SECTION 232 TARIFFS AND THEIR EFFECTS
Section 232 of the Trade Expansion Act of 1962, as amended, gives the executive branch the ability to conduct investigations to “determine the effects on the national security of imports.” Within 270 days of initiating any investigation, the Commerce Department issues a report to the President with the investigation’s findings, including whether certain imports threaten to impair America’s national security. The President has 90 days to determine whether he concurs with the findings and, if so, to use his statutory authority under Section 232 “to adjust the imports” as necessary, including through tariffs or quotas.
In January 2018, the Department of Commerce delivered the Section 232 reports on steel and aluminum to the President. In February 2018, the Commerce Department publicly released Section 232 reports on imported steel and aluminum. The reports concluded that the quantities and circumstances of steel and aluminum imports “threaten to impair the national security,” as defined by Section 232. The reports found that United States steel imports were nearly four times our exports, and that aluminum imports had risen to 90% of total demand for primary aluminum. The Commerce Department recommended that President Trump act to protect the long-term viability of our nation’s steel and aluminum industries.
On March 8, 2018 the President imposed a 25 percent ad valorem tariff on steel articles, imported from all countries except Canada and Mexico. (later revised) and a 10% tariff on aluminum. Certain companies, countries, producers and users have sought exemption, and how and where 232 will be applied is expected to be modified over time.
Prior to the 232 investigation the U.S. had filed numerous trade cases through the World Trade Organization (WTO) and other agencies against steel and aluminum imports that were typically product-and-producer based, i.e. galvanized steel coils from China or Taiwan. When successful these cases sometimes resulted in massive duties on the offending products. Prior to final determination of WTO duties or tariffs, producers and importers will typically ship as much as possible into the U.S., blunting the effect of the tariffs for months.
Faced with duties on direct shipments offshore producers were thought to be selling semi-finished goods to other countries where they were brought to completion and then exported them to the U.S, still undercutting U.S. producers. Circumvention is also achieved by selling slightly different products, not covered in the trade cases, to be used in the manufacture of the same finished products or converting coils into pipe which is then sold at below market prices in the U.S and elsewhere.
The 232 Tariffs, in their current configuration, limit circumvention since they are applied against virtually all countries. Canada and Mexico were initially exempt and later included. This adds complexity to tariff application since certain goods commonly cross the border multiple times; steel coils made in the U.S are shipped into Canada, processed into steel tubes, and then sold in the U.S.
The domestic Steel industry includes a mix of legacy companies such as AK Steel, United States Steel Corporation (U.S. Steel) and ArcelorMittal’s North America operations primarily using iron ore and blast furnaces to produce steel, and more recent entrants using electric arc furnaces to melt steel scrap and modern thin-slab casting methods. While both legacy and newer steel makers are rapidly modernizing, the industry remains in danger form foreign predation. Multiple factors contributed to a relatively strong steel industry including:
- The rise of the mini-mill, which makes new steel by melting scrap and other iron-baring products rather than making steel through blast furnace operations.Using electric arc furnaces to melt and alloy steel, scrap mini-mills can have production rates similar to the traditional “fully integrated mills” with significantly less capital investment.
- The introduction of Thin-Slab Casting technology used at most mini-mills where liquid steel is poured into a thin slab where it is immediately rolled into a coil, eliminating multiple intermediate process steps common at the older integrated mills.
- The reduction in legacy cost brought about through the bankruptcy of the traditional steel mills including Bethlehem Steel, LTV Steel, Acme Steel, Weirton Steel and other entities.Multiple old-line steel makers were streamlined and merged to form the International Steel Group (ISG) by Wilbur Ross beginning in 2002.In 2005 ISG was sold and merged with other operations to eventually become ArcelorMittal North America.
- Rationalization of capacity where older less efficient, fully integrated mills were closed and dismantled, replaced to some degree by newer mini-mills.
- The rise of new competitors including Nucor Steel, Steel Dynamics, Inc., and the more-recent Big River Steel and others typically using thin slab casting technology and spurring the older steel companies to be more inventive and competitive.
While the industry has had a resurgence of sorts it is in constant completion with off-shore producers which flood the market with low-cost goods which depress both demand from domestic mills and domestic market prices. As mentioned previously the industry is involved in a never-ending series of efforts to impose duties, tariffs or quotas on a variety of goods including rebar, hot rolled, cold rolled, and galvanized coils, pipe, plate and other product types. As shown in the chart below imports of semi-finished and finished products can represent about one-third of apparent steel usage in the country, reaching approximately 38% in 2014 and 2015
MARKET PRICE DRIVERS: THE COST OF STEEL
Despite efforts to monetize steel as a tradeable commodity, most sales are direct from producer to end users, or from producers to steel service centers to end users. Recent market prices for steel products are shown in the chart below. Market prices varied in a narrow range for most of 2016 and 2017 and trended upward in the fourth quarter of 2017 and the first quarter of 2018, in response to strong demand and in anticipation of some action by the Trump administration.
To some extent the 232 tariffs have had their desired effect. The mills immediately increased prices after the 232 Tariffs were announced and current June 2018 market prices for most commodity-type goods are 25% to 30% higher than they were in January 2018-more or less matching the 232 tariffs. After increasing rapidly, market prices have stabilized. As domestic prices and demand have increased. The steel companies have responded by expanding capacity at existing facilities and restarting idled facilities. U.S. Steel is currently in the process of restarting two blast furnaces at its Granite City, Illinois mill, creating 800 jobs and adding more than two million tons of steel coil capacity. Big River Steel announced the planned expansion of its Arkansas facility and is exploring the possibility of a new mill in Texas.
WORLDWIDE STEEL PRODUCTION TRENDS
While the U.S. has slowly dismantled obsolete facilities and added newer mills the trend in worldwide steel production shows China rapidly expanding output and currently representing approximately half the world’s production while production in other countries remained stagnant or reduced output. World crude steel production-molten metal produced and ultimately converted into steel beams, plates, coils, and consumer goods increased from 1.3 billion tonnes in 2007 to 1.6 billion tonnes in 2016. In the same period Chinese production increased from 490 million tonnes to 807 million tons. While worldwide steel production increased by 278 million tonnes between 2007 and 2018, Chinese production increased by 318 million tonnes as shown in the chart below.
As China expanded output it now dwarfs most other countries as shown in the chart below and Chinese export policies can easily disrupt domestic pricing in any market it chooses to compete.
The common thread in both global steel production and aluminum is the expansion of Chinese capacity beyond that needed for domestic consumption, much of it thought to be subsidized by governmental agencies. The unimpeded flow of Chinese goods into other Asian countries, Europe or the U.S. decreases market prices and demand from domestic mills in those countries. In some cases, competition from Chinese producers forces mills in Korea or Turkey to export their own goods, indirectly affecting mills in the U.S and elsewhere.
The recent 232 Tariffs have generally been described as ill-timed, ill-planned, ineffective and worse. The tariffs will likely bring about countermeasures that will likely disrupt international trade and negatively affect other sectors of the U.S. economy. They will likely continue to evolve, with exclusions for certain countries or products and the tariffs as we understand them today could be radically different or completely removed by year end.
The 232 tariffs are applied against semi-finished products including wire rod, plates and coils, and the like, in addition to finished products like steel pipe. For example, certain U.S. domestic producers purchase imported steel rod. The tariffs make steel rod more expensive, which increases the total cost of steel wire produced in the U.S. As domestic wire prices increase, the U.S. market will become more attractive to off-shore wire producers, the result being a decrease in imports of steel rod and a corresponding increase in imports of steel wire. In the long term the current tariffs might reduce the quantity of steel coils coming into the country but lead to an increase in the importation of products made from steel coils like hot water tanks, furnaces, vehicles, etc.
As shown in the chart below, Primary aluminum production in the U.S.-the conversion of bauxite into pure aluminum-was more than four million tons in 1990 and has trended downward since that time, reaching 818 thousand tons in 2016. Increases in worldwide production resulted in higher-cost facilities in the U.S. and elsewhere being phased out, while new facilities were built in China, Russia and in the Middle East. While U.S. production has slowly decreased, Chinese production increased from less than a million tons in 1990 to more than 20 million in 2012, representing 44% of the worlds production. While China consumes much of that aluminum in country, it’s is also a major exporter of aluminum in ingot form, aluminum semi-finished products like coils and plate, or finished products like windows and doors. In 2017, Chinese smelters produced 32 million tonnes.
Prior to the 232 announcements in March 2018, aluminum market prices had trended upward. As shown in the chart below, the LME cash price of aluminum increased from $0.67 per pound in January 2016 to $1.05 per pound in May 2018. The Midwest Premium averaged approximately $0.10 per pound in much of 2017 and 2018 and increased to $0.22 per pound after the 232 announcements. The total Midwest Transaction Price, the sum of the LME and Midwest Premium increased from $0.76 per pound in January 2016, to $1.13 per pound in February 2018, prior to the 232 announcements, and averaged $1.26 in May 2018. The effect of a 10% tariff on aluminum imports is probably minimal in comparison to a market-based price increase of almost 60% between January 2016 and February 2018. It’s unlikely that a 10% tariff will change market behavior; those historically importing goods will continue to do so.
As of April 2018, there are only two major primary aluminum producers in the U.S.; Alcoa and Century Aluminum, operating a handful of facilities in the Kentucky and New York. What primary smelting capacity is left will likely increase output incrementally if possible, restarting idled capacity when practical. Century Aluminum announced the planned restart of its idled Hawesville, Kentucky facility in March following the 232 announcements, and then announced a reduction in operations in Hawesville in June 2018. It’s highly unlikely that the current tariff, or any tariff, would bring about the construction of new domestic smelting capacity in the short term. Its unlikely tariffs will continue in their present format; they could be eased against certain countries or products or eliminated in exchange for other trade concessions.
With an uncertain market, massive capital investment in aluminum smelting plants with decades-long operation life is doubtful and the positive impact of the tariff is difficult to quantify.
232 TARIFFS AND RECOVERY VALUES OF METALS COMPANIES
The parallels between domestic Primary Aluminum production trends and Crude Steel production trends should not be ignored. While the current tariff policy might be considered deeply flawed, without some sort of protection, the domestic steel industry will continue to be threatened by offshore producers discouraging investment, which will further increase dependence of foreign products.
Domestic steel mills are enjoying increased demand bringing about certain economies of scale which reduce unit cost and higher market prices directly related to the 232 Tariffs. Steel service centers and other distributors typically raise sell prices as soon as the mills announce their price increases, selling goods purchased in prior periods at lower market prices at the then-current higher market prices. Gross margins for steel processors and distributors typically increase as the mills raise prices and decrease as the mills announce market price decreases. Those fabricating goods from steel will have higher raw materials cost which will negatively affect sales margins unless those producers can effectively pass on increased material cost to their customers.
As described above, the aluminum tariffs will likely have only a marginal effect on market prices and recovery values for companies currently in an ABL agreement. Most aluminum producers, distributors, and end users have some sort of pass-through pricing where changes in the cost of raw materials are passed through in the price of finished products. We would expect the average cost of raw materials to increase slightly as a result of the 232 tariffs, which when coupled with market price increases led to a significant increase in the cost of aluminum products in 2017 and 2018, followed by a corresponding increase in sell prices of finished goods. Gross margins may negatively be affected as market prices increase, stabilizing to historical values as the market stabilizes. As always, periods of rapid increases in the price of metals are sometimes followed by equally rapid market prices decreases-especially if the recent run up in market prices was driven more by financial activity than by physical demand.
Contact Michael Sullivan - Hilco Valuation Services Inc. Appraiser: 847.313.4714 email@example.com.