Donald Trump's tariffs are bad economics but good politics

An aurora borealis appears over pumpjacks in Alberta. Canada provides more than half of US oil imports and almost all gas imports. The Canadian Press via AP, File

“If it moves, tax it,” as Ronald Reagan once said, describing the government’s view of the economy. Donald Trump appears to hold a similar perspective on tariffs. We might soon find out whether crucial US energy supplies keep moving, and whether this is good or bad for the Gulf.

Mr Trump threatened 25 per cent tariffs on all imports from Canada and Mexico, in response to their alleged failure to prevent the passage of illegal drugs and immigrants. He also plans to impose a tariff on Chinese products 10 per cent above any other tariff, having earlier proposed tariffs of 60 per cent on China, and 10 per cent or 20 per cent on all other countries.

As usual with the incoming US president, this is not in the nature of a carefully crafted policy proposal. Sources told Reuters they would apply to oil. But it is not clear whether these tariffs will be imposed at all, or how they might be lifted. In turn, Ottawa and the Palacio Nacional would decide how to respond.

Canada and Mexico are major energy suppliers to the US. The northern neighbour provided more than half of the US’s oil imports of 6.3 million barrels per day and Mexico came in second with another 8 per cent in September. Saudi Arabia and Iraq were the next two largest, but make up less than 9 per cent between them.

And Canada dominates natural gas: 99 per cent of US imports in September. These were not just voluminous but cheap, costing just $1.25 per million British thermal units, compared to the $12.30 paid for a small amount of liquefied natural gas (LNG) that makes up the other purchases. Canada is also an important minerals supplier, including about half of the US’s nickel requirement.

Conversely, some US natural gas flows to Canada, mostly to the eastern provinces, while Mexico is an important outlet for US gas exports.

Untangling the impact of these tariffs is complex. They will affect US energy consumers, the suppliers, downstream businesses, and competitors.

The simplest, and largely correct, view of tariffs is that they are ultimately paid by the final consumer in the importing country. They slow economic growth and raise inflation. Domestic suppliers, such as US oil producers, will enjoy higher prices, and presumably increase output. But the higher prices mean that American oil consumption overall will be lower than otherwise.

The effect on refiners, though, is complex and needs a microanalysis of the US oil industry. Several sophisticated centres import Canadian and Mexican heavy oil to break it down into lighter, more valuable products.

Faced with paying more for feedstock, they might cut their runs, or buy alternate crudes. Middle Eastern heavy grades such as Arab Heavy from Saudi Arabia or Basrah Heavy from Iraq are the most likely, but not perfect substitutes.

And contrary to the most basic economic theory, in this case, the supplier too may suffer from tariffs. Producers in western Canada rely on pipelines to the US for exports, some of which goes all the way to the Gulf of Mexico coast to be sent elsewhere.

With limited non-US outlets, Canadian companies might have to absorb some of the levies themselves. Their production costs are high, but Canada has been one of the leaders of global production growth over the last decade. A slowing of that output raises prices worldwide.

Canadian gas producers have been suffering rock-bottom prices for years. The LNG Canada export plant, led by Shell, is expected to start up next year and ease the glut. But again, tariffs will raise prices for US consumers, probably modestly given how cheap they already are, and cut Canada’s output.

The second stage of Mr Reagan’s view of government is, “If it keeps moving, regulate it”. No doubt US energy users will lobby for exemptions and claim special circumstances, a feast for influencers, political contributors and purveyors of corruption. Temporary shortages or local hikes in fuel prices will be met by further state interference.

Canada and Mexico will also respond. So far Mexico’s new president, Claudia Sheinbaum, appears inclined to stand firm on concessions. They may seek more non-US outlets, and they could also impose reciprocal tariffs, whether on energy or other goods, but Mexico in particular relies heavily on US gas imports and would have to consider the impact on its domestic economy.

Perhaps it might finally get serious on unlocking its own significant resources, including shale and deep offshore. Or it might turn to more LNG imports, which would indirectly benefit Gulf and other exporters, including Qatar, Oman and the UAE.

Projects intended to import US gas and re-export it as LNG, such as Altamira which started up in September, may be stuck with tariffs that are not offset by higher prices, similarly to the transit of Canadian oil through the US.

The emerging US effort to build up its clean energy industry will also be hit. It is unlikely the tariffs will encourage much more manufacturing of solar panels or batteries domestically. They will, in fact, increase input costs, such as those for nickel. They could actually make the US more dependent on China, if it replaces Canadian nickel with that from Indonesia, where most production is by Chinese companies.

But the most significant global impact will be uncertainty. Energy investors, producers and consumers will have to contend with flows of oil, gas and minerals that are driven by politics more than economics, that might change overnight with a presidential post. This will deter investment. And it further diminishes the flexibility of the global energy system, already hit by the stoppage of Russian gas to Europe and the interruption of most shipping through the Red Sea.

The final step by government, according to Mr Reagan, is, “If it stops moving, subsidise it”. So we can expect trade barriers to bring much more government interference, probably to bad effect. Indeed, tariffs are bad economics but good politics.