At a Glance
- As equity markets experience sell-off on trade war news, oil may follow them lower
- The impact for oil in U.S.-China tensions could be far greater than in past trade wars
This has been a great year for oil. The price of crude is up 30 percent from its December low and oil bulls are wondering if there’s more room to rise. The economy is recovering and many central bankers including Federal Reserve Chairman Jerome Powell feel that uncertainty is easing, and global growth is improving.
That was until the latest round of volleys in the U.S.-China trade dispute, in which each country raised tariffs on billions of dollars of goods.
Oil, which peaked in April, extended its slide as the Dow Jones Industrial Average tumbled hundreds of points in the days to follow.
We all know that trade wars are bad, and crude suffers from the double blow of risk aversion and weaker demand. As trade wars intensify, markets sell off and crude prices follow lower. Industry, economic and global growth are affected because slower growth in China means lower Chinese oil demand. Weaker Chinese demand will lower oil prices. A further slowdown in China’s economy takes a toll on all of its trade partners whose demand for oil also suffer as a result.
Trade wars boost prices as well which is bad for oil because it pinches pocketbooks and reduces the purchasing power of consumers. Tariffs on Chinese made clothing, electronics and other goods could lead to higher prices and in turn higher inflation. The problem is when price pressures are not caused by oil, it is a drag for the industry. The good news is supply is being constrained by U.S. sanctions on Iran and Venezuela along with OPEC production cuts but they will ease not erase the pain.
Trade Wars Past
The U.S. has only experienced a handful of trade wars over the last 100 years and each has negatively impacted oil. While oil prices increased after the United States imposed steel tariffs in 2002, in 1993 Europe and Latin America engaged in a Battle over Bananas and U.S. stocks had a good year but oil fell 27 percent. In November 1985, the U.S. raised tariffs on pasta from Europe, oil prices crashed hard in the months to follow. The same was true in 1981 when the U.S. was getting increasingly frustrated with Japan who was rapidly growing its exports of Japanese cars. The U.S. restricted sales, sending stocks and oil prices tumbling lower that year.
The 2018-2019 trade war is more encompassing and damaging for the global economy than previous trade wars so the impact on oil should be even more significant. The latest trade wars began in early 2018 and during that time, we’ve seen widespread volatility in equities and currencies. There’s no coincidence that crude prices rebounded 30 percent in a period when US-China trade tensions were easing. This year was off to a good start when the U.S. delayed additional tariffs on China. The S&P 500 hit a record high and oil prices went from $45 a barrel to $65. After Trump issued his latest threat, crude prices tumbled as risk aversion and Chinese growth concerns returned.
To Be Continued
Looking ahead, trade wars will continue to influence oil. If the U.S. pressures China into a deal, traders will bid oil higher in relief and we could see the bull market renewed. However, if the trade war intensifies with no end in sight as the U.S. proceeds with more tariffs on not only China, but also the European Union, oil could fall sharply, slipping down to its December lows near $45 a barrel.