Taxing times in the US
A proposed US border levy would lift producers, hit consumers and upend oil markets
American oil executives should probably start brushing up on tax law, some big changes could be on the way. As part of their bid to overhaul the US tax regime, Congressional Republicans and the Trump administration are seriously considering a border adjustment tax (BAT). It would be the most radical shakeup of the US tax code in generations and could have far reaching consequences for US oil company finances, global trade flows and oil prices.
Put simply, the BAT is a protectionist measure that would levy imports, at 20% under House leader Paul Ryan's proposal, while making exports tax free.
American oil producers would reap a windfall, but it would come at the expense of refiners, and ultimately consumers who would pay more at the pump. In the end, such a transfer of wealth from Americans' pocketbooks to oil producers might make the proposal politically unworkable. However, the BAT has strong support from many in congress and fits neatly within Donald Trump's campaign rhetoric that emphasised domestic manufacturing and saw running trade deficits as "losing" in the global economy. For that reason, Corporate America is taking the proposal seriously and oil companies are starting to think through how the BAT could roil their industry.
For US oil producers, the BAT would act essentially as a hefty subsidy. In broad strokes, here's how: Under the current system, US oil producers receive the same tax treatment for a barrel of oil sold at home or abroad. The BAT system would change that. A Permian or Bakken producer could now sell their oil abroad tax free, but would still have to pay tax on oil sold to a domestic refiner. Assuming a 20% border tax rate and a $60 a barrel oil price, then, it could sell the oil abroad tax free generating revenue of roughly $60/b (less any transportation costs). Selling to a domestic refiner at $60/b, however, would incur a 20% tax, generating $48 in revenue. A domestic refiner, then, would have to offer the producer $60/b plus 20%, roughly $72/b, to match the revenue a producer could get from exporting its crude.
This windfall would almost certainly spur new investment and production in the US. More marginal areas of the Bakken, Permian, and Eagle Ford shale plays would become economic at lower international oil prices. So too would mature areas such as California and Alaska. Companies would likely shift investment within their portfolios to the US to take advantage of the country's higher oil price. Rising production from light-oil producing shales would mean a surge in US exports as the domestic refining system is already absorbing about as much light crude as it can take. Permian and Eagle Ford producers pushing tax-free light oil onto global markets would pose a huge threat to other producers of similar crude grades such as Nigeria, Angola and Libya.
The flip side of this boon to US producers would be a big hit to US consumers. Even if the US becomes a net exporter of oil over the next decade, it will still import huge amounts of crude from abroad. Major consuming regions on the west and northeast coasts are not well connected to domestic output and US refineries are geared to process medium and heavy crudes, which will have to be imported. So refiners, especially those on the west and northeast coasts, will continue to be reliant on heavily taxed oil imports.
While refiners have come out against the border tax, they have also made it clear they intend to pass on the border tax to drivers. "The refiners are going to have to be able to pass any incremental costs on to the consumer. And I am very confident that we will be able to do that, just as we did when crude prices went from $100 to $147, we passed the price on to the consumer," Marathon Petroleum's president Gary Heminger said in early February.
That the administration is even considering a plan that would clearly result in higher prices for consumers marks a sharp break from past US energy policy, which typically focused on delivering the lowest prices possible at the pump. However, as US output has risen in recent years and the US moves closer to becoming a net oil exporter, there has been a notable shift in rhetoric, especially among Republicans, towards policies that would favour oil producers over consumers. So it may not be the barrier it once was.
The effects of a US border tax would also ripple through global oil markets. On a number of fronts, it looks like the border tax would be bearish for prices, presenting a threat to Opec and other producers. In addition to boosting US supply, most economists agree that the border tax would see a surge in the value of the dollar. A stronger dollar typically weighs on oil prices. A stronger dollar would also make oil relatively more expensive in emerging markets. That could dampen crude demand in countries like India and Brazil where oil markets count on rising consumption to underpin prices. More broadly, a US border tax would likely trigger trade wars between the US and its major trading partner, dragging down the global economy in the process - an obviously bearish signal for the oil price.
The BAT remains something of a long shot. However, the consequences are too far reaching, and in many cases unpredictable, to ignore.