Should Midstream Steel Itself for Steel Tariffs?

One of the appeals of investing in energy infrastructure is that it’s real assets. For some investors, there’s reassurance in owning steel in the ground. Of course, steel has become a hot-button political issue lately with steel tariffs in the spotlight. With steel being a critical material for energy infrastructure, it seems like a good time to discuss steel uses in energy, price trends, and the impact to midstream companies.

To recap, earlier this month, President Trump signed a proclamation imposing a 25% tariff on steel imports and a 10% tariff on aluminum. The tariffs will become effective on Friday, March 23rd. Canada and Mexico, which together accounted for a 26% of US steel imports by volume, are exempt from the tariffs. Additional countries may also be exempt, but it remains unclear for now. The proclamation provides relief for steel materials deemed “not to be produced in the United States in a sufficient and reasonably available amount or of a satisfactory quality” with the impacted party required to file a request for exclusion. This provision is encouraging for midstream. Pipelines often require special types of steel, some of which are not currently available domestically. However, media reports are indicating that it may take up to 90 days for exclusions to be processed.

Of course, within the energy space, steel is necessary for much more than pipelines. Rigs, offshore platforms, oil and gas wells (steel casing and well equipment), refineries, and terminal infrastructure all rely on steel. It’s critical across the energy value chain for production, transportation, storage and processing. Railcars, which are a transportation alternative to pipelines, also rely on steel. While the energy industry counts numerous steel purchasers, we’ll just look at the implications for midstream companies, particularly in terms of pipeline projects.

Rising steel prices a bad headline; existing pipelines more valuable.

Not surprisingly, steel prices have been on a tear recently as shown in the chart below. The US Midwest Hot-Rolled Coil Steel Index — a widely used benchmark — is at price levels not seen since early 2011. Back then, floods in Queensland, Australia, were wreaking havoc on commodity markets. Higher steel prices increase pipeline project costs, but higher prices also mean steel in the ground (or already purchased for construction) is more valuable and represents a competitive advantage. Companies that can expand existing pipelines by enhancing pumps have a leg up on new projects anyways, but particularly in an environment of high steel costs. Enterprise Products Partners’ (EPD) analyst conference presentation discusses expectations for steel and line pipe prices to increase this year, while 16”-24” line pipe supply is expected to be constrained. As shown in the presentation (slide 90 of 120), prices for Electric Resistance Welded (ERW) steel pipes is much higher per ton than the underlying steel price but tends to follow a similar trajectory.

It’s difficult to say what proportion of a pipeline project’s cost is related to steel given fluctuations in labor and material costs and the varying topography for pipeline locations. We’ve seen recent estimates ranging from 20% to 40%. Regardless, steel is a significant cost for new pipelines, and midstream companies will have to factor higher costs into new project economics. However, higher steel costs should also factor into tariff rates. MLPs take a conservative approach when it comes to building pipelines, and they typically won’t start construction without a degree of certainty as to what their project returns will be. While the headline of higher steel prices and steel tariffs seems negative, higher prices are just something MLPs will have to incorporate into their models and likely pass on to their customers through higher tariffs.

What happened with steel tariffs in 2002?

Of course, this isn’t the first time the US has dabbled in tariffs on steel imports. The US imposed steel tariffs back in March 2002. Several countries were exempt, among them Canada and Mexico. Tariff rates were also reduced from their initial levels. The tariffs were originally meant to be in effect for three years but were lifted in December 2003. The impetus for the early removal was a US International Trade Commission report describing the negative impact on steel consumers and showing that the costs were more than offsetting the tariff revenues, resulting in an estimated GDP loss of $30.4 million on an annual basis. Furthermore, the European Union had threatened trade sanctions, and the World Trade Organization had deemed the tariffs illegal. Overall, the tariffs resulted in net job losses. The steel tariffs from 2002 are an interesting historical reference, but we’ll have to wait and see what the outcome will be of the new tariffs.

Bottom line

It’s too early to fully understand what the impact of the new steel tariffs will be on future pipeline costs and the energy industry more broadly, particularly as country exemptions and relief for certain steel materials play out. We do know that higher steel prices, assuming they persist, will have to be factored into project economics but also future tariff negotiations.

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