Section 232: Trade Anticipation Looms for Steel and Aluminum
The Announced Tariff: 25% for Steel & 10% for Aluminum
On March 1st, President Trump announced his plan to implement the most severe of the three options recommended by US Secretary of Commerce Wilbur Ross in the recently released Section 232 report — a 25% tariff on steel and 10% on aluminum imports into the US. The announcement came after nearly a year-long review process that began last April. Article 232, a section of the Trade Expansion Act of 1962, gives the President sweeping power to enact unilateral trade legislation to curb foreign imports in the interest of national security. The investigation wrapped up in January, 2018, culminating in Secretary Ross’s report and list of recommendations to the President. Keeping with his campaign promise to enact protectionist policies to help hard hit American industries, President Trump appears to be attempting to follow through by placing major tariffs on aluminum import categories such as bars, wires, plates, tubes, castings and forgings, and steel import categories including carbon & alloy flat, long, pipe, tube, and semi-finished products, as well as stainless.
The tariffs would be in addition to any previously existing duties on steel or aluminum products and, under Trump’s policy, no country would be exempt from these tariffs, although individual parties would have the opportunity to apply for any exclusions and are guaranteed a decision within 90 days of application submission. Critically, these proposed tariffs have not yet been officially signed into law, meaning that they may still change. Such change would hardly be surprising given the split in the Trump administration over the proposal as fellow protectionists clash with free-trade advocates and many members of the GOP who have voiced strong opposition to the President’s announcement. While the exact outcome remains uncertain for the time being, Trump is expected to confirm and sign into action a final decision by the end of this week or early next week.
For the us: short-term inflation and long-term re-evaluation on the horizon
Assuming Trump enacts the trade legislation in its current form, it will have broad and significant impact on both the US domestic as well as global metals markets and the industries that rely upon them for raw material inputs. Beginning at home, in the immediate aftermath of implementation, domestic steel and aluminum prices would rise for buyers as mills hike prices and service centers likely move to renegotiate contracts in order to pass on price increases to their downstream customers. Domestic prices will rise to approach the “breakeven point,” slightly undercutting the prices of imported metals with newly-imposed tariffs. Already, April futures show a 20% increase over February hot-rolled coil (HRC) spot prices and continue to rise in anticipation of Trump’s official decision.
Initially, the increase in domestic demand will strain capacity and drive longer lead times. Over time, however, demand should stabilize, with domestic production expanding to push utilization up from current levels of roughly 72% toward the targeted 80% level for which this legislation was designed. As domestic production expands to meet new demand and alternative supply chains are established, lead times will begin to normalize, and prices will slowly be reined in (although they will remain above pre-tariff levels due to higher costs of production in the US). As a result, some buyers of steel that cannot pass on the increased costs of steel and aluminum to their customers may choose to re-evaluate their place in the value chain, potentially moving component or assembly production outside the US to escape import tariffs. Ultimately, this could lead to greater losses in the downstream workforce than at the upstream mills – an analysis of the Automotive industry showed that for every ton of steel produced in the US, OEMs drive between twenty and twenty-five times the number of employed hours that steel mills drive.
Globally: Disruption for allies and trade war
Globally, the effects of these tariffs are harder to anticipate. The tariffs are not limited to those countries with which we have associated trade conflicts in the past, and countries like Canada stand to be the hardest hit by US protectionist policies, rather than well-documented trade offenders like China. In response, recent rhetoric suggests that current NAFTA partners Canada and Mexico could enact retaliatory tariffs against the US on automobiles and other goods that the US has historically relied upon for trade. EU countries will likely retaliate as well on metals and 25% tariffs on other traditional US exports like motorcycles, blue jeans, and whiskey. Additionally, China and other countries may also levy protectionist legislation in response. In the slightly longer term, President Trump has suggested that he may use these tariffs as a bargaining chip to secure concessions from Canada and Mexico in the ongoing NAFTA negotiations, and may ultimately exclude them from these tariffs if a new agreement is reached. However, with experts predicting no decision on NAFTA until Q4 2018 at the earliest, the tariffs would likely go into effect for Canada and Mexico, at least for the next two quarters.
Over in the EU, while there exists only slight direct impact on steel mills exporting steel to the US because of negligible volumes, there are significant concerns that US protectionist policies will divert more cheap imports toward Europe and lead to a flooding of the market and depressed prices. To combat this scenario, EU leaders have suggested that they may be forced to consider enacting their own protectionist policies in response to the US, potentially sparking a trade war. Historically, steel prices tend to be regional but are influenced by global market conditions, however this new wave of protectionism could lead to more regional isolation in pricing.
Business impact: serious profitability questions loom for manufacturing industries
In terms of the immediate business impact for steel and aluminum buyers in the US, price increases are expected and supply constraints will lead to longer lead times driven by very tight capacity. More permanently, US steel and aluminum buyers across a range of industries will experience varying degrees of damage to their profitability and margins—the magnitude of price increases and the ability to pass on these price increases will ultimately determine whether jobs and operations will be moved offshore or remain here. To illustrate, if Company X currently has an EBIT margin of 10% and steel raw material costs represent 20% of sales, a conservative steel price increase of 10% as a result of the tariffs would represent a 20% reduction in EBIT, assuming sales prices go unchanged. Such an impact will be hard to swallow without increasing prices to customers or adjusting supply chains.
Already, major US steel buyers across various industries have announced changes in their investment plans. For example, European home appliance manufacturer Electrolux has announced it will delay its $250 million investment in a Tennessee plant and sources have indicated that Exxon Mobil may also be reconsidering a proposed expansion of its refinery in Beaumont, Texas. This is likely just the first wave of many such announcements as companies weigh the impacts of Trump’s proposed tariffs on their long-term success in the US.