By Andrew Zirkle | United States
Although oil prices have been taking a steep nosedive over the past few months, there is a new underlying problem that can be expected to hit the oil industry in the next 5-10 years due to the indirect effects of US metal tariffs. Since early 2018, the United States has imposed a 25% steel tariff on all but four countries and a worldwide tariff on aluminum set at 10%. These tariffs, enacted using the Trade Expansion Act of 1962, have been repeatedly been justified by the Trump administration as retaliatory tariffs or tariffs designed to protect the American metal industry. The current near $50pb price of crude oil seems to indicate prices have been unaffected in the short term by the application of these tariffs, however, there it is clear that these measures, if sustained, could have long-term implications on the profitability of America’s rapidly expanding oil industry. The US oil industry, which relies on steel and aluminum for refinery construction as well as tanker and truck construction, has not faced large tariffs since the Bush administration, and those tariffs were short lived. The expansion and long-term growth of US oil processing is incredibly dependent on the on the price of metal and although it’s not apparent yet, the damage that these tariffs could have on domestic oil production in the US is irreversible.
Above is an abstract diagram illustrating the effect of import tariffs on crude oil processing firms that need to purchase metal to make investments in production capital. The sections A, B, C, and D, which are above the price but below the demand curve represent the consumer surplus, which shrinks during the tariffs. The monetary loss to the consumers of the metal, which in this case is oil companies, is much larger than the monetary gain for domestic metal producers, which is a producer surplus represented by section A. Section C represents new government revenue collected through taxation and Sections B and D represent deadweight loss: a loss in economic efficiency achieved due to taxation. Although this loss in economic inefficiency is not optimal, there are greater long-term losses that are shouldered only by the oil industry.
The demand for petroleum-based products in the United States is expected to increase in the coming years, and to maintain energy independence, the United States will have to increase its production, transportation and refining capabilities. All over the United States, new refineries are under construction, oil pipelines are being laid and new tanker fleets are being built. All these capital goods are necessary to the health of the petroleum industry, yet companies in the petroleum industry will have to either cancel these projects or increase the price of their product to maintain viable profit margins.
The domestic oil tanker construction industry is already under intense pressure. The International Maritime Organization has set new standards and regulations for the environmental performance of oil tankers. This is causing an excess in tanker scrapping and a new demand for updated oil tankers. The new demand for updated tankers will require the tanker building industry to consume more steel than it normally does. This increased demand for tankers combined with an increased price in steel and aluminum could result in oil companies shouldering a huge price burden when looking to update their fleet. In the next 5 years, the Aluminum and Steel tariffs will cost the petroleum industry an additional 1.45 Billion dollars, as tanker building companies will struggle to deal with the increase in materials price when building 2020 compliant tankers. Anything transferred by sea between two US ports must be carried by an American built ship, per the US Jones Act of 1920. This means that despite a great increase in materials costs due to tariffs, American petroleum supply chains must continue to rely on US built ships even if they are drastically more expensive. This will likely mean that the domestic seaway petroleum supply chain will contract, meaning that overseas transportation from offshore refineries will become much more expensive and transporting petroleum to areas in the US that can’t produce it locally will become much costlier. The domestic shipbuilding industry will also become much less competitive worldwide, as global supply chains will become much more reliant on shipbuilding in countries like Bangladesh, India, and China, which can build ships for a significantly lower cost due to a lack of trade barriers for raw materials.
Refinery construction is also heavily dependent on stable steel and aluminum pricing. The United States sped up refinery construction and upgrades as an aging generation of oil refineries built in the ’60s is rapidly approaching the end of its safe and usable lifespan. Currently, refinery construction costs range between $70,000 and $90,000 per barrel capacity, however, this figure is heavily dependent on the size and type of refinery being built. Steel and aluminum make up a strong majority, around 75%, of the construction materials used to produce refinery components. With these factors considered, as well as the refinery construction and upgrade trends in the United States, the Petroleum industry can be expected to pay an additional 3.5 Billion dollars over the next five years for refinery construction. This number is especially troubling, as oil refining has small and volatile profit margins, especially in refineries that produce less than 100k barrels per day. These smaller refineries are becoming more common in the United States, with 5 of them being built in the last 5 years5 of them being built in the last 5 years.
The oil industry is also highly dependent on the construction of transportation pipelines used to transport crude throughout the country. Pipeline transportation is by far the most efficient method of transporting crude oil, much more effective than truck transportation. Pipeline construction is accelerating across the country; however, the new tariffs are putting that growth in jeopardy. Pipelines and pipeline components are almost completely composed of the two metals targeted in the tariffs: steel and aluminum. Major pipeline construction in the next 5 years will take a cost hit of 2.2 Billion dollars, a price which may force project delays and cancellations. This development will weaken the transportation capabilities of crude oil companies trying to transport both crude and finished product. The alternatives to pipelines, trucking, and rail, are much less efficient than pipelines and are also affected by the metal tariffs.
Pipeline transportation is another part of the petroleum supply chain that will also take a hit from tariffs. Pipelines have become an increasingly important part of the domestic petroleum industry as more US companies are processing oil in Canada and then using pipelines to ship the crude oil to US refineries. The increased pipeline development in the United States will be hampered due to increased raw materials cost. This increased cost will likely cause current projects to be finished over budget and future projects to be canceled due to rising costs. This new difficulty in above ground transportation will make it much more difficult for US-based companies to take advantage of the new supply opportunities in Canada, and will likely prevent the domestic supply of petroleum products from keeping up with demand.
The United States has had a recent spike in oil production following a lull in oil production in the early 2000s. This recent spike in domestic production was caused by the efforts of the US Government to reduce foreign dependence on oil as well as other market factors including unrest in the Middle East. Overall, the United States has seen positive results from increased oil production. Prices of petroleum products, which used to be heavily influenced by the whims of foreign governments and OPEC, are now stabilized due to a larger part of the market coming under the influence of a market-based competitive domestic market. The upward trend of US petroleum production was expected to continue, however, these new tariffs put that favorable trend in jeopardy. Petroleum refining already has incredibly thin profit margins and with increased costs for construction, repair, and upgrades, planned refinery construction will either be reduced to meet cost goals or will be more expensive to oil companies due to increased material cost. In the first case, domestic oil production will not expand at the same rate as demand and foreign control over the oil market will increase. In the second case, domestic oil will increase in cost which will result in higher prices for petroleum products or more foreign control.
Should these measures remain in place, the US petroleum industry can be expected to take a $7.15 Billion profit hit in the next 5 years just due rise in cost to these 3 elements of oil production. Other elements of oil production that rely on steel and aluminum will also cause a rise in production cost, including well construction, offshore installation construction and even the development of fracking technology. Overall, the tariff affects almost every aspect of domestic oil production in a negative way. The United States can expect to lose control of their oil market to foreign producers unless serious protections are put into place for domestic producers. Even if these protections are put into place, the price of oil will rise long-term as domestic supply contracts. In order to continue the healthy growth and development of the US oil industry, steel and aluminum tariffs must be removed or reduced to lower materials cost.
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