President Trump’s order to impose a 25% duty on steel and a 10% duty on aluminium imports has dominated the news cycle this week, triggering the departure of Trump’s economic advisor Gary Cohn. The order ended up being more flexible than originally pitched, with Canada and Mexico excluded unless the NAFTA renegotiations breakdown and left the door wide open for other nations to be levied at a lower rate down the road. As with all things Trump-related, everything is negotiable. As an aside, the role of the NEC chair in the past has not traditionally been as high profile as it was for Cohn. But the position was given “elevated” status as Cohn gave the Trump economic team much-needed credibility at the time. While there has been a lot of focus on his replacement, whoever is chosen to follow Cohn may not be as meaningful as some seem to think.
Considering all that has happened this week, risk assets have held up pretty well. As of this writing, S&P is still up on the week, while the VIX is down. In short, markets retain a semblance of a risk on flavour to them. Investors are betting that the Trump bark is much worse than his bite. It would seem that the only thing the market cares about right now is the 10-year yield, which remains below 3%.
|Fig 1: US risk assets||Fig 2: Major US steel imports by country, %|
Note: Indexed to 1 March
|Source: Peterson Institute, Energy Aspects|
But the imposition of tariffs, even if symbolic, is important on many levels. While dumping by China is cited as a primary motivation, the reality is that China only represents a small percentage (less than 5%) of total US steel imports, with the bulk coming from allies: Canada, the EU, Japan and South Korea among others.
In addition to country exclusions, companies that rely on steel and aluminium imports can ask the Commerce Department for a waiver if there is a limited supply of the product in the US, or for a special national security consideration. How these somewhat arbitrary standards will be interpreted is anyone’s guess. The auto industry and pipeline builders are among the sectors now lobbying to argue why they should also be exempt. The natural gas industry plans to seek an exemption because some of the steel it needs for special tankage, such as cryogenic storage tanks in LNG, is not available from US sources. Agriculture groups are worried at the prospect of getting caught in the crossfire, as they would be one target for retaliation by China, which is a big importer of commodity crops like soybean. There is no doubt that the tariffs will translate into higher input costs across the board. The only question is what the wider fallout will be. As with big sweeping regulatory change, lawyers and lobbyists are the big winners.
The tariffs will most certainly be challenged at the World Trade Organisation and the idea that national security includes the protection of jobs for trade purposes will be tested. But how the tariff saga evolves will be messy and will depend in large part on how trading partners choose to respond. Will the EU try and negotiate with the US before imposing countervailing tariffs? Or will it impose first and negotiate later? EU trade commissioner Cecilia Malmstrom will meet US trade representative Robert Lighthizer in Brussels this weekend, and we should learn more about intentions after that. Given the EU relationship with the US, many Europeans believe they should get an exemption.
However, the Malstrom-Lighthizher meeting could prove to be a disappointment for the Europeans. The departure of Gary Cohn from the administration means that Trump’s economic policy is being driven by a three-headed protectionist monster in Peter Navarro, Wilbur Ross and Robert Lighthizer. These three men are outspoken critics of the globalisation impulses of the US since the collapse of the Soviet Union. Ross and Navarro believe that globalisation, rather than automation, is responsible for the lion’s share of the decline in manufacturing jobs.
Perhaps most worrying is that Ross and Navaro believe that countries with bilateral trade surpluses with the US (e.g. China, Japan and Germany) are basically using the accumulation of Treasuries as a way to prevent their currencies from appreciating, which in effect prevents currencies from making the necessary adjustments. These views are clearly outlined in a September 2016 paper they co-authored on the Trump Economic Plan. Many of their policies dovetail nicely with Trump’s desire for a weaker dollar.
Note that most of the countries in the trade surplus short list have trade and/or important military ties to the US. Now we would note that while the departure of Gary Cohn is seen as a blow to the free traders in the Republican wing and that the protectionists are ascendant in the White House, the reality is that Trump’s worst impulses have been somewhat watered down in the delivery. The president wanted to rip up NAFTA but is negotiating instead. He wanted the toughest and most sweeping tariffs possible but that has been caveated in a number of ways. He wants to reimpose sanctions on Iran, but hasn’t yet. But we will watch closely how negotiations with various trading partners evolve, to confirm of Trump’s bark is worse than his bite.
Brent: Timespreads have continued to grind lower as refinery TARs are set to peak in May. Brent May/Jun is now hovering around 20 cents with Urals still very weak. If cargoes fail to arb east, then there is perhaps more downside to that spread. However, we do expect spreads to firm again as the distillates market cleans up (also on turnarounds) and as refiners come back. It may not quite be the bottom yet, but we are getting close.
WTI: Cushing stocks have continued to grind lower and are now down by some 21 mb in the year to date and by 36 mb since November 2017. This is the fastest pace of drawdowns of Cushing stocks on record. Higher than expected flows on Marketlink may mean smaller than expected builds in March, but Cushing will still build this month for the first time since the last week of November 2017, followed by only small draws expected from April onwards. This will take Cushing stocks lower, but not significantly lower when compared to end-February levels and not low enough to reach actual tank bottoms and send spreads to the moon. We expect to see higher volatility in summer time spreads for, though we don’t think we will get anywhere near ‘tank bottoms’ this summer, the market will have to start pricing in the risks that we do so. Much of this reverses in H2 18 as takeway constraints in the Permian begin to take root. But first, we have to deal with tighter summer stocks (for more details see our Macro E-mail alert: Is the arb anchored?, 19 Mar 2018).
|Fig 3: Cushing crude stocks, mb||Fig 4: Gasoline gross long position, k lots|
|Source: EIA, Energy Aspects||Source: CFTC, Energy Aspects|
Gasoline: Inventories on the east coast drew impressively this week and stocks in New York Harbor in particular remain tight. However, gasoline markets right now are somewhat priced for perfection, and given the massive gross length in gasoline (there are an elevated number of shorts too), the market is betting heavily on European turnaround activity to clean up the overhang in ARA and ensure that USEC stocks are tight heading into the spring. However, in the near term, European exports to East of Suez markets will fade due to high supplies out of China and exporters will look to place barrels into the New York Harbor once the summer pricing season begins. Moreover, unlike last year, supply growth will likely exceed demand growth and, given that gasoline inventories only declined modestly in 2017 despite Hurricane Harvey, a year with lower disruptions poses big problems. There are great expectations for gasoline, and a high hurdle to meet them.
Distillate: Spreads have been underpressure as the surprisingly high refinery run rates in Q4 17 and Q1 18, coupled with warm winter weather in Europe put undue pressure on gasoil in particular. However, things should begin to stabilise here and over the coming weeks we should see some support. TARs will help a lot to clear some of the overhang, while demand should be rising seasonally from here. It may take a bit more time, but we do think the worst is behind us rather than in front.
Yasser Elguindi, Energy Market Strategist
+1 646 798 1700 (US)