US Tariffs Put to the Test by Markets

The 10% tariff on aluminium imports will not be able to spark a fast increase of the production of primary metal in the US, largely insufficient to meet the domestic demand for the metal. The effect of the new tariffs on the European aluminium system is still uncertain

by Massimo Grifone, Director, Cauvin Metals

On March 1st, in spite of the expectations of the best part of US operators, who would have preferred the second recommendation of the Department of Commerce of the US (23.5% tariff on imports from China, Russia, Vietnam and Venezuela), considered the most efficient to check Chinese excess capacity and to reinforce the primary industry in the US, the President of the United States Donald Trump announced the introduction of 25% commercial tariffs on steel imports and 10% on aluminium imports for an indefinite period. These tariffs are effective as from Friday, March 23rd, at 00:01, New York time. This is a highly relevant event which may change the flow of aluminium in the world and the dynamics of prices and premiums.
The President then partly changed his stand by introducing the possibility of not applying the tariff to the closest commercial partners and, more in general, to those States which will sign trade agreements more favourable to US interests. Indeed the North American partners of the free trade area, Mexico and Canada, have been excluded from tariffs at the moment when the agreement was signed. Canada and Mexico are “special cases” and, according to official statements, they have been exempted from the tariff on account of “the physical proximity of our respective industrial bases and the solid economic integration between our countries”. However, the permanence of this exemption will depend on the outcome of the renegotiation of the Nafta trade agreement. A few days later Australia too was exempted. Trump also stated that exclusions could be allowed to goods which are not produced in sufficient quantities or with sufficient quality in the US, or to products which are subject to specific “considerations based on security”. The situation is thus constantly evolving and, therefore, the consequences are difficult to evaluate.

Tariffs coming up even for semis?
The motivations underlying the introduction of tariffs appear on the contrary more evident. By reading the text of the proposal it can be seen that the commission which designed these restrictive measures mainly supported the idea of introducing tariffs on primary metal, with the aim of favouring the return of the US aluminium industry to its 2012 production levels.
From 2012 to 2016, US production of primary aluminium decreased by 60% and the rate of reliance on imported aluminium went up from 11% to 52% (figure 1). Even though protectionist policies and commercial restrictions were present in Trump’s presidential campaign, complaints against Chinese aluminium exports had already been filed with the WTO by President Obama. Figure 2 shows that China is the main exporter of aluminium semis in the US and that Chinese aluminium semis tend to have much lower prices with respect to those coming from other countries. The commission upholds the need to apply tariffs even to semis, because levying a tariff only on primary aluminium would be devastating for American semis manufacturers, since they would not be able to compete with cheap Chinese manufacturers if domestic primary aluminium were to become more expensive. A tariff applied to China alone could increase the export of other nations towards the US. The net impact would be represented by higher LME prices, lower SHFE prices and by a higher physical premium both in the US and in other countries. This is why the tariff, at any rate right now, has been extended, besides China, to other countries too such as Russia, but with the exemption of the countries which are allies of the United States, such as Canada and Australia, and, on account of geographical proximity and of the high level of integration with the US industry, Mexico. On March 22nd, Trump authorized the suspension until May 1st of tariffs on steel and aluminium imports from Brazil, Argentina and South Korea and also from the European Union.

Short-term implications
From the beginning of the year, the forecast of the introduction of tariffs drove premiums in the US upwards, and supported premiums in Europe (figure 3). Premiums went up mainly for two reasons: spot purchases increased, so as to ensure the availability of material not burdened by tariffs; traders offered increasing premiums on spot purchases, fearing that what is sold today might need to be replaced tomorrow with purchases at higher premiums because of the tariff.
The exclusion of Canada partly downsized the effect of the tariff because Canada is by far the greatest exporter of primary aluminium towards the US (figure 4).
The possible implications, based on the current situation, that is, the application of tariffs on primary metal and products with the sole exceptions of Canada, Mexico, Australia and Europe, may be summarised as follows:
• Increase in costs for American aluminium downstream: in this respect, the Aluminum Association, which represents 114 member companies which employ 713,0000 workers in the US, sent a letter to President Trump stating that “Tariffs suggested will do precious little to tackle the fundamental issue of massive excess capacity for aluminium in China, while they affect the supply chains of our partners
who work by the rules” and may concern downstream jobs, representing 97% of the total occupation in the aluminium industry. The alarm was partly turned off after the exclusion of Canada and Mexico, but concerns remain.
• Increase in premiums for primary metal, an implication which as we saw has come true and is still in place
• Support to premiums in Europe: material has been displaced from Europe to the US to enable it to arrive before the introduction of the tariff, and the availability in Europe decreased as a consequence. Besides, with the current premiums in the US (the Metal Bulletin revealed a further increase of the Midwest premium at the same time as the introduction of tariffs), the American market remains still attractive, even for those origins which will pay the tariff.

Medium and long-term consequences
The growth potential of the US Midwest premium could be mitigated, because it already increased by 96% since the beginning of the year on account of speculation relative to the investigation of Section 232. Several operators state that a 10% tariff seems to be already almost completely compensated by the current Midwest premium. Besides over one million tons of primary aluminium are recorded as available in American harbours. The determination of an almost immediate effect of the tariffs does not allow the organization of further shipments to unload the aluminium before the tariff becomes effective. During the past few days, with the disappearance of support to shipment towards the US, the “tariff paid” and “tariff not paid” premium markets in Europe saw a decrease in the availability of the metal due to an increase, or the possibility of an increase. Therefore the increase in premiums could have lost its momentum and several operators believe that a correction of premiums is upcoming.
The US import more aluminium from Russia than they do from China. There is still a lot of metal production capacity in China and this policy, for now, does not seem to be about to change. Where will this metal end up? Europe is the most obvious destination and in the sort term we could witness a weakening of the premium market. However, for now, there is talk about correction and not inversion of the trend, because the US aluminium market, which keeps on suffering from a supply deficit, will have to continue importing so long as, and if, its production will not be capable of supplying the best part of the nation’s demand.
It is important to note that the capacity in use in Canadian production plants, the main suppliers of the US, is close to 100% and, therefore, it will not be possible to increase it in a short while. In spite of various announcements made by American primary producers, such as Century and Magnitude 7, regarding their readiness to increase production, it is estimated that the necessary increase in production will take from one year to three years. The flows of primary metal may be slow in changing.
In the long run, it is likely that the negative impact of tariffs will be felt more strongly, both on premiums and on prices. The production of primary in the US should increase, the reliance on foreign markets decrease (one of Trump’s objectives) and, as a consequence, premiums in the US should decrease. The decrease in the American need to import primary metal will increase the flow of aluminium towards those regions where tariffs are absent or lower, such as Asia and Europe, increasing its availability. The increase in the offer will make fundamentals worse and might therefore have a depressive effect on the price listings of the London Metal Exchange. Finally, the tariffs could have negative effects on the European industry both on account of the increased difficulty in exporting towards the US, and because of the increase in trade flows towards Europe. However, even in the medium term, as recent indications from the financial markets go to show, fears of a commercial war between two giants such as the US and China could change the positive “mood” which so far characterised the global financial markets, including the metal exchange. Stock exchanges, indeed, reacted negatively to the possibility of commercial warfare on a global scale, since tariffs are seen as the straw which is breaking the camel’s back on financial markets which have already been cowed by the prospect of four increases in rates by the Federal Reserve this year. Trump’s decision to suspend tariffs on imports from Europe should be considered as partially good news. Tariffs would not only have paved the way for a commercial conflict, but they would also have had negative effects on the European industry on account of the greater difficulties in exporting to the US. Europe is not a frequent exporter of aluminium to the United States, therefore, regarding the dynamics of premiums, little would change. Europe however does export aluminium products and semis. Some sectors of the European industry could actually benefit from the tariff policy. For example, the United States every year import considerable amounts of aluminium sheets from China. Tariffs on Chinese imports could make European companies more competitive and therefore increase export flows towards the United States. The news item is “partially” good, because there is still the risk of an increase of commercial flows towards Europe from those countries whose products pay tariffs to enter the United States, such as China. The risk that the Chinese goods, which will no longer be exported to the United States, will be redirected towards the European markets is high. The situation is still evolving and, therefore, the real impact of tariffs on the market is uncertain. With the door open for other countries to ask for exemption, new turbulence linked to tariffs is feared. The United Arab Emirates, Bahrain, Qatar and Saudi Arabia are among the first exporters of aluminium in the United States and, currently, it is not possible to determine whether they will be exempted. Operators believe that an exemption for Arab countries would drive the Midwest premium down, considering that the United Arab Emirates by themselves accounted for 26.3% of all aluminium exports to the US in 2017. All of this causes uncertainty in a market which relies on primary aluminium imports to cover downstream demand. As a local American operator recently remarked, “the drama is not over yet”.

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