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The lesson from Trump's steel tariffs? Short-term gain but long-term pain

"Our steel industry is the talk of the world. It has been given new life, and is thriving."

While typically boastful, the tweet from President Donald Trump in September 2018 was a fairly accurate description of the state of the U.S. steel industry three months after the imposition of 25% tariffs on imports of the ubiquitous alloy.

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Steel prices have fallen below the pre-tariff level as demand from the weak manufacturing sector slumped.

Source: AP Photo

Imports were falling, domestic production rates had climbed, profitability of steelmakers was at multiyear highs and a string of major investments to build new production hubs had been announced.

The apparent success of this tariff suggested Trump's broader protectionist economic strategy was working, emboldening U.S. policy as the president embarked on a trade war with China.

Fast forward a year and the picture is somewhat different.

The surge in prices, production and profitability has already sagged, while the addition of capacity could see the U.S. market structurally oversupplied in the coming years as economic output slows.

"I think the tariffs were very much misguided," said Benn Steil, senior fellow and director of international economics at the Council on Foreign Relations. "Overall, the steel industry has been hurt by the depressing effect on manufacturing broadly."

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Back in the black

The tariff was a shot in the arm for manufacturers such as U.S. Steel. At one time the world's largest steelmaker by volume, and the largest by market capitalization, U.S. Steel's decline was seen as symbolic of the fate of American manufacturing. The company fell out of the S&P 500 in 2014 and now sits outside the world's top-25 steelmakers.

In 2015, the former blue chip made a net loss of $1.64 billion and hemorrhaged a further $440 million in 2016. Steelmakers pointed the finger at imports, which accounted for 30% of U.S. supply, and a raft of anti-dumping measures were imposed under the Obama administration.

An uptick in the economy helped push U.S. Steel back into the black as demand improved, but it was Trump's tariffs that truly sparked the revival. A profit of $1.12 billion in 2018 marked the company's best performance since the end of the commodity super cycle in 2008.

Domestic steel prices ballooned to a premium of around 80% over Chinese steel, the price setter in the global market, and even 50% above European product, which is burdened with environmental regulation and high energy costs.

A combination of the 25% tariff, added to anti-dumping and countervailing duties combined to over 500% for imports of some steel products from China.

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Customers wary of reduced imports due to the imposition of the tariffs and quotas rushed to buy steel. But in 2019 demand has collapsed as end users were highly stocked, and the economy slowed.

Manufacturing has slumped as business holds back on the investment Trump had predicted would follow the tax cuts he implemented in 2017. The ISM index showed U.S. manufacturing contracted for the third consecutive month in October with an index level of 48.3 only slightly higher than September's decade-low level of 47.8 a reading below 50.0 indicates contraction.

The price of hot-rolled coil, a bellwether steel product, has fallen by 46% since its post-tariff peak in July 2018, according to the price reporting agency S&P Global Platts, a sister company to S&P Global Market Intelligence. This compares to a 26% fall in the Chinese price even as the Chinese economy suffers its own growing pains.

Good intentions

U.S. capacity utilization rose from the doldrums of 70.5% in 2016 to reach the global industry standard of 80% — Trump's target — in October 2018, while imports fell from 21 million tons in 2017 to 18.8 million in 2018, well down on the peak of 22.7 million tons in 2015 when the U.S. began implementing duties.

Steelmakers were encouraged to invest billions in new capacity, much of which is aimed at the car industry which Trump also has his eye on boosting with import tariffs.

But as an extra 8.2 million tons of steel is set to hit the market within the next three years, according to Platts calculations, utilization rates have slipped back below 80% amid the contraction in manufacturing.

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Part of the problem facing manufacturers is higher costs from tariffs. The Tax Foundation calculates that the tariff levied on steel and aluminum raises $6.4 billion of that total, primarily related to steel. An exemption granted to Canada and Mexico following the renegotiation of the NAFTA trade agreement, reduced tariff revenue by $2.6 billion.

That revenue gain for the government is a cost to manufacturers with steel in their supply chain.

While the total pales in comparison to the $79.3 billion in revenue the Tax Foundation calculates the government will raise through its section 301 tariffs on China, the added element of import quotas reduced supply and raised prices further.

'Steelmageddon'

Some analysts are worried now that instead of focusing on consolidation and improving performance, the extra investment has instead gone to oversupply an already oversupplied market.

"I think this is the most transparent train wreck I've seen in my career," said Timna Tanners, an analyst at Bank of America Merrill Lynch. Tanners coined the phrase "steelmageddon" to describe the potential shock to steel prices when the new capacity hits the market in the next two to three years.

The nervousness is apparent in the share prices of major American steel companies. Despite the apparent assistance from the U.S. government, steel stocks have lagged the performance of the S&P 500 since 2018, with the former blue chip U.S. Steel down 69% this year as of Oct. 31.

"If the president’s policies were working as planned, the steel industry should outperform other sectors," Steil said.

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