There was a big relief felt at lunch yesterday in Calgary with the Trump/Trudeau press conference, when Trump said the US/Canada has an “outstanding trade relationship, we will be tweaking it, we will be doing certain things that will benefit both of our countries, it’s a much less severe situation than is taking place on the southern border. For many many years, the transaction was not fair to the United States, its an extremely unfair transaction, we are going to work with Mexico, we are going to make it a fair deal for both parties, I think that we are going to get along very well with Mexico, they understand and we understand.” This is being viewed as a big confirmation for those that didn’t expect to see a House Republican Border Adjustment Tax (“BAT”) enacted that would hammer Cdn oil and gas exports to the US (“No BAT”), and also cause the Yes BAT to at least question their views. Note we are discussing BAT only related to Cdn oil and gas exports to the US.
BAT is part of the House Republican overall tax reform plan and is a term from the House Republican “A Better Way” tax plan released on June 24, 2016. This was not a joint House/Senate plan nor a Trump plan, but a House Republican plan. BAT is only part of the plan, which included the full picture of tax reform items such as corporate tax cuts, personal tax cuts, bring back money from foreign subs, etc. The BAT language is pretty clear “sales to US customers are taxed and sales to foreign customers are exempt”. The BAT fears are that all countries are included, including Cdn oil and gas exports to the US would end up being hit by a 20% tax.
These BAT fears have been the major factor driving the strong underperformance of Cdn E&P stocks relative to the US peers since the beginning of the year. Many US investors pulled back from Cdn E&P, and many Cdn investors moved to the sidelines seeing the US departure. The pull back of capital is a major reason why we haven’t seen the expected IPO market in Q1/17 to date. For Cdn natural gas stocks, this has been compounded by the forecast for warm Feb weather and weaker AECO gas prices relative to HH prices. Below is a graph showing the relative performance since Jan 1, 2017
Relative Performance of Cdn Vs US Energy Stocks In 2017
Source: Bloomberg, Stream Asset Financial
We recognize that Trump’s tweak comment is far from indicating any firm policy direction. But his comments are consistent with his election platform – his focus was on specific countries like Mexico and China. There are going to be changes in the Canada/US trade relationship, but his tweak is being viewed as a notice to Canada that he doesn’t plan to hammer Canada. With Rex Tillerson (former CEO of ExxonMobil, the parent of Imperial Oil) in his cabinet, Trump has to realize a BAT on Cdn oil and gas exports to the US would be a big hit to Canada, certainly more than a tweak.
The big event is coming in the next couple weeks, likely Feb 28. Last week, Trump noted he is coming out with his phenomenal tax reform in a few weeks – a logical day is his address to a joint session of Congress on Feb 28. No one is expecting a detailed income tax reform plan, but we should hear more concepts/focus items for trade, taxes, tariffs and possibly specific countries like Mexico. It will be the major test to reaffirm the concept of only tweaks to the Canada/US trade relationship, or possibly even just reaffirm that Canada is not in his sights. After that, it will take months for the House and Senate to work thru the specifics of developing legislation, and working thru to find common ground with Trump. If no change to the tweak concept in the tax reform unveiling, this is very significant as it would carry the tone on BAT for months until detailed legislation is being developed.
The primary question that will continue to keep the Yes BAT side from jumping fully over will be if No BAT, where will the revenues come to fund tax cuts? Tax cuts are probably the first priority in the Trump tax reform package and BAT is a primary funder to add revenues.
This wasn’t the first blog we expected to write on BAT. We had planned a series of what is BAT, how and where Cdn oil and gas exports to the US, etc. But the Trump tweak comments were too significant to ignore, especially with his upcoming tax reform unveiling.
Trump’s tweak comments came out around 12:45pm mountain and didn’t really rally Cdn E&P stocks. We expect some capital to return today focused on oil vs natural gas that is being hit by the forecast for very warm end to Feb. But the upcoming Trump tax reform outline could be the catalyst to significantly increase the flow of funds back to Cdn E&P stocks and plays. If it is in line with yesterday’s tweak, then a No BAT view could carry the tone for months until congress works to find common ground on legislation.