of total demand. U.S. exporters could simply reroute shipments elsewhere, and because China would have to make up for lost U.S. imports, it would be buying from elsewhere as well. So, oil flows would be reshuffled, rather than significantly interrupted. Still, U.S. exporters might have to offer discounts to other buyers if they lose the Chinese market.

More broadly, however, the effect of tariffs on consumer demand could be significant. The initial $34 billion has only been lightly felt in the U.S., but moving forward with tariffs on $200 billion of Chinese imports would mean higher prices for a long list of consumer goods, acting as a drag on household income. Ultimately, that could begin to cut into gasoline consumption. More expensive consumer goods comes hot on the heels of the sharp increase in retail gasoline prices this year. According to the EIA, gasoline demand dipped by 40,000 bpd in May, year-on-year. Industrial activity would also slow down, further cutting into demand. Related: An Unexpected Windfall For U.S. Solar

Ultimately, that could reverberate around the world. China’s economy would likely slow substantially, with knock on effects elsewhere. It is hard to put solid figures on the downside risk, especially with so much still up in the air.

“While the likelihood that creeping US protectionism spins out into a broader trade war has unfortunately moved from tail risk to plausible scenario, we believe that cooler heads will ultimately prevail,” Scotiabank wrote in a note, “that the world economy will be spared the worst of mercantilism’s potential casualties, and that commodity prices will rebound through summer’s end.”

Unfortunately, whether or not that prediction proves accurate largely depends on the decision-making in the White House, which, needless to say, is rather unpredictable.

By Nick Cunningham of Oilprice.com

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