Podcast: Xi vs Trump. How have global and Chinese and US commodities markets shifted with each blow of the trade war?
The US-China trade war has seen more than $600bn of bilateral trade fall victim to tariffs, including crude, LNG, natural gas liquids (NGLs) and other commodities related to manufactured industrial goods. While China just wants the tariffs to be removed, US president Donald Trump wants something much more comprehensive, which means we might be in this for a while. In this first episode of our China Connection miniseries, Argus Chief Economist David Fyfe and Associate Editor Haik Gugarats discuss how the most significant economic battle in recent history may affect energy and commodity markets.
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David: Hello. I'm David Fyfe, chief economist with Argus Media.
Haik: And I'm Haik Gugarats, associate editor with Argus Media.
David: Welcome to an episode in our China Connection miniseries. The series examines China's rising presence in global commodity markets, and this episode focuses on the ongoing trade war between Washington and Beijing, what are some of the causes of the dispute, what does it mean for the global economy and for energy markets, and how likely is an imminent resolution. The China Connection is brought to you by Argus, a leading independent provider of energy and commodity price benchmarks.
Today, more than $600bn of bilateral trade between the US and China is now subject to tariffs, as a trade dispute that began some 15 months ago looks like it is worsening. Washington is going to host more talks this month aimed at finding compromise for both sides, but the initial signs are not particularly promising. This month, we'll see coming out of Washington the IMF's next World Economic Outlook, which many expect will start to reflect the impact of the trade war on the 2020 macroeconomic outlook. We are here together today to discuss the causes of the trade war, its impact on commodity markets, and potential routes to resolution. Haik, let's start on the impact of the trade war as far as we can see it so far on the energy and commodity markets. What do you think?
Haik: The first impact, a measurable impact if you will, is on US exports of energy products to China, and that in itself may give you an idea of how trade between the countries has been structured in recent years. The US was exporting a lot of crude and LNG and NGLs, together with other energy commodities to China. So the primary resources if you will, and of course the US was importing mostly manufactured industrial goods, which created the trade deficit.
Trump is focused on the trade deficit, but the immediate impact of this war is that energy exports to China have dried up completely. The US was exporting something to the tune of 400,000 b/d of crude to China in the first six months of last year before the start of tariff wars, since when they've fallen to zero before recovering to 250,000 b/d in the first six months of this year following tentative signs of progress in trade talks. But starting in August, we see China imposing a 5pc tariff on US oil, and exports dropped to zero right away. The same goes for LNG and for other energy commodities. So that's something measurable and that's something that can be seen by the exporters. But that's not all of the story. The bigger story is the macroeconomic impact from this war because these are the world's two largest economies, and this has an impact on demand globally as well as in both countries. David, you probably have a better idea of how to translate that into oil demand figures.
David: Yeah. I mean, I think you're right, Haik. The impact on oil and gas flows out of the US to China has been very dramatic. We should bear in mind that as a percentage of China's total crude and gas imports, you know, US supplies were probably 3pc, 4pc. But I think probably looking forward, it's much more about the potential for that market for US suppliers. And the concerns must be there for a lot of these projects that were designed to leverage the expected growth in energy demand in years to come. But you're right also, I think the impact that this has. And let's face it, we hear that in fact the US is also extending tariffs to the EU, and the IMF in an intermediate note after its last World Economic Outlook estimated that trade wars, if they exacerbate and get worse, could knock anything up to about an eighth of a percent off global economic growth in 2020. When you run that through a sort of typical oil demand model, you get an impact on 2020 oil demand globally of anything up to half a million barrels per day. Now, that may not sound very much, but in a 100mn barrels per day market, it's the last half a million barrels per day that really tends to set the price and determines really whether the market is well supplied or under supplied. So the trade war coming at a time when we're heading for cyclical macroeconomic slowdown is clearly something that is a very, very big concern.
Haik: And it is a concern that ought to be on any economic decision maker's mind — not just the energy industry. But here we are, and we are looking at what could actually happen in talks.
David: Are you optimistic about that, the talks in the next month?
Haik: I'm not, and not because of any public statements to the contrary. We hear quite a bit out of Washington of course, out of the White House, that usually runs the gamut of “China wants a deal badly” to, you know, “the US will not accept the deal,” but it comes down to this. These talks are highly, highly centralized. There are two key decision makers, President Trump on the US side and President Xi on the Chinese side. And that's quite unusual for a US trade negotiation. You have USTR, the US Trade Representative's office, one of the well-run agencies of government that tended to take the lead on this. But the China file, so to speak, is firmly in Trump's hands, and you have his pronouncements that usually move the market one way or another. So China wants tariffs to be gone, to be removed. The US wants something more comprehensive — a reduction in intellectual property theft, and a reduction in what the White House sees as a structural cause of deficits, which is Chinese restrictions on US company activities in China, and a host of other issues. It's a comprehensive file that grows more comprehensive daily. We also have an impeachment inquiry going on in Congress that somehow fits into this conversation. But again, it comes down to Trump and Xi. The two will next meet in November in Santiago, Chile, at a regional conference [the Asia Pacific Economic Conference]. So if there is any movement, I think that might be the date to watch.
David: I think what you say is very important. It's not just about the simple number of a $400bn or $450bn trade deficit that the US runs with China. It's also about these very stringent, basically, revisions to China's industrial policy that the Trump administration is effectively asking for. And their position, of course, is emboldened by the fact that there is a fair amount of cross-party consensus in Congress about the need to do something about China and its industrial policy. So, it's kind of difficult to see either side backing down. I mean, if we have to think about an end game to the trade war, what do you think of some of the scenarios that could represent this outcome?
Haik: The current base case for me is maintaining these tariffs in some way at the current level and consider that to be the new normal. So, you'll have $650bn in bilateral trade subject to tariffs in one way or another, at rates of 15pc to 25pc on the US side. And once that happens, that will be sort of again, the new normal. The US trade deficit with China, some of this will decline this year together with the rest of the trade. But overall, the US trade deficit has not. So essentially if reducing the trade deficit is the goal, the US is transferring its trade deficit with China to southeast Asia and elsewhere. Mexico is now the US’ largest trading partner as a result, and the same goes for US trade in oil and LNG. US oil and LNG exports continue to be strong, but instead of going to China, they are going somewhere else. So that's one... I think that's the baseline in the next year.
Optimistically, the scenario that probably every industry-insider executive exporter hopes for — at least here in the US — is that the tariffs are gone and that we go back to where we were in July 2018 and the two countries continue to discuss various things. But that’s looking quite unlikely. Unfortunately, we have even more scenarios to consider where, you know, as the trade war escalates and more tariffs are put in place it becomes this sort of cycle of retaliation. And so more numbers for you to crunch to figure out how much further it can go.
David: Oh, and the timing is key, because it's happening at a time when we have, as I said, the cyclical slowdown in the global economy and it really just acts as a drag on activity. And all of the key indicators out there of global trade, whether it's in container freight, or air freight, or total merchandise trade over the past 12 months, have been heading into negative territory. So, this is just something that worsens the situation. Just to end up really, what would you say are two or three of the key barriers that need to be surmounted — or maybe they can't be surmounted — before we can resolve this issue?
Haik: One is — quote, unquote — structural. It's a word that has come up quite a bit in this trade conversation and it has nothing to do with the structure of the Chinese economy, which essentially is a mix of state-owned and private enterprise and is hard for investors to break into. It creates this perception that the game is stacked against foreign participants and of course, this is something that was a drag on Chinese growth, and it is something that Beijing has been trying to address for some time. So, the biggest barrier would be this perception of trade as essentially a very mercantilistic exercise where a trade deficit is disease and the way to cure it is through tariffs. And it's quite a remarkable change. I'm sure you'll recognize not just in history, but in just the past decade that there is this potential view. You know, you can probably look and see where this might go. But one point to emphasise, as you said, is that there's a wide political consensus here in the US that, you know, China needs to change its ways. I mean, whether it's fair or not fair, we don't have time to talk about it. But I think there is a broad consensus here in the US that somehow something needs to be done about these trade deficits.
David: And the flip side of the coin of course is that we have a very assertive, relatively new Chinese leader in Beijing who’s out to re-establish the position of China within Asia. And of course, one of the things that we'll be talking about in future episodes of the podcast — whether it's the belt and road initiative or territorial issues within southeast Asia — is a very assertive Chinese leadership that seems equally unlikely to back down on some of the big issues regarding its industrial policy, which the US is asking Beijing to change its behaviour on. So, we are sounding a little bit pessimistic here. It's a little bit of a down note to end this podcast on, but thank you very much, Haik. And thank you, everyone, for listening.
Haik: Thank you, David.
David: And look out for the next edition in our series of podcasts on China and the commodity markets. Bye for now.