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A oil pump jack ear Dorothy, Alberta. Canadian energy firms are extremely vulnerable to shifts in U.S. trade policy. Canada produces close to 4-million barrels of crude a day, and about three-quarters of that is exported to the United States.© Todd Korol / Reuters/Reuters

The threat of a U.S. border tax is taking a toll on the Canadian energy sector.

Energy shares surged following the November political victory of Donald Trump, buoyed by the concurrent election of a Republican-led Congress, the U.S. President's pledge to fast-track the approval of major pipelines such as TransCanada Corp.'s Keystone XL, and his predilection to pro-oil cabinet picks.

But now, optimism in the U.S. trade-dependent Canadian oil and gas industry has faded. Amid lingering skittishness over prices, concerns about pipeline capacity to key markets and a resurgent U.S. shale industry, there are fears Washington's protectionist bent will see Canadian producers hit with a 20-per-cent border tariff.

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The S&P/TSX energy sub-index, comprised of major oil producers and their service providers, has skidded nearly 14 per cent from its peak in mid-December following the U.S. election.

Todd Kepler, a Calgary-based analyst with Laurentian Bank of Canada, believes a number of institutional investors are selling shares or holding off from taking significant positions in the Canadian energy sector. "You have this building of fortress America," Mr. Kepler said. Investors are saying "we can afford to sit and wait, and see what happens."

Early on, all eyes were focused on Mexico – as the trade deficit and manufacturing south of the U.S. border seemed to be the new President's main target, he said.

But attention has increasingly focused on the push by the U.S. House of Representatives to enact a 20-per-cent border adjustment tax on all goods, from all countries – which would include oil and natural gas. The measure is envisioned to encourage U.S. manufacturing and production, but would also pay for a planned corporate tax cut, and is one suggested means of paying for a border wall with Mexico.

A cool reception to the proposed tax from Mr. Trump and some Republican Senators hasn't ended speculation about whether it will actually be enacted. And the uncertainty will linger: It will take months for Congress to finalize the tax reforms.

Canadian energy firms are extremely vulnerable to shifts in U.S. trade policy. Canada produces close to 4-million barrels of crude a day, and about three-quarters of that is exported to the United States. Less than 1 per cent of Canadian oil exports go to markets outside the United States. Mr. Kepler said the prospect of the U.S. border tax, combined with questions about carbon pricing and fallout from the planned U.S. corporate tax cut, has led to increasing concern about Canadian energy sector competitiveness.

In a week when Canada's Foreign Affairs Minister Chrystia Freeland meets with her counterpart U.S. Secretary of State Rex Tillerson, Republican House Speaker Paul Ryan and other U.S. leaders, provincial governments are also paying attention.

Alberta Premier Rachel Notley's office is in close contact with the province's Washington envoy and is receiving daily updates and briefings on the issue.

A border tax would hit especially hard for Canadian natural gas producers, who already face competitive pressure in traditional markets owing to the shale revolution. Canadian exports that still flow south have nowhere else to go, Barclays PLC analyst Nicholas Potter said, citing ongoing delays to liquefied natural gas (LNG) terminal plans on Canada's West Coast and shaky domestic demand.

Producers have benefited from a weak Canadian dollar, but Alberta wholesale prices would likely need to fall for exports to remain competitive if a border tax were imposed, he said. A tariff would also offset any gain from lower shipping fees being discussed for TransCanada's west-to-east Mainline system.

"It's another negative for Canadian gas producers," Mr. Potter said.

Uncertainty over a border tax has quickly become a top concern for the Canadian Association of Petroleum Producers. The industry's main lobby group points out that U.S. refiners remain opposed to such a move. Several major ones in the U.S. Midwest – including Koch Industries, Exxon Mobil Corp., BP PLC and Husky Energy Inc. – run plants that are tooled to process heavy Canadian crude oil rather than the light oil from U.S. shale deposits.

"What we're still trying to grapple with is how well these Americans who are drafting this legislation really understand their own refining complexes," said Jon Stringham, CAPP's manager of fiscal policy and economics.

A leading importer of Canadian oil, Phillips 66 cautioned last week that if the border tax goes through in its current form, its crude input costs will go up 25 per cent. Phillips 66 chief executive Greg Garland predicted that under such a scenario, U.S. gasoline prices would increase by 30 cents or 40 cents (U.S.) per gallon.

However, a Reuters report from Washington said Republicans are considering changes to the design of the border tax to accommodate industries, such as oil refiners, worried about being harmed by the levy.

Mr. Kepler believes there's a low probability of a U.S. border tax being applied to Canadian crude.

He noted that Mr. Trump's inner circle has been built with a "pro-energy" deck of players, including Mr. Tillerson, Exxon Mobil's former chief executive. U.S. companies, including Exxon Mobil, Chevron Corp., Apache Corp., have significant operations in Canada.

"They are sort of stabbing themselves in the arm if they're going to do an import tax on some of their own crude oil, from their friendliest neighbour."

With a file from Jeffrey Jones

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 28/03/24 10:45am EDT.

SymbolName% changeLast
TRP-N
TC Energy Corp
+0.48%39.83
TRP-T
TC Energy Corp
+0.39%54.01
XOM-N
Exxon Mobil Corp
+0.37%115.39
BP-N
BP Plc ADR
+0.45%37.63
CVX-N
Chevron Corp
+0.46%157.07

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