Exit the Dragon? New steel tariff could divert Chinese steel back to Asia

With new steel tariffs imposed by the US, Chinese and ASEAN steel is becoming more expensive in the US. While China contributes only 2% of finished steel entering the US, Chinese items made from steel and aluminium – along with countless "transiting metals" – are likely to take a far greater share.

In fact, China was the second-largest source of imports of steel and aluminum products into the US in 2017, second to Canada but above Mexico. Should a strong uptick in US domestic steel production fill the gap, Chinese steel may be forced to retreat from the US market, meaning around 1 million mt would be redirected to Asia.

A worst-case scenario would be the entire export surplus remaining in China, adding to already high domestic inventories and potentially having a bearish impact on sentiment and prices.

MORE THAN 2%

China and the US are the world's largest steel exporter and importer, respectively. However, trade between the two countries has long been in decline, accounting for approximately 2% for each in 2017.

This can be seen in steel data from 2017 showing total US imports of 34.6 million mt, in of which China accounts for only 2%, or 881,000 mt. This is equivalent to just over 1% of China's total exports of 75 million mt in 2017. However, when we look at Chinese exports of not only finished steel but all items manufactured from steel and aluminium, such as pipes, tubes, sheet piling, tanks, drums, fabricated sections, nails, cables and even barbed wire, the impact is far greater.

We have used Harmonized System trade data that classifies traded products into internationally standardized groups to analyse China's trade with the US. The chart shows China's exports of three groups of metal products to the US: Iron and steel (HS code 72), primarily finished steel like hot rolled coil and bar; products manufactured from iron and steel (HS code 73); and also aluminum and products manufactured from aluminum (HS code 76).

As can be seen in the chart, trade in steel and aluminium metals and products has risen over the last couple of years to $17 billion last year, with articles manufactured from steel items accounting for 75% of this trade.

This makes China the second-largest source of imports (18%) of steel and aluminum products into the US after Canada (19%) but above Mexico (8%), according to UN Commodity Trade Statistics.

In addition, this 18% does not include the countless Chinese-originated metals that were transiting through a third-party country such as Vietnam and a number of other ASEAN countries. The true exposure of "Chinese metals" to the US, therefore, could be much greater than 2%.

ASEAN PROVIDES AN ALTERNATIVE MARKET FOR 'RETURNED' CHINESE STEEL FROM THE US

Since 2015, Chinese steel exports have fallen sharply due to the numerous countervailing duties and anti-dumping tariffs the US and EU have applied to Chinese finished steel products. This has facilitated the shifting trade flows from the West to the East, with Asian destinations taking the lion's share. Southeast Asian (ASEAN) countries are the largest receivers, accounting for 28% of the Chinese steel and aluminium products (HS code 72, 73 & 76), or $26 billion in value in 2016.

In 2017, Chinese exports of finished steel fell a sharp 30% from 2016 to 75 million mt. Total Chinese shipments to ASEAN also even more, by 41.5% to 22.78 million mt. However, it is still the largest destination, taking over 30% of Chinese steel exports. Given the size of ASEAN demand, it will likely provide continued optionality for Chinese exports, and potentially absorb the 1 million mt shifted from the US.

An important caveat, however, has been the US complaints against Chinese-originated steel imports from Vietnam and other ASEAN markets. The US has accused China of routing goods through another country to disguise their origin. Although this seems more political posturing than something which might have an impact, whether or not ASEAN will be able to absorb the Chinese export surplus remains to be seen. If it is unable to, an estimated steel surplus of 1 million mt will most likely stay inside China.

WHAT DOES A 1 MILLION MT STEEL SURPLUS MEAN?

In the unlikely event of China's immediate retreat from the US steel market, along with lackluster ASEAN demand, the additional supply will be added to Chinese stocks. At present, domestic inventories are estimated at around 17 million mt, so 1 million mt will be equivalent to a 6% increase. This volume does not appear to be large, and is more likely to be phased rather than in one big hit, but China is currently sitting on its highest inventories since 2013. Adding to these could hit sentiment and prices.

From the chart it is clear seasonal factors play a major role in Chinese steel inventories, which typically peak in March, followed by a steady decline throughout the year. This is largely a result of inventory rebuilding ahead of the Chinese construction season that starts in April after the Chinese Lunar New Year.

At present, it appears that the market is following the seasonal trend, with inventories shrinking from the peak of near 20 million mt in March, to around 17 million mt now.

The chart shows a five-year average inventory level of around 7.6 million mt, which is about 9.4 million mt lower than now. It also illustrates an erratic relationship between steel stocks and steel raw materials in China.

This could be due to the complexity of the steelmaking supply chain, which requires a certain lead time of over 30 days for inventory pressures to be passed on from steel to raw materials.

If China retreats from the US market before domestic inventories are down to normal, this potential addition of 1 million mt could be the straw that breaks the camel's back.