US oil market suffering as the trade war escalates

The ongoing trade war with China is impacting many industries. Market volatility is being exacerbated by President Trump’s pattern of vacillating between threats and cease-fires on the topic.

At the beginning of August, the markets were sent into a tailspin by President Trump’s threat to impose tariffs on another $300 billion of Chinese imports. The markets were broadly impacted, but the energy sector was hit especially hard. Crude oil prices suffered their largest drop in over four years.

President Trump subsequently backed off, citing concerns about retail spending headed into the holiday season. As if to further emphasize the risk, the yield on the 10-year US Treasury bond recently fell below the yield on the 2-year US Treasury. This yield curve inversion happens when investors are flocking to safety and it’s historically a strong recession indicator.

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What could possibly cause a recession? Most economists think the economy is still pretty healthy, but trade wars cost consumers money. When consumers have less money to spend, they buy fewer goods. The overall economy slows down. That could push the US and the entire world for that matter into recession.

Fears of a slowing economy have an impact on the oil industry which is why the oil markets sold off so sharply on President Trump’s tariff threat. But he wasn’t finished. In a series of recent tweets, President Trump said he would retaliate against China’s response to the tariffs that we had imposed:

"China should not have put new Tariffs on 75 BILLION DOLLARS of United States product (politically motivated!). Starting on October 1st, the 250 BILLION DOLLARS of goods and products from China, currently being taxed at 25%, will be taxed at 30%. Additionally, the remaining 300 BILLION DOLLARS of goods and products from China, that was being taxed from September 1st at 10%, will now be taxed at 15%.”

This latest Twitter-salvo particularly rattled the markets, with the Dow Jones Industrial Average closing down over 600 points and oil prices shedding another 2%.

Rystad Energy Senior Analyst Artyom Tchen summarized the potential impact of the trade war on the oil market:

"We believe that the United States-China trade war and resulting weak economic growth sentiment is among those factors that balance supply risks and cap oil prices. We forecast 2019 demand growth at 1.2 million barrels per day (bpd), as opposed to a pre-trade-war forecast of 1.4 million bpd.”

However, in addition to the threat of an economic slowdown, a trade war with China impacts the oil markets in two other ways. The oil industry is capital intensive, and some of that capital equipment comes from China. Chinese steel, for example, is considerably cheaper than US steel. If a pipeline company, for example, is forced to buy more expensive steel, it will impact capital budgets and result in fewer projects.

But a final, and more direct way the oil industry is impacted is that China was becoming an increasingly important market for US oil exports. Last summer US exports to China had reached half a million barrels a day, but because of the trade war China stopped buying US crude. They turned instead to Iran for their crude oil needs.

Enterprise Products Partners CEO Jim Teague recently noted China’s reluctance to sign any long-term agreements for US crude oil: “When I was in China, I heard two words at every meeting: ‘Trump’ and ‘tariffs.’”

The bottom line is that this ongoing trade war is inflicting real pain on the US oil industry, and there is no end in sight. That is going to create headwinds in the oil markets for the foreseeable future.

This article was originally published on Oilprice.com