Donald Trump is back in the Whitehouse and has started sending shockwaves to the global trade scenario in less than a month of becoming the U.S. president. The news about the potential 25% Trump tariffs is known to all, and a 10% tariff is proposed on Canadian oil. Even though Trump says, “We don’t need anything they [Canada] have,” America needs Canadian oil as much as Canada needs America to sell its oil. The conundrum is who has the ultimate bargaining power.
Trump tariffs and Canadian oil
In 2023, Canada exported 97% of its oil production to the U.S. for the simple reason of proximity, integrated pipeline infrastructure, and limited access to alternative trade partners. The U.S. imported 60% of its oil from Canada.
Why can’t the U.S. replace Canadian oil?
The U.S. and Canada have an integrated pipeline infrastructure that makes oil and gas transmission cost-efficient. The U.S. shale gas exploration made Canada’s biggest customer its competitor. It no longer needed to import oil. It even decreased its oil imports, but that could not replace Canadian oil.
This is because 20-25% of U.S. refineries are equipped to refine Canada’s heavy oil. The United States decided to sell the light oil produced from the Permian Basin at the benchmark Western Texas Index price of US$74 per barrel, giving it export revenue. It imported an equal amount of heavy Canadian oil for US$60 since it takes more refining to be used as fuel. This export helps America reduce its trade deficit with other countries, as per an intelligence memo published in the C.D. Howe Institute.
Canada-U.S. energy ties too big to fail
An alternative is to undertake a mass capital expenditure in making U.S. refineries suitable for Permian Basin oil and lose the export revenue. If the United States is willing to take that fall and Trump can subsidize this transition, maybe America won’t need Canadian oil after all. Moreover, if America can produce more oil from the Permian Basin, it could resume oil exports.
However, it will take a lot of time and money to make such a switch. With the world moving towards green energy, policy changes could discourage refiners from taking such a step.
Canada, on the other hand, has a lot of oil and limited domestic consumption. It has looked at non-U.S. markets for its oil, but supplying it requires significant transmission capability. Canada has been exploring new markets with the Trans Mountain Expansion Project. It will supply Canadian oil to the Westridge Marine Terminal, which will ship oil to Japan, India, and Southeast Asia.
While it may present an opportunity to enter new markets, it will require a lot of money and time. Moreover, it may not be as cost-efficient as supplying to the United States.
Who will pay for the Trump tariffs?
It is established that the U.S. and Canada energy ties are too entangled to let go of in the medium term. Trump has paused its tariffs for now. But if it implements the 10% tariff of US$60 per barrel, the tariff would be paid either by the Canadian exporter or the American refiner. Another option is to divide the tariff equally.
The takeaway
Canadian energy stocks like Cenovus Energy (TSX:CVE) with high exposure to U.S. exports may not offer a safe haven amid Trump tariffs. The tariffs would hurt their profits partially in the short term. It would be better to stay away from oil stocks because of their cyclical nature. Suncor is already trading at its 2018 peak as it realizes a higher price on its produce.
Canadian energy stocks do not have the cost advantage to sustain higher profits if the oil price drops below US$60. However, pipeline stocks could be a safe haven as they are unaffected by oil prices.
Scotiabank Global Equity Research expects the tariffs, if applied, to be short-lived as the cost will ultimately be passed on to American consumers. America risks using domestic oil and leaving 20% of its refineries redundant.
