The Crude Report: Trade Wars: The Liberal that got mugged

Tom: Hello, and thank you for joining us for this episode of "The Crude Report: Trade Wars Versus the Oil Market." I'm Tom Reed, VP for China Oil Markets. And joining me again is Haik Gugarats, our editor at large and top policy pundit in D.C., to discuss what's going on with Trump's trade wars and what it means for the oil markets. Hey, Haik.

Haik: Hi, Tom.

Tom: Okay, let's dive straight in. Canada just had an election. The win for Mark Carney, late of this parish, where he was our central banker, is being seen as an indictment of the state of U.S.-Canada relations. I have two questions. Is that too simplistic an interpretation? And what, if anything, does the election have to do with the politics around energy in Canada?

Haik: You are spot on, Tom. And let me begin by saying that, as an American, I am very envious of a national election that lasts six weeks and concludes with results known right away. The loser congratulating the winner, the winner acknowledging the loser, all the proprieties being observed. So Mark Carney...

Tom: The hallmarks of democracy.

Haik: Democracy works. So Mark Carney won the election and, you know, he won a parliamentary seat for the first time, and his opponent, the Conservative Party leader, Pierre Poilievre, not only lost his chance to form a government, but he lost his own parliamentary seat. So that's the outcome. And for that, I think it is fair to thank President Trump, who did not list that among his many, many, many other accomplishments when he celebrated his 100 days in office on 30th of April. But it is due to what Trump has done that the liberals got reelected for another term after 10 years in office.

So just as a recap, when Trump took office in January, he proceeded to imposing a stiff tariff on Canadian energy imports, 10% and 25% on all other Canadian imports. He talked about fentanyl and human smuggling across the border. He said many mean things about then Prime Minister Justin Trudeau. He has been calling for Canada to become the 51st U.S. state, most recently on the day of the election. So all of that, I don't know what he was planning to do with that, but I think that was a key factor in rallying the Canadian electorate around the liberals, who were not doing so well in the polls before January.

Tom: Enormous swing, right?

Haik: A huge swing. And essentially, a two-party system has reemerged in Canada. Liberals and the Conservatives, between them, have garnered most of the votes. And the Conservatives did pretty well, too. They actually have done the best since 1988. But the Liberals have the party, and Mark Carney is now the elected prime minister of Canada.

And, of course, you mentioned his tenure as the Bank of England head, but let's not forget that he was also a leader since stepping down from Bank of England. He was a leader in generating ways to direct funding for net-zero, for an energy transition. Funding for emerging countries to promote renewable energy. He was the co-chair of the Glasgow Financial Alliance for Net Zero, most recently. And, of course, that man is now the prime minister of a country that is a major oil producer and has been forced to look for ways to diversify that oil production because Canada produces roughly five million barrels a day. Four million barrels a day is exported by pipeline to the United States. And all of a sudden, it has become a huge headache.

Tom: On that note, I mean, that does beg the question. So Carney came in, he had all these green credentials. Canada is a massive oil producer, but Carney was talking the energy and the economic security game. Did that sway Conservative voters to his cause? Was he able to play up the energy security credentials and play down the green energy credentials in the election?

Haik: So one thing that he did right away was to remove the carbon tax on consumers. That was very unpopular and kind of set him aside from the previous liberal government that Trudeau led. And I don't think Carney's message necessarily endeared him to producers. You know, the Liberals didn't do as well in Alberta, Alberta being the top-producing province. But it's a huge change. It's a huge change in messaging from a liberal government in Canada, because Carney has been talking about diversifying away from the United States. He's been talking about needing more oil pipelines.

One of the things he's talking about is this infrastructure corridors, investing in ports, investing in pipelines, and investing in ways to promote Canada and not leave it dependent on the United States. So, you know, just in terms of rhetoric, that's a huge change. And, you know, that's a transformation of, I guess, global climate politics. That's a transformation of North American climate politics. And, of course, for that, too, one way or another, we can thank Trump.

Tom: I mean, that's really interesting. I mean, you mentioned Alberta. It's a key crude-producing province in Canada. One thing that really struck me in recent weeks, in fact, as recently as March, Alberta Premier Danielle Smith was talking about working with the U.S. on actually increasing Canada-U.S. pipeline capacity by up to two million barrels a day in the next decade or so. There's a plan to expand the Enbridge mainline system from Hardisty to the Midwest and the Gulf Coast, and another one to expand the Keystone route into Illinois. Is that still a thing, or is Smith...? Are these comments from Smith now out of tune with the times now?

Haik: So those two things you mentioned are actually in the works, as in, the companies have expressed interest. So Enbridge is keen to expand its export capacity to the United States. There is also the South Bow midstream company. You know, it's soliciting shipper interest in something called the Big Sky, essentially transporting oil from Hardisty to Illinois and onward to Texas via Energy Transfer Crude Oil Pipeline.

So the projects that are actually advancing would add 450,000 barrels a day of export capacity by pipelines to the United States. The Alberta Premier has spoken about more pipelines. She talked about two million barrels a day of additional export capacity. And it wasn't quite clear what that entailed. Trump, a month ago, said he would, you know, resurrect the Keystone XL pipeline, which on and off was talked about, but never acted upon for the last 10 years. So I think Carney and many other Canadian producers are speaking about projects that would take Canadian oil away from its only current destination, United States.

Of course, there's this project that has been discussed for a decade, Energy East. Energy East would transport almost a million barrels a day from Alberta to East Coast, because... Canada is a net exporter of crude, but it also imports crude. It has a major refining hub in east, in New Brunswick. So, you know, that oil is coming from the United States, some from Nigeria, some from Saudi Arabia. So it kind of makes sense to deliver Canadian oil to the east of the country, if you can work it out.

Tom: That's my question. So in terms of those diversification plans, are those just absolute moonshottery? Are any of them realistic within the lifetime of the current Canadian, you know, voter?

Haik: Well, it can be done. In theory, everything can be done if the price and economics is right. That's what we like to tell ourselves. But just to rewind, so this project, Energy East, for example, it came about 10 years ago, because again, when Justin Trudeau became the prime minister in 2015, that coincided with then U.S. President Barack Obama's decision to stop Keystone XL from proceeding. Keystone XL would have added about 900,000 barrels a day of export capacity from Canada into the United States. Obama essentially stopped that project. Trump became president in 2017 and, you know, tried to resurrect it, but at that point, the economic interest for it dissipated.

Now, in 2015 and 2016, Trudeau talked about diversifying away from the United States as the only offtaker of Canadian pipeline routes. So a lot of the projects, a lot of the pipeline projects you see now, actually have been in discussion for a decade, and they haven't happened. A, you know, global market kind of moves daily, hourly, and pipeline projects, especially in difficult terrain, take years to conceive and to advance.

So Carney himself has actually expressed support for some of the projects. You know, he's talked about something called Pathways Alliance project that would include a carbon capture and storage hub. One of the energy corridors he talks about would transport oil from, you know, Alberta to Canada's Arctic coast in Nunavut or to Hudson Bay. So those aren't new. It's not just regulation. It's not just the carbon taxes, although Canadian producers say that, you know, Carney has promised a two-year review window. They want to cut the review window for big projects to just six months. Of course, they aren't very happy with the carbon tax assessed on the industry either. So it's going to be an ongoing discussion in Canada. I'm actually kind of curious to see how it is resolved, but pipelines...

Tom: Too early to say, I guess, whether those expansion pipelines into the U.S., you know, have now fallen through favor or will go ahead, or whether this kind of Energy East project will allow the Canadians to diversify their export routes. Is that fair?

Haik: That's fair. And, of course, Trudeau himself became a convert of sort because he put his government behind the biggest expansion that has happened, Trans Mountain Express, that has opened additional capacity from Alberta to the West Coast of Canada. And then all of a sudden, Canadian crude has become a player in China. And how did that come about?

Tom: Imagine my surprise. Well, I mean, it was fascinating for me to see that and how rapidly that developed. Because, you know, like you say, you know, Canada has this incredible dependency on exports to the United States. Most of what it exports is very heavy, very sour grades, like Cold Lake and Access Western Blend or AWB. And that's fine. I guess if you have one of those very sophisticated refineries in the U.S. Gulf Coast, but I think a lot of refineries actually struggle to process them outside the U.S. And as a result, they tend to trade these very, very deep discounts to benchmark prices, like ICE Brent or whatever.

And China's refineries are probably among the better suited to Canadian crude outside the U.S., partly because, you know, it's a relatively modern refining fleet in China. They've got a lot of coking capacity, which you need to upgrade heavy crude into those more valuable fractions like diesel. Also, because Chinese crude, and it's a big producer itself, tends to be quite acidic, so like the AWB crude that you'd see coming out of the Canadian TMX pipeline. That's very acidic.

The other reason is geography. It's a far shorter sailing distance from Canadian crude out of Vancouver on the West Coast than it is for Canadian crude from the Gulf Coast in the United States to get to China. And what we really saw is Chinese refining margins weakened. And we've talked in the past about how China's EV program is really cutting into demand for things like gasoline and diesel and how that's hitting refining margins in China. And Chinese companies have become more and more price-sensitive and begun to look more and more actively for these cheaper discounted crude grades, like the AWB, like the TMX crude that they now have this fantastic access to.

And one of the advantages to China, of course, and this was the punch one, didn't see the Western sanctioning of Russian crude, is that it drastically reduced competition for Russian crude. So when you have a Russian crude grade like ESPO Blend, which is quite light and sweet, but at the same time has quite a heavy residue content, it turns out that ESPO Blend is great for blending with Canadian heavy sour crude. And you can get quite a nice blend out of that.

Haik: Yeah, and so, of course, you know, China, one way or another, has been both a beneficiary and an enabler of many countries exporting despite U.S. sanctions, Iran, and Venezuela. President Trump's administration has been trying to cut down on Iranian exports to China. You know, they went after a couple of teapots just in the last month. But Venezuela has actually been kind of flying under the radar recently. So U.S. hasn't quite stopped Venezuelan exports yet. It allows continued imports by Chevron. At least the license for Chevron to stay in Venezuela is through May 27th. But we have noticed a quite significant decrease in Venezuelan exports, something to the tune of 400,000 barrels a day.

I'm kind of curious, has less of it been coming to China? What's happening with China? And, of course, we will have noticed Iran, Venezuela, both are OPEC. So China and OPEC, but let's start with China and Venezuela.

Tom: Yeah. I mean, as you mentioned, the U.S. waiver on imports of Venezuelan crude doesn't come into effect till the end of May. But, of course, crude markets tend to trade some months ahead of delivery, right? You can't just buy a crude and have a cargo of crude that day. It'll trade a month, two months ahead. So it's unsurprising, I think, we're starting to see exports fall because, of course, they can no longer go into the U.S. from essentially the start of June.

Like Canada, Venezuelan crude is heavy and sour. The key export grade is Merey. I think the first place we're already starting to see a decline in Venezuelan exports is because companies like Chevron have had to pull out of the upstream, and because they're going to be stopping buying it.

What does still come out of Venezuela is probably going to go into Shandong province in China, where, as you mentioned, you've got these little independent refineries, and they're kind of okay with taking crude that has been sanctioned by the U.S. Although, as you mentioned, right, the sanctions on those two little teapot refineries, Luqing and Shengxing in March and April have put the wind up them slightly. The U.S. is clearly also scrambling around for replacement heavy sour crude now that it can't get Merey anymore.

And we're seeing that in far stronger pricing for, in particular, Colombian grades like Castilla, Vasconia, and those grades are now trading at narrower discounts to benchmark prices than they did. I suspect that's because of the loss of access to Venezuelan crude from the United States.

What we're also seeing in the last month is that Middle Eastern heavy sour crude grades, so like Iraqi Basrah Heavy, those are becoming more and more competitive on price because OPEC is unwinding its production cuts far faster than expected, okay? Originally, it had a plan to return around two million barrels a day in voluntary cuts over a year. Suddenly, in May, it was like, "We're going to pump a lot of that back into the market all at once." So in May, they...

Haik: Of course, we are speaking ahead of May 5th meeting of OPEC, so we will not be guessing what will happen. But I bet the market in China is already taking some steps.

Tom: Yeah, exactly. So yeah, we are very much the hostage to upcoming political events as we've learned to our cost on this podcast. Everything can change and often does in six hours. At least at this point, we know the OPEC meeting is coming up on the 5th of May. And I think it was interesting to see how, certainly, refiners in Asia were positioning themselves for that meeting. So what we saw over the course of this month was a really dramatic run-up in the relative price of sweet versus sour crude. So in the derivative market, there's an instrument called the Brent-Dubai EFS, which allows you to hedge the difference between sweet and sour crude costs. That is back over a dollar a barrel. That's a significant increase in the premium of sweet to sour crude.

Why has it gone up? It's because they expect supply of sour crude to increase and its price to fall relative to sweet crude. We also saw the Dubai market sell-off, the prompt Dubai market sell-off. So what does that tell us? Presumably, that is the expectation that OPEC will continue to accelerate returns to the market in June as it plans to in May. Whether that bet was on the money, I guess we're all about to find out. And this sort of thing, it just adds to the uncertainty in the market. What will OPEC do? Which way will it move? We don't know. We're going to find out on the 5th of May. I think that's probably all we have time for.

Haik: Pleasure speaking with you.

Tom: Yeah, always a pleasure. Thank you very much. Let's do it again. As ever, thanks, everyone, for listening. If you'd like to learn more about our products and services, please look at argusmedia.com or hit us up on LinkedIn for connections. That's been us. Thank you very much, Haik. I will talk to you soon. Bye, everyone.

Haik: Take care.