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How Trump's Border Tax Would Hit U.S. Refiners

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One of the key election promises of President Trump was to levy a hefty tax on corporates that import goods into the U.S., thus encouraging local manufacturing and therefore domestic jobs. The controversial proposal would also pay for a wall with Mexico to stop illegal immigration.

The Republican-controlled House of Representatives’ plan for a Border Tax include trimming the corporate income tax from 35% to 20%, while imposing a 20% tax on all imports and exempting export revenue from taxable income.

It’s quite clear that the border-adjusted tax would hurt the businesses of industries that rely on imports. The Oil and Gas - Refining and Marketing is one sector, which could see drastic fallout from such a tax. Let’s see why.

The Business of Refining

This industry includes companies engaged in the operation of oil refineries for the production and sale of gasoline, kerosene, jet fuel, diesel oil, heating fuels, lubricants, as well as hundreds of petrochemicals. In other words, refining companies use oil as an input from which they derive refined petroleum products like gasoline, the prime transportation fuel in the U.S.

Some Refiners Prefer to Import Oil Despite Ample Domestic Supplies

Now, despite the U.S. being one of the largest producers of oil globally, a number of domestic refiners – especially those located along the Gulf Coast’s vast refining sector and in the Midwest – prefer to import crude from countries like Mexico, Canada and Venezuela. This is because most of the refining units in the region were constructed or modified about a decade ago i.e. prior to the shale revolution.

At the time, these facilities were configured to process the heavy/sour grades of oil coming from outside suppliers. In fact, it was then thought that the U.S. would need substantial quantities of such crude from other nations to meet the demand and consequently, many refineries in these regions upgraded their units to run heavy crude.

On the other hand, much of the domestically produced oil from shale plays in recent years are of the ‘light sweet’ variety – not the one the Gulf Coast and Midwest refineries are set up for. As such, these facilities still prefer to import the heavier crude from outside rather than use the locally available type from formations like the Permian and Bakken.

Even some refiners on the East and the West Coast are heavily reliant on crude imports as they lack direct access to the U.S. crude pipeline transportation network. This explains the apparent contradiction wherein oil imports are likely to remain high notwithstanding U.S.’s net energy independence.

Such Units Would Be Strongly Affected

A proposed border tax adjustment would significantly increase the cost of imported oil, which makes up about 40% of the refining industry’s daily input needs. Moreover, it won’t be easy for the refineries to switch to the domestic light sweet crude overnight when they are designed to refine heavier imported grades. A negative for all refiners, the magnitude of loss would depend on the companies’ quantum of imported crude.

Domestic Crude and Fuel Prices to Go Up

The ruling will almost certainly lead to refiners’ looking to increase their usage of untaxed domestic oil, ensuing a jump in U.S. crude demand and prices. This will translate into higher input costs for all refiners almost immediately. With margins already narrow, the companies wouldn’t hesitate to offload a major part of the additional burden to end-users. As refiners pass on their higher feedstock cost to the consumers, American drivers will face higher retail gasoline prices – estimated between 30 cents a gallon to $1 a gallon.

Who Loses the Most?

Among the losers from the Border Tax reform would be major fuel producers like Chevron Corp. (CVX - Free Report) and ExxonMobil Corp. (XOM - Free Report) to specialized downstream operators such as Valero Energy Corp. (VLO - Free Report) , Tesoro Corp. and Marathon Petroleum Corp. (MPC - Free Report) . However, the operators heavily dependent on foreign oil shipments would bear the brunt of the proposed tax ruling.

The foremost name in this category is San Ramon, CA-based supermajor Chevron - the largest buyer of foreign oil. The Zacks Rank #3 (Hold) company imported some 213 million barrels (not counting Canadian imports) during the first ten months of 2016. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Chevron was followed by Valero Energy, which imported around 194 million barrels, and Phillips 66 (PSX - Free Report) , which imported 130 million barrels. While both Valero Energy and Phillips 66 possess the flexibility to replace a portion of imports with domestic barrels, eventually they will have to pay more.

Another domestic refiner likely to have significant exposure to the border tax is PBF Energy Inc. (PBF - Free Report) due to its heavy dependence on foreign crude shipments.

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