The new trade wars
Commodity producers have much to fear from US battle with China
Commodity producers quite rightly fear an escalating trade war between the US and China. A full-blown economic collision between the world’s top consumers of raw materials and energy could hit demand hard for key commodities such as oil and metals. Even more chilling for investors and traders would be a return to resource nationalism.
President Donald Trump raised the stakes with Beijing earlier this month when he proposed tariffs on imports of steel and aluminium coming into the world’s largest economy. China was the target of this legislation with the country’s overproduction of vital products in the manufacturing supply chain, which he blames for weakening America’s economy long term.
Although the initial impact of these regulations is likely to be limited, the raising of new trade barriers and the winding back of globalisation could tilt the scales negatively for commodities markets, which have boomed since China joined the ranks of the World Trade Organisation (WTO) in 2001. Speaking at a recent commodities event in Switzerland following Trump’s proclamation, BHP Billiton’s chief executive Andrew Mackenzie rightly sounded alarmed. As the world’s largest producer of commodities from iron ore, to copper and crude oil, the mining conglomerate depends on open access to markets and commodities still in the ground.
“Free trade is vital to the health of the global economy,” Mackenzie said. “It is our collective responsibility to champion the virtues of free trade to make sure we can compete on level playing fields around the world because those are the conditions under which business, countries and the people who live in them will prosper.”
China’s impact on commodities markets has been profound. Beijing’s economic operating model is brutally simple: gather up supplies of global raw materials and turn them into finished exportable products at competitive prices, or use them to build strategically important infrastructure efficiently and quickly by utilising its vast pool of labour. Consequently, demand for almost every commodity locked underground has soared.
Take crude oil for example. In 2000, before China joined the WTO, world oil demand was stagnating below 80m barrels per day of crude, according to BP’S statistics. After 18 years of Chinese economic growth and an explosion in the country’s exports over that period, global consumption is expected to hit a new record above 100m b/d this year, according to S&P Global Platts Analytics estimates.
This growth in demand BP expects to continue through to 2040, with the world potentially requiring another 13m b/d of liquid fuel provided China’s economy performs as expected. But a protracted and escalating trade war with the US could fundamentally blow these forecasts apart. Instead of oil markets being obsessed about global oversupply, the balance would then shift back to concerns over demand.
The International Energy Agency has already sent the alarm bells ringing. In response to Trump’s latest policy edicts the global energy watchdog warned: “A slowdown (in world trade) would have strong consequences for fuel used in the maritime sector and in the trucking industry.” Transport dominates oil
‘It is our responsibility to champion free trade to make sure we can compete on level playing fields’
demand with commercial haulage by road and sea taking up the largest share of the market.
Ironically, Trump’s attempt to limit the flow of Chinese products into America comes as the US sends an increasing flow of its own oil in the other direction. China has emerged as one of the main destinations for US crudes since President Barack Obama lifted the ban on crude exports in December 2015. Last year, almost 40pc of US crude exports headed to China compared with around 20pc the previous year, according to Platts estimates.
These flows could soon be increasing despite Trump’s trade policies. The first supertanker to be loaded from the Gulf coast’s Louisiana Offshore Port, known as LOOP, set sail last month with China the likely destination. The shipment could signal a rapid increase in US exports to Asia once new deep water loading facilities are ready at Corpus Christi in Texas.
Protectionism could also stoke resource nationalism. The Organisation of the Petroleum Exporting Countries (Opec) was forced to enter into an unprecedented pact with Russia two years ago to revive oil prices. The group of 14 producers may now want to extend the deal for up to 20 years, which would effectively give it control over almost half the world’s crude. This kind of pricing power could be vital if a trade war between the world’s top consumers were to hit demand.
Whereas the US has focused on boosting its own energy security and domestic supply, China is trying to become more independent in the trading space. The world’s largest importer of crude has recently launched a new oil futures contract on the Shanghai International Energy Exchange to help it hedge against future price fluctuations and establish its own global benchmark behind Brent and West Texas Intermediate (WTI). Denominated in yuan, not dollars, international traders are also permitted to buy and sell for the first time.
However, a much bigger jolt to the greenback’s dominance in the $14trillion global oil market could be on the horizon. Should China also decide to pay for its crude in yuan this would signal an even more profound change ahead for how commodities and raw materials are traded. In terms of the market, Beijing increasingly holds all the cards in any face off with the US and Trump.
Meanwhile, the outlook for commodities in general in 2018 looks bright provided the drawbridge isn’t raised any more on global trade.
As BHP’S Mackenzie said: “Some of the key uncertainties that weighed on business confidence a year ago have now been clarified. In commodity markets, we have more evidence on Opec strategy and on the Chinese resolve to pursue supply-side reform and to focus on environmental concerns.”