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Oil Prices Set to Post a Strong Quarterly Gain

Trade War Escalation Looms Large Over Oil Markets

The U.S.-China trade war has now officially entered a new phase, and neither side is showing any sign of backing down.

The Trump administration followed through on hiking tariffs on $200 billion worth of Chinese goods from 10 to 25 percent last week. As U.S. markets were about to open on Monday morning (and after markets were closed in Asia), China announced a retaliatory step - an increase in tariffs on $60 billion of American goods to 25 percent beginning on June 1.

Trump is also laying the groundwork for more tariffs on an additional $325 billion of imports, which would then cover just about everything coming from China. That tranche of tariffs would be a further escalation, and would impact consumers more broadly, although such a measure could be months away. The Dow plunged on Monday morning in response to the news.

"Over the past week, hopes for at least a partial and temporary ceasefire between the two sides have given way to the prospect of a rapidly escalating and broadening economic conflict between the two countries," Eswar Prasad, senior professor of trade policy at Cornell University, told the Washington Post.

The two governments seemingly left open the possibility of an eleventh hour trade deal last week - and negotiations continued in the hours after higher tariffs went into effect - but with talks stalled, they are now digging in. President Trump took to twitter to put on a brave face. Related: Oil Markets Uncertain As Trade War Counters Supply Shortages

Cracks in the Chinese economy are increasingly visible. Auto sales in the world's largest car market fell in April for the tenth consecutive month. Sales were down 14.6 percent year-on-year. The Chinese government was forced to undertake a round of stimulus earlier this year when the economy started to slow, and the intervention propped up growth. It's unclear if Beijing has more dry powder with the trade war growing worse.

There are other signs of trouble on the horizon. In April, car and SUV sales in India fell sharply, dropping by 17 percent compared to a year earlier, another sign that a crucial market is slowing down. Air traffic and demand for bank loans also decelerated, according to Bloomberg.

Even the U.S. economy has some dark clouds forming, despite strong first quarter GDP numbers and low unemployment. Credit card companies, banks and mortgage lenders are seeing a deterioration in the financial health of consumers. Soybean prices fell to their lowest level in 10 years on Monday, and the worsening trade war could push the U.S. farm sector deeper into crisis.

In March, the OECD's Composite Leading Indicator contracted for 12th straight month, a sign that the economic health in rich countries is deteriorating. The index, according to Bloomberg, is intended to offer a leading indicator of turning points six to nine months before they happen. Related: Is This The Most Underrated Upstream Player In The Industry?

The slowing economy is a major headwind for crude oil. Hedge funds and other money managers are increasingly concerned about where oil is trading, and dumped net-long positions in early May.

China's tariffs on U.S. goods will impact LNG, though not crude oil. Beginning in June, U.S. LNG will be subjected to a 25 percent tariff by China.

Despite the trade war, oil jumped in early trading hours on Monday, which was particularly notable given the slumping financial indicators. News that two Saudi oil tankers were damaged from an attack led to a jolt in crude prices, raising fears that tensions in the Middle East would continue to escalate. "With a threat to the free circulation of oil in one of the world's most critical areas, it's no surprise oil is moving," said Harry Tchilinguirian, global head of commodity markets strategy at BNP Paribas.

For now, it seems that oil traders are more concerned about supply tightness than slumping demand.

By Nick Cunningham of Oilprice.com

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Nick Cunningham

Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon.  More