Tariffs: A sticky business
Tariffs: A sticky business
Since Donald Trump’s election, one of the major headlines dominating topics has been trade tariffs. These tariffs are essentially taxes imposed by a government on imported or exported goods. Their primary purpose is to regulate international trade, often by making imported goods more expensive to protect domestic industries from foreign competition. While historically a source of government revenue, tariffs are now more frequently used as a tool of economic policy, influencing consumer choices and impacting the flow of goods between countries.
After a thirty-day reprieve, US tariffs on Canada and Mexico took effect on Tuesday, further fuelling market anxieties about the current administration's trade policies. Canada retaliated with reciprocal tariffs, while Mexico is expected to announce its response later this week. Contrary to Donald Trump’s claim that fentanyl is the primary US import from Canada (less than 1% of estimated fentanyl entering the US originates from the Canadian border), the actual leading import is crude oil.
Canadian crude oil imports to the US have increased both by volume and percentage
Source: Bloomberg, Artorius
Source: Bloomberg, Artorius
Crude oil being the largest import from Canada to the US may appear somewhat strange at first glance. Over recent years, news about US oil has centred on increased local production, mainly from shale oil. In fact, after years of running an enormous trade deficit in oil, the US is now a net exporter. So, why then does the US rely so heavily on Canadian oil? The answer lies in the oil itself.
Oil isn’t just oil; it varies in viscosity. It can be thick, runny, or somewhere in between. The US and its oil refineries were built to process mainly Californian, Canadian, and Venezuelan oil, all of which is "heavy" oil. This oil is denser and thicker than its "light" counterpart and, importantly, requires completely different refining techniques. The issue facing the US is that its shale oil is light oil.
What this means in practice is that the US has two options: rebuild its oil refineries at a huge cost or sell the more valuable light oil and import heavy oil. Unfortunately for the US, there are very few large-scale producers of heavy oil. For a country the size of the US, there are only three viable trading partners when it comes to this oil exchange: Canada, Russia, and Venezuela. The latter two come with well-documented issues regarding their relationship with the US. All of which explains why over 70% of US oil imports are now from Canada.
While the Trump administration promised to "drill, baby, drill" in an attempt to lower fuel prices at the pumps (and therefore hopefully lower inflation and subsequently interest rates) tariffs on Canadian oil imports could have the opposite effect. Coupled with US oil production already being at all-time highs, Trump’s aims may be overly ambitious.
US domestic crude output is already at record levels
Source: US Energy Information Administration (28th February 2025)
Tariffs don’t appear to be having an impact on oil prices worldwide. There is a risk that tariffs, and wider trade tensions, will lead to weaker economic growth than would otherwise have been the case, but time will tell. Global demand is forecast to rise by less than global supply, and the Organization of the Petroleum Exporting Countries (OPEC), which includes most of the large Middle Eastern oil nations and with which Russia maintains a close relationship, has significant spare capacity. Lower prices may well disincentivise US drilling companies from ramping up production. Producers must be convinced they can get a good price before they "drill, baby, drill”.
Crude oil prices have fallen since the introductions of the tariffs
Source: Bloomberg, Artorius (Crude Oil Futures are commonly used to price Crude oil as tracking the price of each real-world sale would be very difficult)
While the global outlook for crude oil currently appears unaffected by these tariffs, from a US point of view it seems that the Trump administration must choose between policies that lower oil prices, leading to lower inflation and interest rates, or policies that boost prices to make drilling attractive. Achieving both is easier said than done. Which leaves us with two possible outcomes: the trade war ends as quickly as it began, or the US looks elsewhere to obtain its heavy oil – with one producer in particular hoping Trump’s diplomacy in Ukraine ends in their favour.
In a week of volatile markets, to which the introduction of tariffs has contributed, it remains to be seen how long this volatility will last. Reports suggest a month's extension may already have been agreed behind the scenes on tariffs on some goods, either way tariff news stories are unlikely to subside any time soon.
Josh Young de Ferrer
Portfolio Manager
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