The Commodity Markets Update last explored the status of the global steel market in spring 2016, following a particularly difficult 2015 for commodity markets at large. A worldwide surplus of commodities, coupled with a strengthening U.S. dollar, drove returns for raw materials to the lowest level since the beginning of the commodity super-cycle in the early 2000s. The fall in the price of steel was significant, even by historical standards. The U.S. price of hot-rolled steel – the benchmark steel product used to make everything from cars to washing machines – declined 39.6% from $609 per metric ton (MT) in December 2014 to $368 per MT in December 2015.1 Over the past 30 years, there have been just four other occasions of a steel price decline of 33% or more in a one-year period.
Numerous factors contributed to the 2016 steel price drop, but most responsible was excess capacity, or “overcapacity,” in the steel sector. The rapid growth of Asian economies since the beginning of the 21st century, particularly in China, led to a dramatic expansion of production capacity by the global steel industry. Over the past 20 years, Chinese steel production increased eightfold to meet the needs of the country’s surging economy. Between 2000 and 2013, Chinese capital investment in new steel production capacity largely kept pace with domestic demand, as evidenced by the country’s stable steel trade balance over that time period. However, beginning in 2014, steel consumption growth started slowing. Despite Chinese demand peaking in 2013, new investment in production continued through 2016, adding excess capacity to the market amid falling demand. China’s role in contributing to the global overcapacity issue cannot be overstated, as it accounted for 58.3% of global overcapacity in steel in 2017.2 On a global basis, excess steel capacity is estimated to be between 500 million and 700 million tonnes, a staggering figure when compared with annual steel consumption of 1.52 billion tonnes.3
Excess capacity has had a distorting and damaging effect on the global steel industry, the principal issue being that steelmakers have been incentivized to produce more product than the market can consume. When capacity utilization rates fall, the cost to produce each ton of steel increases, thus reducing a mill’s economic returns. To reach optimal capacity utilization rates, steelmakers will naturally choose to increase production, which subsequently leads to oversupply and weak market conditions. The situation in China emerged as an acute issue in 2014. This led to a steep rise in exports beginning in 2014 as local markets became saturated and ultimately resulted in downward pricing pressure. Due to strong demand fundamentals, the U.S. became a magnet for steel imports. In 2016, steel imports climbed to a record 29.6% share of domestic consumption, significantly above the 20-year trailing average of 22.9%. The surge had significant political repercussions in the U.S. as punitive anti-dumping restraints were put in place to safeguard domestic producers suffering from low prices.
Despite the persistent overcapacity challenge the industry faces, the global steel market has improved considerably since 2016. A primary driver behind a resurgence in steel demand and pricing has been the phenomenon of globally synchronized economic growth. In the U.S., the combination of strong steel demand and higher price levels has contributed to a significant improvement in domestic steelmakers’ earnings. Even though the U.S. steel industry seems to be on solid financial ground, President Trump fulfilled a key campaign promise in March 2018 when he announced tariffs of 25% on all steel imports under Section 232 of the Trade Expansion Act of 1962. Unlike anti-dumping duties, which aim to prevent foreign goods from being sold in the U.S. at “less than fair value,” Section 232 gives the president sweeping authority to impose tariffs if imports “threaten to impair the national security.” While it seems likely that certain allies will be exempt from the tariffs, the proposal was by far the most punitive option from the list of recommendations submitted by the Department of Commerce (DOC). So, what is the desired effect of President Trump’s tariffs on the market?
This article examines the main drivers supporting positive trends in the steel industry and outlines the implications that President Trump’s tariffs will have on the domestic steel market. While it is clear that macroeconomic conditions have buoyed steel demand, we also analyze several outside factors that have had an outsized impact on the market’s recent (positive) direction.
China Trims Steelmaking Capacity
While it will take the steel industry decades to deal with the issues of excess steel capacity, recent changes have positively affected global steel prices. As noted, it is nearly impossible to measure changes in the global steel market without considering the impact of Chinese economic policy, since the country accounted for about half of the 1.63 billion tonnes produced worldwide in 2016. The gap in production between China and the second largest producer, Japan, is immense. Japan produced 104.8 million tonnes in 2016, compared with China’s 808.4 million tonnes.4 To provide some historical context to China’s growing influence over the global steel market, the country’s share of global steel output was just 12.7% in 1995.
Unsurprisingly, China is also the world’s largest steel exporter. In 2013, the country shipped 62.3 million tonnes of steel overseas, accounting for 15.0% of the global export market. That year coincided with the high-water mark for Chinese steel production and consumption, with demand peaking at 735.1 million tonnes. Starting in 2014, steel demand declined for the first time since 2000, resulting in steel mills using exports as a release valve for surplus stocks. Chinese exports consequently reached a record high of 111.6 million tonnes in 2015, a 79.1% increase from 2013 exports of 62.3 million tonnes. That year, China’s share of global steel exports climbed to 24.3%, also a record. To put that number in perspective, China’s exports in 2015 were 1.42 times greater than total U.S. steel production.
In a reversal of the trend between 2009 and 2015, China’s steel exports surprisingly declined over the past two years, including a nearly one-third plunge last year. In 2017, China exported 73.3 million tonnes of steel, a 31% decrease from 106.6 million tonnes in 2016. The slowdown in steel exports comes despite a 5.7% jump in China’s crude steel output in 2017, according to World Steel Association figures. So, with Chinese steel production still growing, why do exports now seem under control?
Leaving aside macroeconomic indicators for the moment, 2017 was a year in which shifting priorities by the Chinese government influenced the steel industry immensely. The economic-social model of the Chinese government has always placed a high importance on maintaining full employment, even if that meant that further capital investments in the steel sector exacerbated the overcapacity issue and resulted in poor economic returns. However, since 2016, the government has placed an increasing importance on steel production’s environmental impact, including air emissions and wastewater contaminants. This policy decision led to a crackdown on highly pollutant illegal induction furnaces in the first half of 2017, which removed up to 140 million tonnes of steel capacity.5 In another bid to improve air quality, the government mandated forced idling of blast furnaces to 50% at several mills in North China during winter.
Above and beyond the capacity reductions achieved by closing illegal furnaces, China announced “supply-side reforms” in 2016, which focused on cutting overcapacity in a number of industries, including the steel and coal sectors. Ongoing closures of low-tech, outdated integrated steel mills have reduced capacity by approximately 150 million tonnes.6 The move also advanced China’s campaign to shut down loss-making state-owned enterprises, signaling the expansion of market reforms across its economy.
While China has set a clear objective to meaningfully reduce steel capacity, other countries are set to expand capacity in the years ahead. The Global Forum on Steel Excess Capacity (GFSEC), launched by the G20 in 2016 to address the causes of excess capacity, notes that India’s steelmaking capacity will more than triple to 300 million tonnes by 2030 or 2031 to meet growing domestic demand. The nearby chart highlights changes in steelmaking capacity volumes by country over the past three years. Given China’s outsized share of global production, it is difficult to ignore the impact that its policy decisions will have on addressing overcapacity issues relative to other steel-producing countries.
Healthy Global Economy = Growing Demand for Steel + Higher Prices
In addition to the noted supply constraints, the synchronized growth of the global economy has generated strong momentum in worldwide steel demand. This development has supported higher steel prices throughout 2017 and into 2018. In its latest “World Economic Outlook,” the International Monetary Fund (IMF) estimated that global GDP growth reached 3.8% in 2017, up from 3.1% the prior year. The IMF noted that the breadth of the expansion was unique, stating that “growth accelerated in about three quarters of countries – the highest share since 2010.” Even more important, economic growth is accelerating in the largest steel-consuming markets. Real GDP growth in the EU, the U.S. and China – together representing more than 61.4% of global steel consumption in 2017 – was 2.5%, 2.3% and 6.9%, respectively. Economic performance in these countries is approaching levels unseen since the 2008 financial crash.
Given the level of broad-based economic growth, global steel consumption rose at a healthy pace in 2017. According to the World Steel Association, demand for finished steel is estimated to have expanded by 2.8% to 1.62 billion tonnes in 2017. Growth momentum in China’s economy – where 2017 GDP accelerated on an annual basis for the first time since 2010 – accounted for the majority of the global increase as consumption climbed 3.0% to 765.7 million tonnes. China’s economic expansion was faster than expected and defied concerns that the government’s mission to tackle overcapacity and environment issues would suppress growth and, therefore, steel consumption.
The combined effect of higher steel demand and a reduction in excess capacity has been favorable for steel prices. According to Steel Market Update, the global average price for hot-rolled coil (HRC) was $560 per MT in April 2018 – up 20.9% year over year. In China, strong demand coupled with the government’s continued mission to reduce capacity resulted in a unique phenomenon whereby prices in China surpassed international prices at several points during the past two years. With Chinese steelmakers able to garner higher prices by selling domestically, there was less steel available for export, which in turn has buoyed international prices. Even before President Trump’s March 1, 2018, announcement of a 25% tariff on steel imports, U.S. steel prices had climbed 26.4% over the past 12 months. With the protection afforded by the tariffs, U.S. steelmakers increased prices by an additional 10.1% over the course of the seven weeks following the announcement. As a result, the differential between U.S. and international steel prices has hit a six-year high of $220 per MT, which will likely provide an opening for foreign imports to sell competitively in the U.S. despite the tariffs.
Steel Imports as a Percentage of Domestic Consumption Normalize
The net effect of protectionist behavior by the U.S. government, as well as the macroeconomic trends discussed, have had a positive impact on the competitive landscape for U.S. steelmakers.
The following chart depicts annual net steel imports expressed as a percentage of U.S. consumption. Over the past two decades, U.S. steel demand has exceeded total domestic production by an average of 22.9%. The historical average highlights the fact that foreign steel imports have and continue to fulfill a critical role in maintaining the supply-demand balance for steel in the U.S.
In 2015, imports captured a record 29.6% share of the domestic market, largely due to the aforementioned overcapacity issues in China.7 In response to the surge, the DOC initiated 46 new anti-dumping investigations, which accounted for 45.1% of the total trade cases filed that year. The U.S. issued two significant anti-dumping and countervailing duty orders in late 2016. In May 2016, the DOC issued anti-dumping and countervailing duties on corrosion-resistant steel products (CORE)8 from India, Italy and South Korea ranging from 3% to 93%; China was hit far harder, with possible duties of up to 450%. Anti-dumping and countervailing duty orders of 521% were imposed on Chinese cold-rolled steel flat products the following month. In December 2017, the DOC announced additional orders on CORE and cold-rolled steel from Vietnam after U.S. producers argued that China was circumventing tariffs by shipping hot-rolled steel to Vietnam for processing. Although the finished product was being made in Vietnam, the DOC determined that the majority of the product’s value originated from Chinese hot-rolled steel, which was already subject to anti-dumping and anti-subsidy tariffs. To reinforce its case, the DOC noted that shipments of CORE and cold-rolled steel products from Vietnam increased from $11 million to $295 million over the course of one year after preliminary duties were imposed on Chinese products in 2015.
The duties on CORE and cold-rolled steel products were more than high enough to shut out most foreign suppliers from the U.S. market. The combined value of the affected products accounted for approximately 9% of the total value of steel shipped to the U.S. in 2016. Taking into account supply-side constraints, U.S. imports as a percentage of total consumption returned to a more normalized level. In 2016, U.S. steel consumption experienced a marginal decline of 1.5%, while the actual volume of foreign imports fell by a more severe 16.2%. This resulted in U.S. steelmakers increasing their share of domestic consumption by 4.6% to 74.9%. The capacity utilization rate for all U.S. steel facilities reaffirms that trend. According to the American Iron and Steel Institute, after bottoming in October 2016, U.S. domestic steel capacity utilization advanced during 2017 to average 73.9%, up from 70.5% in 2016. As a result of the improving capacity utilization, U.S. steel production rose 3.4% from 78.5 million MTs in 2016 to 81.6 million MTs in 2017. Given the close correlation between capacity utilization rates and steel prices, it is no surprise that the financial performance of U.S. mills has generally improved in the current environment.
It is important to note that while capacity utilization has increased 15.9 percentage points from the 13-year low reached in April 2009, it remains well below pre-recession historical averages. The DOC noted in its Section 232 report that “the U.S. steel industry uses 80 percent as a benchmark for minimum operational efficiency.” The report highlights that the U.S. industry is capable of reaching an 80% capacity, as evidenced by the period between 2002 and 2008 when U.S. steel companies operated at an average 87.4% level.
Likely Impact of Tariffs
The administration’s delayed rollout of the Section 232 tariffs has caused significant disruptions for steel importers and domestic consumers of the metal. Commerce Secretary Wilbur Ross made the initial announcement in April 2017 that the administration would be investigating the effects of steel imports under Section 232, with a self-imposed deadline to publish its report by June 30, 2017. The subsequent delays leading up to the official announcement forced steel traders to amend purchasing strategies due to not knowing the exact form or substance of the tariffs.
While the tariffs have clearly caused near-term market disruptions, it seems increasingly unlikely that importers will be disintermediated, if at all, in the long term. First, the pricing advantage afforded to U.S. steelmakers by the 25% blanket tariff seems to be evaporating quicker than thought. Since the tariff announcement, price increases by U.S. mills have caused the spread between U.S. and international prices to widen to a level that encourages consumers to purchase imported material. When comparing average international prices of $560 per MT, plus an additional $90 per MT for freight charges, against U.S. HRC prices of $870 per MT as of April 23, 2018, the spread is $220 per MT. It is not a coincidence that the U.S. premium over international prices is 25.29% – almost exactly in line with President Trump’s Section 232 tariff.
Second, the staying power of steel imports as a percentage of U.S. consumption – averaging 22.9% over the past 20 years – signals that President Trump’s tariffs will not likely lead to a significant increase in production capacity by domestic steelmakers in the short or long term. The cost for U.S. steel mills to invest in new production capacity is significant and time-consuming. It is unlikely that U.S. mills will deploy capital into new projects without absolute certainty that the tariffs will still be in place by the time a project is completed. That analysis doesn’t even consider the payback period after the project is up and running. One may recall that former President George W. Bush imposed similar steel tariffs in 2002; these were significantly weakened by exclusions from the start, and safeguards were removed after 18 months. Without certain exclusions, President Trump’s tariffs could end up hurting the very people he is trying to protect. Steel plants known as “rolling mills” rely on imported semifinished casting products like blooms, slabs and billets to make finished products. Rolling mills largely import these products, as they are not commercially available in the U.S.
Finally, recent purchasing behavior by domestic consumers reinforces our analysis that the tariffs will have a limited effect on steel trade flows. Service centers are continuing to accept delivery of forward purchases of imported materials that are subject to the 25% tariff, even after given the free option by the shipper to cancel delivery. Without any viable alternate to purchase material domestically, consumers will maintain existing supplier relationships – just at a 25% higher price.
For the time being, the U.S. economy is healthy enough to absorb artificially high import costs. In the long run, the outlook is unclear if domestic mills will use safeguard measures to invest in new capacity and subsequently displace foreign imports. Based on the long-term data, we feel confident that imported steel will continue to feed a material portion of domestic steel consumption.
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1 Purchasing Magazine, Tom Stundza Steel Snapshot and Steel Market Update.
2 Organisation for Economic Co-operation and Development.
3 “World Steel in Figures 2017.” World Steel Association.
5 Output from illegal blast furnaces is sometimes referred to as “gray” production and is often unaccounted for in official production statistic reports.
6 The People’s Republic of China’s State Council executive meeting on January 22, 2016.
7 U.S. Census Bureau and U.S. Department of Commerce Import Statistics Archives.
8 This product category, which includes steel sheet that has been coated with zinc, aluminum or any of several zinc-aluminum alloys, such as cold-rolled or galvanized steel coils, accounts for approximately one-fifth of steel consumed in the U.S.