OCTG and The Section 232: A Numbers Game?
The tariffs are coming, the tariffs are coming! Or are they? The dog days of summer in the oil patch are being dogged by the protracted Section 232: a rare investigation into “national security implications” of steel imports. Stubborn commodity prices are keeping optimism on a short leash as well. The OCTG market is decidedly unsettled as participants await a declaration on the 232 that was introduced with an expedited timeline but hasn’t proven as straightforward as first implied. After our original treatise introducing the subject in our June intel we are revisiting the topic as it continues to hold sway over the market.
The administration outwardly pledges bold action, but much debate is said to be taking place behind the scenes. For the sake of brevity, we won’t detail the fundamentals of the case here. Those facts can be found in our June blog. Instead, we’ll offer reasons for the stalled recommendations and our thoughts on the outcome.
Although the delay has contributed to softer OCTG prices we don’t view it necessarily as a bad thing. We still believe the powers that be need to take a deliberate approach and consider the entire steel supply chain (producers & consumers). While we have repeatedly recognized the need to curb unfairly traded steel imports, any attempt to isolate and aid one segment of a market has the potential to harm other sectors. This begs the question: has the administration bitten off more than it can chew with the 232?
Among the bones of contention is skepticism about the premise of the investigation from parties who argue that only a small amount of domestically produced steel is used by the military (estimated by the American Iron and Steel Institute—“AISI”—at 3%) and a good portion of what’s imported is produced by our allies. They also point out that the administration of George W. Bush decided not to take action against steel imports under the 232 in 2001 because it could find no national security rationale for doing so.
Another concern is that the World Trade Organization (“WTO”; the international arbiter of trade disputes) is likely to challenge a positive Section 232 decision, however there is a national security exception that the WTO would have to work around. The WTO has never ruled on this application as the 232 has only been enforced against crude oil imports.
Also, if China is the chief target as it has been widely reported, it must be noted shipments of Chinese steel to the US have fallen by 72 percent since 2014, the result of tariffs imposed under the former administration. Of the total 30MM metric tons of steel products the US imported last year (30% of the steel it uses), almost a third came from our allies Canada and Brazil. Other leading ally exporters of steel to the US are South Korea, Mexico and Japan. The countries Russia and Turkey follow closely. China was the 11th-largest exporter of steel products to the US last year. This leads to the question: which countries and/or products will be excluded from any potential action?
There’s also the specter of retaliatory measures from America’s allies. The US is the world’s largest agricultural exporter, which makes it especially vulnerable. In fiscal year 2016, the value of agricultural exports reached $129.7 billion. Punitive tariffs from the 232 could harm domestic agricultural producers—as one example—while failing to address steel production across the board in China.
And we can’t deny the assertion that prohibitive trade actions will raise the prices of domestic steel, trickling down to OCTG and its E&P end users. Adding fuel to the fire, opponents argue that the US steel industry employs far fewer workers than downstream producers that use steel. The AISI claims that the domestic steel industry directly employs ~140K people. The Cato Institute contends manufacturers that use steel as an input employ ~6.5MM workers.
Viewing this through the lens of OCTG, the current escalation of imports suggests the 232 threat has had an inverse effect, fueling a resurgence of imported OCTG as importers move to jump ahead of any decision. Early import license data suggests third quarter tonnages are rolling in. This could be considered cause for some alarm in a rangebound oil price environment especially as OCTG inventory levels have been building for two consecutive quarters. However, with the risk of a potential 232 action transferred to the domestic buyer it is more likely that imports will be suppressed in the fourth quarter. This should help to provide some stability for US domestic OCTG prices (as well as inventory levels) while we ride this storm out.
All things considered, we’re of the mind that the 232 may be all bark and no bite. And if it turns out it has a second life—because the president can play the Trump card—we believe it will be challenged and ultimately defeated. As the saying goes: if you want a friend in Washington, get a dog!
Photo Courtesy Apache Corporation, © Jim Blecha, www.oilandgasphotographers.com