A Global Oil Price Shock, due to Trump's border tax plan

While much has been said about the impact on the dollar from the proposed Border Tax Adjustment, as a little has been said about how it could impact US commodity production in general, and oil in particular.

This morning, in a note titled "Destination-based taxation and the oil market", Goldman's Damien Courvalin focused on this issue and found that the price gain from shift to destination-based border adjusted corporate tax would prompt US drillers to “sharply increase activity" as a result of lower US corporate tax rates, which would aggressively incentivize shale drilling, resulting in a global oil price shock, sending domestic prices spiking, as global prices slide.

The border tax would have an inflationary impact on U.S. service costs and reduce U.S. dollar costs of foreign producers. A lower U.S. corporate tax rate “could force a deflationary tax policy response” elsewhere further reducing the marginal cost of oil. In short, "US oil prices would appreciate immediately and sharply vs. global oil prices"

If domestic oil prices remained at the same level as imported crude oil prices upon implementation of the BTA, US refiners would have an incentive to consume only domestically produced crude instead of importing crude as only the cost of domestic crude would be deducted for tax purposes, and (2) US producers would have an incentive only to export crude rather than to sell to domestic refiners as there would be no taxes on exports. This would lead to a sharp appreciation of the US domestic oil price relative to the global price oil.

Because US oil demand of 19.6 mb/d currently vastly exceeds domestic crude production of 13.5 mb/d, the US market requires imports of crude. As a result, refiners would bid domestic crude up until domestic prices rise enough to leave them indifferent about importing crude for their incremental barrels. Put another way, pricing power would be in the hands of producers upon introduction of this policy and they could charge US refiners up until these prefer to import foreign crude instead. Financial markets would anticipate this new equilibrium, with domestic oil prices reacting immediately to offset the impact of the border adjustment and leave refiners with the same pre-policy incentives to consume domestic or imported crude oil.

The magnitude of this relative price move would be determined by the new US corporate tax rate and, at 20% (the rate currently being proposed by the Republican tax BluePrint), it would imply US prices trading at a 25% premium over global oil prices.

Goldman warns that rising U.S. production would create a “renewed large oil surplus into 2018” and that there would be an “immediate decline in global oil prices” as other producers offset ramp-up in U.S. output. OPEC would probably raise production, supplies would grow and forward curve would move into “steep contango."

In pricing terms, the higher U.S. crude price would pass through to consumers with modest impact on U.S. fuel demand growth. With $5/bbl rise in U.S. crude, demand to rise 70k b/d in 2018, 55k b/d below present forecast. Meanwhile, refiners would be left with excess returns as a result of the border tax.

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