In his first week in office, President Donald Trump created a diplomatic crisis with Mexico regarding the border wall, who will pay for it, and a proposed 20 percent tariff on all goods coming into the U.S. from its southern neighbor.
The Trump administration received immediate push back on his proposed tariff, even from some Republican lawmakers. But the proposal did not come out of nowhere. The president and his Republican allies have been floating a proposed border-adjustment tax for months, one that has raised the ire of some in the refining industry.
If the tariff or border-adjustment tax became law, it would have profound implications for the energy trade between U.S. and Mexico, a cross-border trade in oil, gas and refined products that goes in both directions. Bloomberg notes that if the U.S. slapped a tariff specifically on Mexican goods, Canada’s oil industry would receive a huge boost. It “would attract more Canadian crude because it would be cheaper,” Bart Melek, the head of global commodity strategy at TD Securities in Toronto, told Bloomberg. “It just makes Mexican oil more expensive by 20 percent so it gives Canada a comparative advantage.” Last week, President Trump signed an executive order to advance the Keystone XL pipeline, which would allow an additional 830,000 bpd to flow to the U.S. if constructed.
Mexico meanwhile, would get hit hard by the tariff. Mexico produces heavy oil and much of it is refined along the U.S. Gulf Coast. Because of its proximity, the heavy Maya blend, as it is known, trades at a premium to other varieties of heavy oil, such as Canada’s Western Canadian Select. It’s a short ride from the Bay of Campeche to Texas and Louisiana.
The tariff would only be negative for Mexico’s oil sector, which has been suffering from steady decline for years as its aging giant oil fields deplete. Pemex, the state-owned oil company, has been unable to replace lost output. Mexico produced 2.3 million barrels per day of crude oil in 2015, and the declines are expected to continue. As part of OPEC’s deal with non-OPEC countries, Mexico promised to cut production in the first six months of 2017 by 100,000 bpd, although the contribution was a clever bit of rebranding, describing the inevitable depletion as a production cut. Related: Is The Oil Crisis Over? Oil Majors Report Positive Cash Flow
Nevertheless, if Mexico suddenly saw its oil hit with a 20 percent tariff, and it lost market share from its largest customer – where it sends about 60 percent of its exports – it could damage Mexico’s oil industry, potentially accelerating the decline rates. The Maya blend would have to be discounted, undercutting the finances of already cash-strapped Pemex.
One mitigating factor is the structure of the contracts. Mexico exports roughly 550,000 bpd to the U.S., which is traditionally traded under long-term contracts. Unlike the spot trade, the contracts would be much trickier to change, so the effect of the proposed tariff is unknown at this point.
Natural gas trade between the two countries would also be affected. Texas shale gas drillers stand to benefit immensely from the growing demand in Mexico for natural gas. Gas exports to Mexico have tripled since 2010 to just over one trillion cubic feet in 2015. A handful of large gas pipelines are currently under construction between Texas and Mexico, which will connect shale gas from the Eagle Ford and Permian Basin to Mexican buyers. Pipeline capacity is set to double between 2016 and 2018.
This gas trade could be directly damaged by cross-border tariffs, raising the cost for refiners and utilities on both sides of the border. But volumes moving between the countries would take an additional hit if a trade war slowed manufacturing activity in northern Mexico, reducing industrial demand for gas. Plus, the rapid transition from coal and oil to natural gas in Mexico’s electric power sector could slow. The combined effect would be to severely reduce Mexican demand for American gas.
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On top of the existing trade in oil and gas, Mexico liberalized its energy sector after seven decades of state-owned control, allowing private companies to bid on offshore acreage. The oil majors arrived in full force, with interest from ExxonMobil, Chevron and many others. Again, since the policy has not been laid out with specifics, it is unclear whether or not some international companies might rethink their development plans due to the deteriorating relationship between the U.S. and Mexico.
Of course, there are plenty of reasons to think that the tariff will never see the light of day. First, putting the energy trade in jeopardy might spook lawmakers, not to mention the vast economic ties in other sectors. In addition, the tax could raise gasoline prices if U.S. refiners have to pay more for imported fuel, a move that is always politically dangerous.
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Moreover, the tariff would probably violate WTO trade rules, so its implementation is highly suspect. It would almost certainly be met with retaliatory measures from Mexico, inciting a trade war. That could deter even some of the most bellicose members of the Republican caucus.
By Nick Cunningham of Oilprice.com
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