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Why a US border adjustment tax would matter for oil

The oil industry is zeroing in on a prospective tax shift in Washington that has the potential to upend energy flows around the world. 

The “border adjustment tax” (BAT) put forth by Republican lawmakers and embraced sporadically by President Donald Trump would radically change the way companies are levied, taxing imports and exempting exports in the world’s biggest economy.

While the Trump administration’s stance on BAT has been muddled, with some political observers doubting it will ever come to pass, its potential to transform the economics of global oil flows means the industry is still paying close attention.

The US consumes almost one in every five barrels of oil produced globally and it remains dependent on imported crude to meet about half that demand, even after the shale boom raised its own domestic production.

The heavily populated Atlantic coast also depends on imports of petrol, while the vast refining sector along the Gulf of Mexico coast — able to process nearly a fifth of the word’s daily crude supply — also exports millions of barrels of refined fuels every day.

If the tax were enacted at 20 per cent, it would add that much to the price of imported crude oil. Instead of the international benchmark Brent crude trading for $55 a barrel, its current price, US refiners would pay $66 plus freight costs. 

US refiners would then bid up the price of domestic US crude until it neared the taxed price of imported barrels — a boon for US producers but likely one borne by drivers.

“The bottom line is that the price of crude oil rises,” says Andy Lipow of Lipow Oil Associates, a consultancy.

Over time, higher relative US crude oil prices could spur oil companies to explore for more domestic oil, increasing US production in line with Trump’s “American First” policy. That could force Canada, Mexico, Saudi Arabia and other foreign suppliers to the US to search for alternative markets.

Olivier Jakob, at Swiss-based consultancy Petromatrix, said those with a long history of exporting crude to the US, from Opec members to UK North Sea operators, would need to quickly find new buyers for at least some of their barrels.

That could reignite the price war of the past two years that saw Opec and other producers compete in an oversupplied market, driving Brent to its lowest level in 13 years in early 2016. The cartel called a ceasefire two months ago after Russia agreed to join it in curbing production to help balance supplies and let prices recover.

“Producers need to start thinking of alternative markets even now,” Mr Jakob said.

“It could put pressure on producers globally to try and renew this fight.”

The potential tax would also likely affect markets for refined fuels. Since exports of goods would not be taxed, a US refinery able to send its finished petrol or diesel abroad would do so in order to avoid the 20 per cent charge, forcing higher domestic prices to entice merchants to sell the fuels stateside.

Big consuming regions such as New York, already dependent on imports of petrol from places such as Europe and India, would have to buy it with a 20 per cent tax added on. 

Border tax adjustment has been championed by Representative Kevin Brady, the chairman of the House tax-writing committee who hails from a district just north of Houston, the oil industry hub.

Chevron, the second-largest US oil group, believes the proposal could bring positive effects such as higher US production, but also “unintended consequences in terms of impact on consumers, exchange rates and knock-on effects on the global economy”, John Watson, chief executive, told analysts last week.

The American Petroleum Institute, the biggest US oil lobby group, hasn’t taken a position yet but “we’re concerned about it”, Jack Gerard, API chief executive, said earlier this month. Among the companies opposed to the tax plan is Koch Industries, the company with extensive oil interests backed by heavyweight Republican donors Charles and David Koch.

Though it is separate from the suggestion from the White House that the US could use a tax on imports from Mexico to pay for a wall between the two countries, that proposal on its own would also redirect energy flows.

Mexico sends about 560,000 barrels a day of oil to the US, accounting for about 8 per cent of its total crude imports. Conversely, Mexico is one of the largest buyers of US petrol exports and is taking increasing flows of natural gas.

In Canada, the largest foreign supplier of crude to the US, the tax “most certainly is on our radar”, says Tim McMillan, head of the Canadian Association of Petroleum Producers. If the proposal went through it would shift investment towards US producers and away from Canada, he adds.

Whatever the uncertainties, investors are already placing bets on the outcome. The price difference between US crude benchmark WTI and international market Brent for delivery in December 2018 has narrowed to about 25 cents a barrel, from $1.60 a barrel in early December. Open interest in options contracts that track the price difference between the two benchmarks has risen almost sevenfold, according to CME Group. 

If analysts are correct, the biggest political count against the tax plan is the likelihood it would raise petrol prices — among a US politician’s biggest fears.

Barclays estimates the proposal could cause US petrol prices to jump and increase the average American family’s annual gasoline costs by $300-$400 a year.

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