Geopolitics and Tariffs See Crude Get a Big Lift, But Upside Has Limits
By: Bart Melek, Ryan McKay
févr. 03, 2025 - 8 minutes
Overview:
- After some three quarters of following a downward trajectory, which saw WTI crude drop all the way down to U.S. $67 per barrel (/bbl) at the start of December, prices have bounced up to a trading range in the mid-70s. The reversal comes on the heels of cold weather-driven inventory tightening, more robust sanctions on Russian supply and the potential for stringent limitations on Iranian supply.
- The risk of a direct conflict with Iran, which may negatively impact oil infrastructure, and the threat of a massive 25 percent tariff on the 4.3 million barrels per day (b/d) Canada sends to the U.S. have also prompted traders to start building long exposure over the last few weeks.
- The market is going long despite OPEC+ overproduction and overcapacity, and weak Chinese demand, which are projected to generate a surplus of some 700k b/d over the next six months. Traders seem also to be dismissing the newly minted Trump Administration's promises to materially increase U.S. crude production, as it makes regulatory changes to make good on its "drill, baby, drill" policy.
- Considering the strong likelihood global oil demand will only increase by about one million b/d in 2025, while non-OPEC+ supply is set to grow by about 1.2 million b/d, OPEC+ is overproducing by over one million b/d with a spare capacity of more than five million b/d, it is unlikely that oil rallies further on a sustained basis.
- However, it is quite possible that WTI temporarily surges if Middle East tensions rise due to conflict or if a more robust sanctions regime is imposed on Iran and Russia. Long-lasting tariffs on Canadian crude also has the potential to see a robust and sustained price increase. But OPEC's spare capacity and its determination to regain market share, along with the likelihood any tariffs on energy products would be shortlived, will make it hard for any additional surge to survive.
Tariffs on Energy Could Spike Prices but Are Unlikely to Last Long-Term
The key question for the oil market under President Trump is that of potential tariffs, particularly on Canadian crude and the risk of restricting energy flows as retaliation by Canada. The U.S. imports some +4 million b/d of Canadian crude oil, which represents just over half of all U.S. imports. The main issue arises due to the heavy sour grade of Canadian crude, which makes it more difficult to replace, especially with domestic supply.
Before the U.S. shale boom, U.S. refiners ran mostly heavier grades of crude from Venezuela and then Canada, and because of the steep investment in those refineries, the refining capacity in the U.S. remains tailored to the handling of this type of crude. In this sense, Canadian imports play a very important role in all three of the major refining areas in the U.S., including PADD 3 (Gulf Coast), PADD 2 (Midwest) and PADD 5 (West Coast). The Gulf Coast, the largest refining area, imports nearly 500k b/d of Canadian crude, which represents just over 30% of crude oil imports and is the largest single supplier to the region.
Likewise, the West Coast imported nearly 400k b/d of Canadian crude in 2024, which represents over 30% of crude oil imports and is again the largest single supplier to the region. In the Midwest, it is more drastic; Canada accounts for 100% of the regions 2.5-3 million b/d crude oil imports and over 60% of the refinery feedstock in the region. The Midwest is the pressure point considering these refineries have limited connectivity to U.S. crude and product pipeline infrastructure, suggesting tariffs would have a large impact on the region.
Retooling the U.S. refining complex to handle more light-sweet shale crude is certainly an option, although it is a costly and time-consuming procedure which offers little respite in the short or even medium-term.
Major Refining Regions Use Plenty of Canadian Crude
Additionally, replacing Canadian crude suggests the U.S. would need to enter the market for medium-heavy sour Middle Eastern grades, which are currently in high demand. The most readily available substitutes for Canadian crude are the heavy sour crude from Venezuela, Colombia or Mexico. However, President Trump has stated the U.S. will likely stop buying oil from Venezuela, Colombian production is not enough, and Mexico is planning to refine their own crude while also being in the crosshair of President Trump's tariffs.
All of this suggests the U.S. would need to enter the market for medium-heavy sour grades from the Middle East which are now in high demand from the likes of China and India amidst sanctions on Russia and the anticipation of a "maximum pressure" campaign on Iran.
No matter how you shake it, a tariff on Canada that includes energy will increase the cost of crude in the U.S. and globally as most of Canadian supply will be landlocked. This will weigh on refining margins and tightening product supplies and prices. This would be a painful endeavor for all involved, and we anticipate any tariffs on energy are unlikely to last in the long-term because of this burden.
Alternatively, should President Trump forgo tariffs on Canadian energy, market prices could be prone to a reversal in the near-term, given medium-heavy sour crude has been the driver of supply risk premium lately amid tariff and sanction concerns.
U.S. Production to Remain Policy Agnostic
Regarding President Trump's "Drill, Baby, Drill" mandate, we expect U.S. oil production will remain policy agnostic and will continue to operate with respect to the underlying economics of the market. In this sense, major producers' appetite to materially grow production remains low amid a not entirely optimistic market outlook for the coming years with slowing demand growth, strong non-OPEC production growth and the lingering OPEC+ production cut unwind. Indeed, surveys have indicated firms are not planning to increase investments in 2025.
With that said, production in the U.S. is expected to grow to 13.5 million b/d, up from an average of 13.2 million b/d in 2024. The lion's share of this production is expected to come from the Permian, and it is mainly due to the new natural gas pipeline that has come online which has eased bottlenecks in the area, rather than due to presidential policy action.
Aside from this, U.S. production growth is expected to be much slower. The abundance of drilled but uncompleted wells (DUCs) have been depleted with the data now showing nearly the lowest amount of DUCs since the data began being collected. This suggests there is less low-hanging fruit to quickly increase production. Furthermore, there is only so much remaining “Tier 1” shale acreage, and the less productive "Tier 2" locations have similar costs to drill and complete, making them less economically attractive. With breakevens on new wells ranging from $59-70/bbl, volatile price action and steep backwardations making hedging less favorable are further factors that weigh on the viability of substantially increasing production.
DUC Inventory Near Lowest on Record
Middle East Conflict, Robust Sanctions Regime on Iran, Russia Could See Sharply Higher Crude
With Donald Trump now occupying the White House again, more robust sanctions against Iran are very much in the cards, and a Republican emboldened Israel may take more aggressive military action against the Islamic Republic, notwithstanding the recent ceasefire agreement. If a full-blown war erupts in the Middle East with Israel targeting Tehran's oil infrastructure, Iran could in turn retaliate against oil tankers navigating the Strait of Hormuz, as well as pipelines and other energy infrastructure of nations "friendly" to Israel and the United States. Oil prices would very likely surge. Iran produced some 3.4 million b/d in Q4-2024.
If flows from Iran were to be temporarily disrupted, prices would likely surge. However, given that OPEC nations have some five million b/d of spare capacity, it would not be the end of the world if Iran's production and exports are reduced, although an erosion of said spare capacity would catalyze a rise in supply risk premia nonetheless.
If Tehran were to attack Gulf State energy infrastructure and tanker traffic through the Strait of Hormuz, the impact would be much more severe and long-lasting, as those supplies cannot be replaced. Saudi Arabia, UAE, Kuwait and Iraq alone produce some 19.2 million b/d of crude. As such, $100+ crude for a prolonged period would be very much in the cards.
Middle Eastern Crude Trading at Premium amid Sanctions Concern
Similarly, the maintaining of more stringent sanctions against Russian oil will also lift prices, but OPEC spare capacity could also serve as a buffer here, limiting serious price escalations. The Biden Administration imposed the most severe sanctions on Russia’s oil yet, designating two major Russian oil companies, 183 vessels, dozens of oil traders, oilfield service providers, insurance companies and energy officials as sanctioned entities.
This has led to the tightening of near-term physical markets. December-to-December spreads have rallied, Middle Eastern crudes are trading at a premium, tanker rates from the Middle East to China and India have surged, while floating Iranian storage has hit four-month highs amid sanction concerns. Indeed, India’s refiners have stopped doing business with the Russian tankers and companies sanctioned by the U.S. However, sanctions are not unanimously bullish for crude oil markets. Follow-through dynamics could hurt already modest demand growth expectations from China, particularly for independent Chinese refiners who have relied on cheaper sanctioned crude. Increased crude sourcing costs for Chinese refiners could lead to reduced runs and hence slower demand from the largest oil importer.
Independent Chinese Refiners Already Feeling Sanction Pinch
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