Home' Trinidad and Tobago Guardian : February 16th 2017 Contents BG14 | FINANCE
BUSINESS GUARDIAN guardian.co.tt FEBRUARY 16 • 2017
A looming oil price shock
Last Thursday US President Don-
ald Trump, following a meeting
with airline executives, indicat-
ed that he will be making an
announcement "over the next
two or three weeks that will be
phenomenal in terms of tax."
The US stock market reacted positively
to this news with all the major market in-
dices posting record highs as at the close on
Thursday last. In addition the US dollar rallied
against a basket of global currencies on Friday
last confirming the more optimistic market
stance as a result of the sound bite from the
There is a need for specifics on tax reform
and there have been none since Trump as-
sumed office. What there has been is specu-
lation that whatever comes out will be positive
for stocks and the markets have been rallying
on the rumour. It is left to be seen if they will
sell on the news.
There are three key elements to the tax re-
form agenda that the market is anticipating.
The first is a lowering of the tax rates in the
US. This would presumably leave more on the
table for companies to reinvest in capital and
business development. Overall it is expected
that returns to shareholders will all other things
being equal increase as the effective tax rate
for companies falls.
Better shareholder returns are obviously
good for stocks but the flow through to the
masses, especially those in Middle America
that voted for Trump, is based on a tenuous
concept of trickle down economics that has not
worked from the last recession and is unlikely
to do so now.
A report from the Boston Consulting Group
showed that from 2010 to 2015 the number of
billionaires in the US increased by 26 per cent,
persons with a net worth of US$100 million
to US$1 billion was up by 61 per cent. Those
ranging from US$20 million to US$100 mil-
lion increased by 64 per cent but what they
defined as middle-class incomes declined by
1.5 per cent.
As I have repeated many times this year, la-
bour's take from the pie of corporate profits is
steadily decreasing and more is going to the
owners of capital than ever before.
Another key element to the tax reform also
speaks to further benefits for corporations in
the form of reducing the tax rate for multina-
tionals seeking to repatriate funds to the US.
Currently there are billions of dollars of prof-
its held outside of the US by US corporations
because the tax impact of bring it back to the
US is uncompetitive. Many companies have
opted instead to borrow in the US to fund share
buybacks and dividends while leaving surplus
cash outside of the US.
If this portion of the tax code is adjusted and
corporations do bring funds back into the US
the implication is that there would be a demand
for US dollars and a selling of other countries
currencies. This will result in the US dollar
strengthening against a global basket and the
movements in the US dollar subsequent to the
Trump announcement reflect that reality.
Given the correlations between the price of
oil and the US dollar, appreciation is likely to
see oil prices fall. At present the relationship
between oil prices and the US dollar is not as
strong as has historically been the case but
some impact will be present.
For example between 2007 to 2013 there was
an almost a one to one inverse correlation be-
tween the currency and the commodity in that
as the currency fell the price of the commodity
However, from 2013 the correlation has been
more muted as increase supply from shale oil
producers, increased production from OPEC,
the resulting standoff, and other exogenous
factors such as the turmoil in many oil pro-
ducing countries impacted the price dynamic.
Regardless of the extent of the correlations
going forward a strong US dollar is likely to
have an impact on the price of crude oil and
other commodities for countries around the
world as the price to them will increase if the
US dollar appreciates against their currency.
This is one dynamic that we need to keep a
The third aspect of any proposed tax reform
is what is known as a border tax.
In T&T the equivalent is the value added
tax (VAT) and it is a tax that is applied to all
goods brought into the country and off set by
all goods exported from the country.
If such a tax were to be implemented in the
US the theory would suggest that the US dol-
lar will increase by the amount of the border
tax. This would mean that if a 10 percent tax
increases the price of imported goods, the cur-
rency would strengthen by a similar amount
to reduce the price of the imported goods re-
sulting in a zero-sum game to the consumer.
Appreciate that things don't always work out
as the theory may suggest but a stronger US
dollar is again going to impact the price of oil.
For us in T&T the biggest issue comes from
the impact that this new tax may have on oil
prices not from currency moves but from pure
demand and supply. An analyst from Goldman
Sachs last week penned a note which sought
to explain what is potentially at stake.
Currently, the US demand for oil is greater
than its domestic supply and so it has to im-
port crude. With a tax on imported crude the
incentive would be to use domestic (US crude)
first. This would then flow through to US oil
producers (shale oil especially) to increase
production levels to meet this new demand.
However for crude once it is produced in
the US and then refined in the US there would
be an incentive to export the product as there
would either be no taxes on export or an off
set as is the case with our existing VAT rules.
It means that US producers would want to
not only satisfy domestic demand but would
rather seek to push supply internationally and
only supply local US demand when the cost
of the product in the US rises to make them
indifferent to the tax incentive.
The net effect of all this is to see prices for oil
and its derivative products in the US rise and
for prices outside of the US to fall as first of all
increased US exports and secondly increased
supply from other countries to match the US
action pushes prices down.
According to Goldman Sachs the medium
term outcome would likely be "modestly higher
US oil prices and sustainably lower global oil
prices, with a shift down by US producers and
refiners on the global cost curve".
The implications for us in T&T should be
obvious. Initial forecasts for oil prices in 2018
were in the region of US$60 per barrel but those
forecasts would be adjusted to the low US$50
region if the US measures comes through as is
currently being suggested. We already have a
production issue and lower prices for longer
negatively impacts the incentive to produce
and makes our proposed adjustment to the
supplemental petroleum tax even more im-
portant and urgent.
Finally there is the issue of Petrotrin where
we already stand on the high end of the global
cost curve. A reduction in the price of crude
and a lowering of the cost of production by US
producers makes the national oil company an
even greater outlier and this means that the
need for corrective action is much more urgent
It should be clear from all of the above that
T&T is running after a target that is moving
faster than we are. If we do not accelerate our
rate of change so that we get in front of the
problem instead of playing catch up we will
end up completely left behind.
On our present path that should not come
as a shock to anyone.
Ian Narine can be contacted at firstname.lastname@example.org
The net effect of all this is to see prices for oil and its derivative
products in the US rise and for prices outside of the US to fall.
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