Possibly discontent with the (lack of) progress with China over a new trade deal, US President Donald Trump is turning its sights elsewhere. After slapping tariffs on steel from close allies in North America and the European Union and embarking on an ever-escalating trade war with China, it is now the turn of Mexico.
In a surprise move, President Trump announced that imports of all Mexican goods into the US would now be subject to a 5% tariff. And this would rise unless Mexico stops the flow of illegal immigration across the Rio Grande, with US officials confirming that the tariffs would reach to 25% by October. This came as a blindside to the market. Not only was the North American Free Trade Agreement (NAFTA) successfully renegotiated only recently, some American manufacturers had only just recalibrated their supply chains away from China to Mexico as a result of the trade war. The new tariffs on Mexico have been described as ‘very disruptive’, threatening a symbiotic relationship that has largely benefitted the USA.
Most of all in energy. US refineries along the Gulf Coast have long been geared to process heavy crude from Mexico, Venezuela and Canada. With Canadian oil sands stuck in Alberta over a lack of pipeline infrastructure and Venezuela being persona non grata, Mexican oil is increasingly prized by refineries owned by ExxonMobil, Chevron, Marathon Oil and more. Some 630,000 b/d of Mexican crude is shipped to US refineries that are too finely calibrated for those grades to be easily replaced. A back-of-the-envelope calculation suggests that the tariffs will add about US$3/b to the cost of Maya crude to the US, slashing current refining margins by half. This will be passed on to the American consumer, just ahead of the summer driving season. And these Gulf refineries also send more than a million barrels of fuels back to Mexico (which has a net fuel deficit), worth some US$20 billion in revenue. Natural gas trade will also be affected – threatening the 20 pipelines sending some 5 bcf/d across the southern border, along with new LNG projects in Mexico that are dependent on American shale gas.
While Mexico has made overtures to mitigate the flow of illegal immigration, it is not likely to just take the bullet. Reprisal tariffs are likely, mainly on US fuels and, crucially, US corn that impacts the two key America industries supporting Trump: energy and farming. Crude prices have already tumbled in response to the Mexican tariffs, with fears that it could cut the legs off already weak global energy demand.
And there’s more. President Trump has ordered that India’s status as a preferential trade partner be removed, which would result in the imposition of tariffs on a package of currently 2,000 duty-free products. While India is in a weaker bargaining position than China in capitulating to American demands, it is currently a major destination for American crude after sanctions on Iranian crude and the flourishing US LNG export industry is also banking on increased demand from India. Reprisal moves from India, where Prime Minister Narendra Modi has just won a resounding election victory, must be expected, particularly since Modi campaigned on a nationalist campaign reminiscent of a diluted Trump message.
And if it is China, India and Mexico today, who else will it be tomorrow? The US’ trade war stance may score short-term political points but it adds much more fragility to the market. In the meantime crude oil imports from Mexico will be subject to a 5% tariff, which will rise to 10% on July 1 and continue rising towards 25% in October, if the immigration issue is not resolved.
US Trade War Tariff Targets:
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Working natural gas inventories in the Lower 48 states totaled 3,519 billion cubic feet (Bcf) for the week ending October 11, 2019, according to the U.S. Energy Information Administration’s (EIA) Weekly Natural Gas Storage Report (WNGSR). This is the first week that Lower 48 states’ working gas inventories have exceeded the previous five-year average since September 22, 2017. Weekly injections in three of the past four weeks each surpassed 100 Bcf, or about 27% more than typical injections for that time of year.
Working natural gas capacity at underground storage facilities helps market participants balance the supply and consumption of natural gas. Inventories in each of the five regions are based on varying commercial, risk management, and reliability goals.
When determining whether natural gas inventories are relatively high or low, EIA uses the average inventories for that same week in each of the previous five years. Relatively low inventories heading into winter months can put upward pressure on natural gas prices. Conversely, relatively high inventories can put downward pressure on natural gas prices.
This week’s inventory level ends a 106-week streak of lower-than-normal natural gas inventories. Natural gas inventories in the Lower 48 states entered the winter of 2017–18 lower than the previous average. Episodes of relatively cold temperatures in the winter of 2017–18—including a bomb cyclone—resulted in record withdrawals from storage, increasing the deficit to the five-year average.
In the subsequent refill season (typically April through October), sustained warmer-than-normal temperatures increased electricity demand for natural gas. Increased demand slowed natural gas storage injection activity through the summer and fall of 2018. By November 30, 2018, the deficit to the five-year average had grown to 725 Bcf. Inventories in that week were 20% lower than the previous five-year average for that time of year. Throughout the 2019 refill season, record levels of U.S. natural gas production led to relatively high injections of natural gas into storage and reduced the deficit to the previous five-year average.
The deficit was also decreased as last year’s low inventory levels are rolled into the previous five-year average. For this week in 2019, the preceding five-year average is about 124 Bcf lower than it was for the same week last year. Consequently, the gap has closed in part based on a lower five-year average.
Source: U.S. Energy Information Administration, Weekly Natural Gas Storage Report
The level of working natural gas inventories relative to the previous five-year average tends to be inversely correlated with natural gas prices. Front-month futures prices at the Henry Hub, the main price benchmark for natural gas in the United States, were as low as $1.67 per million British thermal units (MMBtu) in early 2016. At about that same time, natural gas inventories were 874 Bcf more than the previous five-year average.
By the winter of 2018–19, natural gas front-month futures prices reached their highest level in several years. Natural gas inventories fell to 725 Bcf less than the previous five-year average on November 30, 2018. In recent weeks, increasing the Lower 48 states’ natural gas storage levels have contributed to lower natural gas futures prices.
Source: U.S. Energy Information Administration, Weekly Natural Gas Storage Report and front-month futures prices from New York Mercantile Exchange (NYMEX)
Headline crude prices for the week beginning 14 October 2019 – Brent: US$59/b; WTI: US$53/b
Headlines of the week
Amid ongoing political unrest, Ecuador has chosen to withdraw from OPEC in January 2020. Citing a need to boost oil revenues by being ‘honest about its ability to endure further cuts’, Ecuador is prioritising crude production and welcoming new oil investment (free from production constraints) as President Lenin Moreno pursues more market-friendly economic policies. But his decisions have caused unrest; the removal of fuel subsidies – which effectively double domestic fuel prices – have triggered an ongoing widespread protests after 40 years of low prices. To balance its fiscal books, Ecuador’s priorities have changed.
The departure is symbolic. Ecuador’s production amounts to some 540,000 b/d of crude oil. It has historically exceeded its allocated quota within the wider OPEC supply deal, but given its smaller volumes, does not have a major impact on OPEC’s total output. The divorce is also not acrimonious, with Ecuador promising to continue supporting OPEC’s efforts to stabilise the oil market where it can.
This isn’t the first time, or the last time, that a country will quit OPEC. Ecuador itself has already done so once, withdrawing in December 1992. Back then, Quito cited fiscal problems, balking at the high membership fee – US$2 million per year – and that it needed to prioritise increasing production over output discipline. Ecuador rejoined in October 2007. Similar circumstances over supply constraints also prompted Gabon to withdraw in January 1995, returning only in July 2016. The likelihood of Ecuador returning is high, given this history, but there are also two OPEC members that have departed seemingly permanently.
The first is Indonesia, which exited OPEC in 2008 after 46 years of membership. Chronic mismanagement of its upstream resources had led Indonesia to become a net importer of crude oil since the early 2000s and therefore unable to meet its production quota. Indonesia did rejoin OPEC briefly in January 2016 after managing to (slightly) improve its crude balance, but was forced to withdraw once again in December 2016 when OPEC began requesting more comprehensive production cuts to stabilise prices. But while Indonesia may return, Qatar is likely gone permanently. Officially, Qatar exited OPEC in January 2019 after 48 years of continuous membership to focus on natural gas production, which dwarfs its crude output. Unofficially, geopolitical tensions between Qatar and Saudi Arabia – which has resulted in an ongoing blockade and boycott – contributed to the split.
The exit of Ecuador will not make much material difference to OPEC’s current goal of controlling supply to stabilise prices. With Saudi production back at full capacity – and showing the willingness to turn its taps on or off to control the market – gains in Ecuador’s crude production can be offset elsewhere. What matters is optics. The exit leaves the impression that OPEC’s power is weakening, limiting its ability to influence the market by controlling supply. There are also ongoing tensions brewing within OPEC, specifically between Iran and Saudi Arabia. The continued implosion of the Venezuelan economy is also an issue. OPEC will survive the exit of Ecuador; but if Iran or Venezuela choose to go, then it will face a full-blown existential crisis.
Current OPEC membership: