On August 8, China announced a 25 percent tariff on an array of U.S. goods, including coal, asphalt, naptha, propane, butane and plastic products. But notably, China declined to include crude oil on the list of U.S. products targeted by tariffs, despite having previously proposed to do so.
The move comes as a surprise, and could be a reflection of China’s need for imported oil and gas. But that does not mean that the energy trade will emerge from the escalating trade war unscathed. Already the trade spat has disrupted the flow of energy between the two countries.
China leaves oil and gas off of tariff list…for now
China’s tariffs hit $16 billion worth of U.S. goods, which correspond to the tariffs that the U.S. put on Chinese imports of the same value. But, unexpectedly, China decided not to include crude oil. “Simply put, crude may have been a bluff—and LNG could be too—and energy scarcity may have led China to retreat from its threat posture,” ClearView Energy Partners managing director Kevin Book said in a recent note.
Roughly 427,000 b/d of that total was crude oil, volumes that won’t be affected by the new tariffs.
China has emerged as a top buyer of U.S. crude after Canada. In May, the latest month for which data is available, China imported 568,000 barrels of oil and petroleum products per day (b/d) from the U.S. As recently as two years ago, China routinely imported less than half of that amount. Roughly 427,000 b/d of that total was crude oil, volumes that won’t be affected by the new tariffs.
Meanwhile, on August 3, China put LNG on a shortlist of goods that could be subjected to future import tariffs, but those levies have not been finalized yet.
However, despite the hesitation on import duties, China has already begun to ratchet down imports of both crude oil and LNG from the U.S. For instance, Unipec, the trading arm of state-owned Sinopec, has suspended crude oil purchases from the U.S. because of the trade fight, according to Reuters. Unipec reportedly has not booked any shipments through October at least. Previously, Unipec had said that it expected to ramp up purchases of U.S. crude to 300,000 b/d by the end of the year. Overall, Reuters estimates that total crude shipments from the U.S. to China will fall to only 197,000 b/d in September, based on tanker traffic data.
U.S. LNG is feeling the strain as well. In May, China imported five cargoes of LNG from the U.S. But over the two-month period of June and July, it only purchased four.
Disagreement over impacts
All told, China buys around one fifth of U.S. oil exports, while also importing nearly 15 percent of U.S. LNG exports. On its face, that would suggest that if China decides to move forward on tariffs, it would significantly disrupt the energy trade between the two countries. But there is disagreement among energy analysts over that point.
“Crude oil and LNG markets are facing similar problems as soybeans, almonds and corn, with short-term bearish impacts,” Citibank said in a research note. “As China Inc. turns away its rising wave of hydrocarbons imports from the US, prices are being hit. The dislocation is an inevitable result as Chinese buyers look elsewhere given uncertainties on pending 25% tariffs on imports from the US.”
However, Citi analysts went on to say the effects may be minimal. “One knee-jerk reaction that is almost certainly wrong is that China’s rejection of US imports poses a significant challenge to US exports. Whether in the long- or short-run, China’s potential imposition of tariffs or quotas on US exports is a tax on Chinese consumers rather than an obstacle to US exports.”
Whether in the long- or short-run, China’s potential imposition of tariffs or quotas on US exports is a tax on Chinese consumers rather than an obstacle to US exports.
Imposing tariffs on U.S. crude would force China to turn to Russia, the Middle East, West Africa or the North Sea, according to a July research note from Goldman Sachs. As China buys from other producers, it will free up other buyers to purchase from the U.S. “Although [U.S. Gulf Coast] prices would initially need to trade at a discount to ﬁnd a new buyer, this period would likely be short lived until a new buyer is found and global trade routes reprice,” Goldman analysts said.
The same may not be said for LNG, which lacks the liquidity of the crude oil market. Tariffs on U.S. LNG could cause disruptions in trade flows, particularly because China is a large and rapidly growing importer. If that tariff goes forward, it could make spot cargoes too expensive for Chinese buyers. “[A] 25% [tariff] is not something we can absorb even if domestic demand is strong,” a source at a state-owned Chinese company told S&P Global Platts. “So while this uncertainty persists, I doubt buyers will be buying a lot of spot US LNG.”
The lack of liquidity would likely mean that China struggles to find adequate supply if it essentially writes off imported gas from the U.S. That is precisely why the Chinese government may hold off on imposing tariffs. “This coming winter for example, China is likely to be short on both LNG and soybeans, two US commodities on which it has placed barriers,” Citi analysts wrote. “Would Beijing continue to tax its own citizens with a 25% (or any other level) tariff?”
The effects over the medium-term of new tariffs would be more muted. For example, with a series of U.S. LNG export terminals set to come online, export capacity will balloon from roughly 2.77 billion cubic feet per day (bcf/d) to 9 bcf/d by 2020 and 13 bcf/d by 2025. That will put it roughly on par with Qatar as one of the largest LNG exporters in the world.
If tariffs on U.S. LNG remain in place, China could simply buy LNG from other sellers, with U.S. LNG rerouted as well. The trade flows shift, but the overall impact on the market is minimal.
As the LNG trade grows, the market will gain liquidity, bolstering the size of the spot market. Currently, much of the LNG trade is still conducted under long-term contracts with fixed pricing. That is rapidly changing however, spurred on by more sources of supply. Over time, more of the LNG trade will conducted under short-term contracts and on the spot market, with market pricing and no restrictions on buying and reselling. The upshot is that even if China puts a tariff on imported gas from the U.S., LNG will increasingly resemble the fungible nature of crude oil. If tariffs on U.S. LNG remain in place, China could simply buy LNG from other sellers, with U.S. LNG rerouted as well. The trade flows shift, but the overall impact on the market is minimal.
Still, while the impact on trade flows might not raise concerns, other analysts argue the trade fight could deter future investment in new export capacity. “China’s announcement last week of a potential 25% tariff on LNG imported from the US, if enacted, would likely increase prices in the short term as the market rebalances,” Barclays said in a note. “Longer term, tariffs would pose a threat to new LNG facilities, which are increasingly looking to China for offtaker contracts.”
Bloomberg argues that the margins for U.S. LNG exports to China would theoretically fall by around half due to the tariffs, potentially scaring away final investment decisions in future U.S. LNG export terminals as project economics take a hit. Industry analysts such as Wood Mackenzie have already predicted that the LNG market could suffer from a supply gap in the 2020s because of a dearth of new FIDs. If LNG becomes ensnared in the trade war, investment could face further headwinds.
Analysts, such as the IEA, have repeatedly warned that an escalating trade war could undercut global economic growth, which would lead to lower oil demand
For now, the immediate price impact may only be temporary, especially if China ultimately decides not to put tariffs on oil and gas. However, even as the trade spat may not threaten the oil and gas trade directly, the broader danger to the global economy does present downside risks to energy. Oil prices sank more than 3 percent on August 8, following the announcement of the new round of tariffs. Analysts, such as the IEA, have repeatedly warned that an escalating trade war could undercut global economic growth, which would lead to lower oil demand. In that sense, the trade war does not need to specifically hit oil and gas with tariffs to have a major impact on energy markets.