Does a 25% tariff mean prices will rise 25%?
So President Trump confirmed, last week, that from later this week, he will formally introduce a blanket tariff on steel imports, at 25%, and aluminium, at 10%.
Both tariffs are in fact higher than those recommended by the DOC (Dept. of Commerce). In return, he stated to a number of metal manufacturers Thursday (March 1) “You’ll have to regrow your industries; that’s all I’m asking”.
To be fair to US steel producers, that is exactly what they have been doing over the past year though they would be the first to admit that this is largely thanks to the plethora (around 30) of anti-dumping duties already limiting imports. To meet the demand for US-made steel in 2017, which rose by an above average rate of 5.0%, local mills increased their own steel production by 4.0%, to 81.64Mt. To fill the gap, whether directly or more often at re-rollers, net semis imports increased by 28% last year to 7.71Mt. In combination, this enabled them to ship 82.45M metric tons of “finished” steel; the highest volume recorded by the American Iron & Steel Institute (AISI) since 2014. However the percentage growth in mill shipments still paled in significance with finished imports which rose more than twice as quickly.
As we had expected, President Trump ruled out “option 3” in the DOC report, which would have restricted steel imports to 63% of their 2017 totals and more than likely would have caused a shortage in the market. A reduction in semis and finished imports would have required crude steel production to rise from 81.6M tons to 95.5M just to supply the same amount of steel required last year.
However, it is hard to imagine what difference to trade a 25% tariff, rather than a 63% quota, will make. For some observers nothing will change and the price simply rises to the level to incentivize the external supplier who is required to service local demand. That presumably is 25% and adds $189 per tonne to the average import price for HRC AMM recorded in February.
That of course is not the point of the exercise and while the tariffs might help government finances, not least with the American Society of Civil Engineers (ASCE) claiming petrol and diesel taxes need to double, increasing by 25cents a gallon to fund the ambitious Highway Trust Fund, it wouldn’t restrict trade or support higher productivity in US metal production. What the 25% does do, however, is give us all a “ceiling” for US prices. So what is a more realistic price outlook?
When we ask external suppliers about commodity grade prices we track, we hear some interesting things. Had the duty been limited to 10-12%, for instance, we hear it would have made little difference to the steels that both local and external suppliers can produce. This may seem strange and need some analyzing (see below) but if true, suggests a more realistic price outlook is based on import prices 13-15% higher. Again using the example of HRC, that is a range from $98 to $114 per metric ton.
According to AMM’s price archive, the average discount for imported HRC is just 8% and so by implication a 12% higher import price would make foreign steel more expensive to import than to buy domestically. This is unusual and therefore unlikely but has happened twice in the past year (see chart). But even in markets where the import price discount is greater than for HRC, such as the 14% for heavy plate, it is hard to imagine a US importer that would ever go through the hassle of importing steel for only a small discount. So the main reason why 10-12% wouldn’t matter, is because the import price would not rise and the foreign supplier would absorb all of the tariff itself.
According to our Global Steel Cost Service update for Q4 2017, we estimate the average margin on commodity grade sales was over 14%, the highest since early 2010. Margins on sales are volatile and by implication not under the control of steel producers and so clearly if profits retreat, the ability of the external supplier to absorb duty diminishes, as during the section 201 period from March 2002-December 2003. But as anti-dumping duties the world over suggest, steelmakers will still sell steel at a loss before they are willing to cut production, especially among the integrated producers that dominate steel markets outside of the USA.
As such there is clearly no guarantee that import prices will rise even the $98 per ton minimum that a 13% price rise would imply. Global consumers have more than enough experience over the years of dealing with unprofitable suppliers even if that is never in their long-term interests. But even in the short-term interests, what can US consumers actually afford for steel?
Clearly this may depend on sector and exposure to steel. Arguably “comparatively” small manufacturing customers such as home appliance producers, who consume about 3% of US steel and 2% of global steel according to recent estimates, are potentially going to cope better than most. In an average washing machine, around half (53% according to a 2012 study) of the raw material is steel and most of that is galvanized. AMM’s latest electro-galvanized sheet price, FOB Midwest, rose $30 to $960 per short ton ($1,058 per metric ton) as of February 22nd. Assuming that price represents the value of steel in a typical washing machine which weighs 87.5kg and the steel is around 46kg, we can assume it is worth $49 per washing machine or less than 10% of the price of a typical $500 washing machine today. A 25% increase would increase the cost from 10% to 12% and assuming mills absorbed half of the duty, from 10% to approximately 11%. Our Tube & Pipe Group took a look at costs of drilling and found line pipe has a similar share of the costs. Moreover, they found that drilling would be negatively affected by up to 5% if prices were to rise 20-30% (Read more...).
Where steel is a far larger share of manufactured cost, in coated steels for construction applications, for example, or in hot-rolled coils and plates used in infrastructure, such as in more basic pipes, the tariff could have a more negative effect on demand by pricing more users out. Identifying this level is challenging but one option is to compare steel prices, on an FOB Midwest basis, with equivalent producer prices (ex-works) overseas. For hot-rolled coil, the US spot base price, which excludes any quality or dimensional extra charges, averages $80 per ton higher than an equivalent base price in northern Europe but in February, traded at a $117 per ton premium. We doubt the premium can rise much more before US customers resist. Already this year, steel demand has fallen year-on-year amidst a high-price environment in the US and for those conditions to change, we doubt prices can rise anywhere near 25%.