Trump’s border tax is bad news for oilpatch
Trump’s proposed levy on imports would make Canada oil less attractive
The energy-friendly tone of president-elect Donald Trump and his cabinet appointees might have industry officials in Canada thinking happy times are here again. Not so fast. While industry attention here has focused on competitiveness challenges presented by the Trudeau government’s move toward a national carbon tax, another looming tax may have a far greater impact.
That would be the border adjustment tax, or BAT, suggested by the new U.S. administration, part of a larger reform package that would see the corporate tax rate cut from 35 per cent to 20 per cent.
It’s not being defined as a valueadded tax or VAT, but increasingly that’s how it is being viewed since it effectively shifts the tax burden to consumption rather than income.
Billed as a job creation mechanism, it’s a protectionist measure bound to have a number of negative outcomes, including on Canada’s oilpatch.
“The border adjustment tax represents a form of trade restriction that is similar in effect, if not mechanism, to import restrictions or import tariffs,” energy consultant and economist Philip Verleger wrote in a paper published by the Cambridge, Mass.-based economic consultancy The Brattle Group.
“When preferences are provided to local producers, production shifts from more efficient foreign producers to less efficient domestic producers.”
While the BAT is not yet anywhere near becoming legislation, its potential impacts means two things for the Canadian oilpatch.
One, domestic pipelines that allow for more product to reach new offshore markets, such as Kinder Morgan’s recently approved Trans Mountain expansion, are critical. And second, there’s even more pressure on Canadian producers to be competitive with their U.S. peers.
In simple terms, the tax would render barrels of crude produced in Canada less competitive than those produced in the U.S. as American refiners would not be able to deduct the cost of barrels bought from Canada and used to produce gasoline.
If a U.S. refiner buys a barrel of domestic crude at US$50 and can sell the refined product at $60, it pays tax on the $10 difference since the oil comes from U.S. sources and the price of the input can be deducted.
But if the refinery buys the oil from Canada, it cannot deduct the cost of the barrel, meaning it pays tax on the full $60 it sells out of the refinery. Assuming the targeted 20 per cent tax rate, it’s the difference between a $2 tax bill and one that is $12.
The same holds true for heating oil and natural gas.
What it will do is put even more downward pressure on the price of Canadian crude and could cause it to be discounted further for sale into the U.S. market, said Verleger.
Trump’s tax reform plan would also exempt American companies from paying taxes if their products are exported. That includes oil and petroleum products and effectively implies that for products to be sold in the U.S., producers of all goods will demand a higher price so as to offset the tax burden.
According to Verleger’s calculations, that means U.S. consumers will pay more for gasoline, which could negatively impact U.S. domestic growth.
Assuming a price of US$50 per barrel, his calculations show consumers on the U.S. East Coast could pay $1.95 per gallon compared with the current spot price of $1.56.
An unanswered question regarding Canadian oil production is the reinvestment made by U.S. refineries to accept Canada’s heavier barrels. The complete displacement by U.S. domestic production of Canada’s 2.9 million barrels that flow every day into the U.S. — of which 1.9 million barrels flow into the Midwest PADD II refinery complex — seems unlikely. In fact, as Verleger points out, the U.S. refinery complex is highly dependent on oil imports.
In 2015, crude imports made up 65 per cent of what went into the U.S. Midwest refineries, 55 per cent into the East Coast, 47 per cent on the West Coast and 35 per cent in the Gulf Coast.
The United States, his paper states, “will remain a net importer of petroleum for the foreseeable future in certain regions” with refineries in the U.S. Midwest, west and east coasts relying on imported crude.
Does this make the approval of the Keystone XL Pipeline a Pyrrhic victory if it means more oil selling at a lower price in the United States? Not necessarily, says Verleger.
“The oil shipped into the Gulf Coast could be loaded onto tankers and exported to world markets,” he said.
The other worry is that the measures will cause an appreciation in the U.S. dollar, bringing the energy sector more to worry about.
And there is an inverse relationship between the value of the dollar. It goes up, oil prices go down.
That’s not good, especially when energy companies are long U.S. dollar denominated debt, which becomes more expensive to service and ultimately redeem when it matures. A higher oil price is more favourable on everything from servicing debt, reinvesting in businesses and balance sheet leverage.
The energy sector is already facing myriad challenges — from commodity prices to labour, transportation and carbon costs.
Now, all of this is about to be compounded by the uncertainty created by a Trump administration that appears determined to create jobs with flawed economic policy that is ultimately distortionary.
Now, more than ever, Canada must pivot to the outside world beyond the continent, to pursue arrangements that are mutually beneficial and respect the terms of trade.
The approval of Kinder Morgan’s Trans Mountain project should be seen as one small step in what must be a much longer journey.