John Auers and Robert Auers
The classic track from The Who’s Tommy, “I’m Free,” doesn’t normally come to mind as an Independence Day tune. However, as we get ready to celebrate the 242nd birthday of America’s freedom tomorrow, it made me think of the dramatic policy moves made by the Trump Administration and how they have both helped U.S. oil companies but could also result in challenges down the road. Certainly the emphasis on deregulation and a move away from “demonizing” carbon has been a welcome change from the previous Administration for all segments of the industry. Perhaps illustrating the change in priorities, most dramatically was the withdrawal from the Paris Climate Agreement and the proclamation by President Trump that the U.S. was setting a goal of “energy dominance.” Although not specifically energy policy, perhaps the most consequentially positive policy action for the petroleum industry has been the cut in corporate taxes, which has not only directly improved the after-tax bottom line, but also supports stronger economic growth, which results in stronger product demand. But not all is rosy, as the recent moves to increase tariffs has led to counter moves by key U.S. trading partners. While the steel and aluminum tariffs will have direct impacts on project costs and tariffs on crude oil and petroleum products will affect trade flows, the biggest fear is that this tit-for-tat will lead to a widespread trade war and slow economic growth or even lead to a global recession. We discuss all that has happened and provide some comments on what might be in store in today’s blog as we contemplate the benefits of “Being Free.”
“If I Told You What it Takes to Reach the Highest High” – Pushing for Energy Dominance
As is often said, “talk is cheap” and while it’s great to set a positive and supportive tone, it takes actual policy actions to help achieve energy dominance. Fortunately, Trump has actually “walked the talk” and his Administration has taken or facilitated a significant amount of positive policy moves which are beneficial to all segments of the industry.
In the upstream, ANWR has finally been opened, lease auctions on other federal land and water have expanded, and Obama era fracking rules for those federal jurisdictions have been repealed. While the positive impacts of these and other similar actions will take years to show up in actual production figures, they certainly provide a very important structural basis to maintain the momentum that the shale revolution has provided. It’s also worth emphasizing that this revolution has been made possible by the free market principles and incentives on which this country was founded. They received a boost back in 1982 when the Reagan Administration deregulated the oil industry, for which it also took some time to achieve the production growth that is now setting new records every month.
The midstream segment has seen the most immediate benefits of the change in the federal government’s attitude toward the petroleum industry. As promised during his campaign, some of Trump’s first actions in office were to grant federal approvals for two high profile crude pipelines which had been stymied by the Obama Administration, the Dakota Access Pipeline (DAPL) and Keystone XL (KXL). The DAPL approval led to a startup of that 525 MBPD pipeline in May 2017, and it has significantly changed crude trade flows ever since (shifting flows from eastbound to southbound). TransCanada’s Keystone XL project was a major issue throughout the Obama years before getting what seemed to be a final rejection in November 2015. Trumps reversal of this decision has revived the project, and despite some continued opposition and some potential roadblocks, TransCanada has announced that they have received sufficient shipper commitments and is proceeding with construction plans.
The refining segment has also received its share of policy benefits (or potential benefits) during the first 18 months of the Trump era. Among the most visible, but one which won’t bear fruit for several years, is the decision by the EPA to review (and likely roll back) very strict fuel efficiency standards for model year 2022 to 2025 automobiles. These regulations, which were first issued in 2011 and confirmed in the last days of the Obama Administration, would have provided a significant jump start to Electrical Vehicle growth and had a materially negative impact on domestic demand for gasoline. A more immediate benefit for refiners has been the efforts by the Administration to modify Renewable Fuel Standards. While no deals have been struck yet to make any changes, the mere talk of some relief has led to much lower RIN costs. Administrative actions to grant hardship waivers to a number of small refineries have also brought joy to some refiners. And finally, the generally more flexible permitting and enforcement standards coming from key federal agencies (EPA, OSHA, etc.) is making life easier for the downstream industry as a whole.
It is important to note that while the federal government is bringing more freedom to oil companies, certain state governments have continued, and in some cases increased, their regulatory zeal. In many cases, states have filed lawsuits to overturn or slowdown the deregulation efforts of the Trump Administration (fuel efficiency standards, methane rules, etc.). California continues to lead the way in both using lawsuits to stymie federal moves and issuing stricter rules in-state rules. For refiners, an effort to ban HF alkylation in that state bears particular attention. Other “blue states,” particularly California’s neighbors to the north and Northeastern states have also been less than friendly. However, one piece of good news on the state front came just last Thursday when Minnesota’s Public Utility Commission (PUC) gave Enbridge the go ahead on its Line 3 replacement project.
“An I’m Waiting For You to Follow Me” – Tariff Threats by Trump Reciprocated by Trading Partners
Not everything the Trump Administration is doing will be beneficial to the oil and gas sector. The most notable potential negative policy initiatives have been Trumps increasing use of tariffs to fight perceived “cheating” by our trading partners. In the short term, this is already leading to worries about both shortages and cost increases for key materials necessary for industry projects. Considering the U.S. has become a major exporter of both crude and petroleum products, it is also exposing both upstream and downstream companies to the potential loss of major markets for those exports. Even worse, is the potential that this escalates into an all-out trade war, which has all sorts of negative implications for both domestic and global economic growth and product demand.
The tariffs being proposed on steel and aluminum are causing the most immediate consternation for all sectors of the petroleum industry. With over three-quarters of the steel used in U.S. pipelines coming from overseas, many key midstream operators (including Kinder Morgan and Plains All American) have cited issues with obtaining the necessary grades of steel pipe domestically. As a result, they are seeking tariff and/or quota exemptions for the construction of upcoming projects. Further, they’ve noted that project delays, and possibly outright cancellations, may occur if these exemptions are not granted due to increased construction costs, and at times, complete inability to obtain the required grades of steel. Similarly, producers have warned that these same tariffs will increase drilling and completion costs and may limit U.S. production growth going forward. The refining sector will be affected in a big way as well, with Exxon recently stating that these steel tariffs may cause it to rethink its proposed Beaumont refinery expansion.
Potential impacts on product demand and trade flows are even more frightening. A very direct effect is the decrease in demand for marine fuels which would result in slowing overseas trade activity. Bank of America Merrill Lynch (BAML) has estimated that every 1% drop in global trade activity has the potential to directly decrease petroleum demand by 44 MBPD. This is a drop in the bucket from what could happen if a global recession is triggered. We only have to go back to the Great Recession of 2007/8 to see how product demand could be impacted in such a scenario – U.S. product demand fell by 2 million BPD and total global demand even declined by 1.5 million BPD from 2007 to 2009. Our hopes and really our expectations are that calmer heads will prevail and potentially even some good could come out of a re-examination of global trade relationships, but only if everybody keeps in mind the mutual benefits that arise from true free trade.
We, at Turner, Mason & Company, will continue to follow energy policy decisions and developments, both at the federal and state levels in the U.S. With the results of the Mexican election just off the presses (which could have serious implications for energy reform as detailed in last week’s blog) and, IMO 2020 growing ever closer, international developments in the policy arena will also bear continual scrutiny. Changes in policy focus and resulting regulations at all these jurisdictional levels will have important impacts on all segments of the industry. Over the next few weeks, we will “drill down” (pardon the pun) into some of the specific issues most impactful to refiners in our weekly blog, with a look at the turbulent world of U.S. RFS regulations in next week’s discussion.
Our policy analysis, combined with similar examination of developments in market conditions, the overall global economic environment, and other relevant events will inform our forecasts on what the future holds for producers, midstream players and refiners. These forecasts of supply and demand for both crude oil and products, as well as resulting market prices, will be included in the next edition of our biannual Crude and Refined Products Outlook, scheduled to be released at the end of this month or in early August. We also use this analysis in our other studies and in ongoing work supporting industry participants. For more information about this publication or studies and other consulting services TM&C can provide, please visit our website or give us a call. In the meantime, we wish y’all a safe and enjoyable Independence Day!