By Avi Salzman

President Trump did not impose tariffs on his first day in office, but he has promised to start announcing them soon. And some of the most market-moving tariffs could come against a country that's historically been a free-trade partner -- Canada.

Trump vowed on Monday to place 25% tariffs on imports from Canada and Mexico by Feb. 1. His tariff talk, which started before the inauguration, has already had an impact on some oil stocks. Canada is the largest foreign source of U.S. crude, accounting for 60% of U.S. imports since 2020, or over 4 million barrels per day. Oil is Canada's biggest export category.

The threat has begun to ripple through the oil market. The stocks of Canadian oil producers have trailed their U.S. counterparts this year. If the tariffs are passed, some investors worry that the Canadian producers will have to cut their selling prices to compete, or risk being replaced by lower-cost supplies.

Canadian crude oil has traded at a discount to U.S. crude for years, because Canada does not have easy ways to export it around the world. West Texas Intermediate crude, the U.S. benchmark, sells for $13 more than Western Canadian Select, the Canadian benchmark. But the spread could grow to $27 if a full tariff goes through, Citi projects.

"I think investors are very much taking it seriously, if not literally," said Eric Nuttall, a portfolio manager at Toronto-based investment firm Ninepoint Partners.

Canadian Natural Resources, the largest of the Canadian names, is up 1% this year, even as the SPDR S&P Oil & Gas Exploration & Production ETF has risen 7%. In the past few days, the stock has fluctuated as news has come out in fits and starts. Canadian Natural Resources' Toronto-traded shares rose on Monday after Trump initially declined to issue tariffs on Day 1. But they were down on Tuesday after Trump said late on Monday that Canadian tariffs would be coming by Feb. 1.

The slump in Canadian oil stocks has created a buying opportunity, some investors say. They don't expect Trump to go through with across-the-board 25% tariffs on all Canadian products. If tariffs do go forward, oil and gas would probably be exempted from any levies, they say.

Tariffs on Canadian oil would undoubtedly hurt American refineries -- some Midwestern refiners process only Canadian crude. So a big tariff "would result in a price shock that would be quickly felt at the pump by U.S. consumers," wrote Natasha Kaneva, head of commodities strategy at J.P. Morgan. "Therefore, our working assumption is that oil will be exempt from any tariffs, and even if imposed, they will be removed very quickly."

Nuttall also doesn't expect tariffs to be placed on oil -- or if they are imposed, then they'll be removed quickly. He has been buying Canadian Natural Resources in recent days. "They have some of the deepest reserves of any super major in the world at the current oil price," he said. Canadian Natural's dividend yield is 5%, higher than Exxon Mobil and Chevron, and the stock is cheaper than those oil majors on the basis of adjusted earnings. Another relatively beaten-down Canadian name he likes is producer MEG Energy.

Other investors are also warming to the trade. Cole Smead, CEO of Smead Capital Management, said in an interview that he sees a similar setup to 2017, when Trump put tariffs on Canadian lumber. That "fear" trade worked out for some of the lumber stocks, which snapped back in the years to come as lumber prices rose.

The same thing could happen in oil. Among energy names, he likes MEG Energy and Strathcona Resources, two oil producers that have performed even worse than Canadian Natural Resources this year. When it comes to a crisis-driven opportunity, "don't look for things that have done the best," he said. "Look where things have been the worst."

Write to Avi Salzman at avi.salzman@barrons.com

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January 22, 2025 02:00 ET (07:00 GMT)

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