What has been the effect of the steel tariffs?

Is there too much steel in the U.S.?

Will the steel tariffs be reversed?

The answers to these questions are critical to evaluating the price risk in the domestic steel market.  The government shutdown resulted in a dark period for data and now that the government has restarted, data releases are backed up.  Weekly steel import data has resumed with official November imports released, but only license data for December and January.  Steel export data has been updated through November 2018.  The following section will look to answer the first question above.

This table totals net imports for January – November 2018 and compares that total to the total of net imports for January – November 2017.  For the period, flat rolled imports decreased by 815k tons, but exports decreased by 843k tons.  The effect of the tariffs for flat rolled actually resulted in a slight increase in net imports over the period.

YoY, net imports of hot rolled exploded increasing by almost 750k tons or 72.6%! However, there was a benefit in the value added cold rolled, galvanized and galvalume products with net imports for those products down 25.5%, 13.4% and 31.5%, respectively.  The CR – HR and HDG – HR differentials have rebounded sharply off their sub-$100 bottom back into their historically normal $120 area.  Imports for tubular goods also saw a drop of 13.3% or just over 900k tons in 2018.  For the first eleven months of 2018 vs. 2017, all sheet plus tube net imports dropped 880k tons.

These seasonality charts track monthly data for 2017 and 2018.  The spike in flat rolled imports in mid- 2017 and early 2018 were mostly in response to the Section 232 investigation.   A dramatic price drop followed both.  The 2017 drop was felt more in higher value add products as collapse CR and HDG differentials fell around $80/t.  It is uncertain if the steep drop in hot rolled and other value added products that started in the second half of 2018 has bottomed or just taken a pause.

One can argue the effect of the tariffs reduced net imports by roughly 900k tons in 2018 and caused extreme volatility in flat rolled prices.  The extreme volatility has had a negative effect on domestic manufacturing, resulted in product substitution and credit issues, especially for many smaller OEMs.  This occurred in concert with a slowdown in European and Asian manufacturing.  Whether that was the result of the trade war and tariffs or exclusive to their own economies and business cycle is a question that cannot be answered at this time and is frankly irrelevant.  The bottom line is demand has slowed globally and may continue to weaken further.

In 2018, 4 million tons of additional/potential flat rolled domestic production capacity came on line (2.5m Granite City, 1.5 JSW). Three weeks ago, 2018 AISI production was analyzed showing annual steel production increased over 4.4m tons or 4.9% YoY.

The AISI puts out weekly raw steel production.  This chart shows a trailing 52-week sum.  This chart is another way to look at the same data showing the increase in production now closing in on levels seen in 2014 and early 2015.

Steel capacity utilization continues to stay well above 80%.

Last week, we examined the balance sheet inventory build in these four steel mills based on their Q4 earnings released over the past few weeks.

ArcelorMittal announced their earnings last week showing YoY and QoQ growth in their inventory levels in dollar terms and this is for their global business, not just U.S. based mills.

This increase looks to be a negative for higher prices, but it is far from clear what it means.  First, what is the mix of this inventory between raw materials, semi-finished and finished goods?  Second, of the finished goods, how much is flat rolled?  Last, how much of the increase is due to higher prices in the mix.  When asked during the conference call, ArcelorMittal CFO Aditya Mittal said:

In terms of excessive inventory, I would say that we talked about $1 billion reversal of 2019. That’s the overspend in 2018. A majority of that is inventory and there’s a small bit, which has to do with more efficient receivable collection. Out of that majority, half is stuck in raw materials and the other half is in finished goods.

 

So, lets revisit the question is there too much steel.

We know there is decreased demand and increased supply.

The evidence argues yes there unequivocally too much steel.

The third question is will there be a reversal of the steel tariffs?  Last week, both the House and the Senate on a bipartisan basis introduced the Bicameral Congressional Trade Authority Act of 2019, which if passed, would remove trade authority under Section 232 from the President and put it back in the hands of congress.  If passed, it will result in the removal of the 25% tariff on steel.  This is not only a major downside risk to domestic steel prices, but also the risk in and of itself is likely a deterrent to boost apparent demand, especially in the face of recent price increases.

The rally in iron ore continued last week with the March SGX futures closing the week on highs at $88.88/t trading as high as $93.50.

The rally in iron ore carried the Turkish scrap futures higher.  The March LME Turkish Scrap future added another $6 on the week closing at $336, but settled as high as $351 during the week.

However, as of publication of this report, iron ore and scrap have sold off significantly since the Chinese markets reopened following the Chinese Lunar New Year.

Higher global finished steel and raw materials have compressed import differentials toward the levels seen prior to rallies (differentials below are unadjusted pre-tariff).  At current prices, tariff adjusted imports are unattractive.  Imports should fall in the coming months tightening supply in the U.S.  However, whether or not this tightening is enough to overcome increased production capacity remains to be seen.  Also, if tariffs are removed, imports become attractive again.

The following issues provide the foundation of our view:

• Declining rates of growth in manufacturing and tariff induced demand destruction
• Increased/increasing domestic steel production capacity
• Weakening global economics
• Crude oil price falling sharply
• Higher interest rates
• Strengthening U.S. dollar
• S. residential construction industry slowing
• Slowing auto sales
• Falling global flat rolled prices
• Tariff resolution potential

After being delayed due to the government shutdown, the November U.S. Durable Goods Report was finally released.  New orders for durable goods and capital goods missed expectations.  Seasonally adjusted new orders for durable goods ex-transportation fell 0.4% MoM, missing expectations of no change.  The table below shows unadjusted YoY and MoM new orders for the top three categories.

These charts show the YoY percentage change in new orders for each category.  These charts show a clearer picture of slowing growth across the manufacturing industry.

The charts consistently show slower growth, which will lead to decreased shipments if the trend continues.  This data is old at this point, but if it is indicative of a downtrend and continued slowing in new orders, the drop in shipments will lead to lower demand.