On Sep 11, the UN Security Council declared fresh sanctions against North Korea. It took only eight days after North Korea’s sixth and most powerful nuclear test for the UN to pass this resolution.
The United States was initially demanding a complete oil embargo to fully paralyze the North Korean economy. But later the U.S. softened its demands and the UN ended up imposing restrictions on the rouge nation’s oil imports. The toughest-ever UN sanctions against North Korea also call for a complete ban on its import of natural gas liquids and condensates.
Nikki Haley, the present U.S. ambassador to the United Nations, said imposing restrictions on fuel and oil supplies will restrict North Korea from funding programs related to nuclear and missile tests. The aggressive step taken by the UN to partially paralyze the North Korean regime is indeed commendable. But tensions within North Korea may indirectly hurt global demand for crude.
U.S. Seeks to Freeze China’s Oil Exports to North Korea
North Korea imports nearly all of its crude supplies from China. In fact, China meets 90% of North Korea’s oil demand, according to media resources. According to the Energy Information Administration (“EIA”), North Korea’s average daily crude import is roughly 10,000 barrels. These volumes are sent to the Ponghwa Chemical Factory, which is North Korea’s only oil refinery.
So, if China stops exporting oil, the economy of North Korea may bear the brunt. Also, scarcity of refined fuel like gasoline and diesel will significantly push up public transportation and logistics expenses.
UN Refrains From Complete Oil Embargo
The UN has decided not to allow North Korea’s crude imports to exceed its last 12-month average. The annual export of refined petroleum products to North Korea has also been restricted to 2 million barrels. This is less than half the volumes — 4.5 million barrels of refined petroleum products — that the country imports annually, as per data provided by some U.S. officials. According to the U.S. estimate, these fresh sanctions will ensure that North Korea gets 56% less fuel from abroad.
Moreover, import of natural gas liquids and condensates by North Korea has been totally banned.
While producing natural gas, producers also get low density crude – referred to as condensates. Also, in its raw state, natural gas contains fuels like propane and butane. With the total ban on natural gas import, North Korea will not receive any substitute for refined petroleum products, supplies of which have now been capped.
Textile Exports, Overseas Contracts Take a Hit
The resolution also places a ban on North Korea’s textile exports. As per Korea Trade-Investment Promotion Agency, in 2016, North Korea’s textile industry generated the second-highest export revenues of $752 million — second only to coal.
Also, the UN will not allow the renewal of contracts for overseas North Korean workers. Investors should note that North Korea makes $500 million annually out of taxing salaries of roughly 93,000 laborers working abroad, according to Nikki Haley.
In fact, Haley believes that all these measures, may not fully paralyze North Korea’s economy, but will take the country several steps backward, from funding its weapons program. As per the estimate provided by the United States, the resolution will likely lead to a revenue loss of $1.3 billion for North Korea.
Crude Price to Fall, Gasoline Price to Benefit
A debate has ensued regarding North Korea’s possible retaliation to these sanctions. Several market watchers think Pyongyang is preparing a strong response for the United States. Overall, the energy sector will be severely affected if North Korean tensions result in conflicts with neighboring countries like China, Japan and South Korea.
According to the U.S. Energy Information Administration, South China Sea is the route through which more than 33% of worldwide crude and 50% of global liquefied natural gas are transported every year. Hence, violence following military actions in and around North Korea may stop the flow of imported oil to South Korea, Japan and China.
According to energy consultancy group, Wood Mackenzie – South Korea, Japan and China are responsible for almost 34% of global trade for crude, transported by sea. Also, data provided by World’s Top Exports (WTEx), shows that China, Japan and South Korea are among the top five oil importing countries in the world, accounting for almost 32% of worldwide crude import, with China being the largest oil importing nation. The total value of crude, imported by the three countries in 2016, was estimated at $211.2 billion by this independent education and research website.
Hence, North Korean tensions will probably lower global crude demand to a great extent. Asia’s leading refining plants, accounting for 65% of the continent’s total refining capacity, are located in China, Japan and South Korea, as per Wood Mackenzie. Therefore, any military action in North Korea might lead to significant reduction of oil demand by refiners. Either way, strong forces are working to push crude price lower.
If the flow of imported crude is cut off, China, Japan and South Korea will have to rely on their respective limited domestic crude reserves to carry out daily operations. As a result, there will be lower gasoline production by refiners. Scarcity of gasoline will likely flare up commodity prices.
U.S. Oil Refiners to Gain
Lower crude price and higher gasoline price will boost margins for U.S. refining players. This is because refiners buy raw crude to produce refined petroleum products like gasoline. The end products are then sold at fuel pump stations.
This is why it is time for investors to focus on the refining industry. The Zacks Oil Refining industry is ranked #62 and lies in the top 24% of industries. This is a good industry rank as the top 50% of the Zacks Ranked industries outperform the bottom 50% by a factor of more than 2 to 1. Stocks belonging to the industry include Marathon Petroleum MPC, Phillips 66 PSX, HollyFrontier Corporation HFC, Par Pacific Holdings PARR and Delek US Holdings DK. Marathon Petroleum, Phillips 66, HollyFrontier and Delek carry a Zacks Rank #3 (Hold) while Par Pacific sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
All refining players performed exceptionally well in the last 12 months, as reflected in the price chart. Moreover, favorable macro factors could boost their prices further.
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