Morningstar Magazine - June/July 2017 - 26

Dispatches

Given the wide-ranging list of criteria regarding
the conditions that represent a threat to
national security, it is difficult to surmise how the
Commerce Department's findings will be
manifested in the form of policy. Furthermore,
considerable uncertainty exists as to how any such
policy might be translated quantitatively in
the form of tariffs. One possibility would involve
a blanket tariff against all imports. We are
skeptical that any such tariff would be sizable
enough to materially alter our long-term
industry outlook.
If a significant blanket tariff were to be enforced,
it could bolster steel prices and increase costs for
industries that consume large amounts of
steel, such as automotive manufacturing. We'd
probably see pushback from affected trade groups.
Steel purchasers would likely argue that the
cure is worse than the cold given the broader
economic implications. Steelmakers would be able
to capture economic rent from those further
downstream the supply chain, and we'd reassess
our industry outlook accordingly. However,
under our base case, our long-term outlook is
unchanged; we don't view a significant change
to the status quo as likely.
Trump's memo reflects the view that, even after
a barrage of steel trade cases, the Commerce
Department has been ineffective in leveling the
playing field for U.S. steelmakers. But
purchasers will always have the choice to buy from
U.S. steel mills or from producers abroad. Trade
protectionism simply factors into the spread
that will be sustained between U.S. steel prices
and world export prices.
U.S. mills would certainly prefer that purchasers
behave in a more "patriotic" manner (as CEO Mark

Millett put it during the Steel Dynamics STLD April
20 earnings call) by eschewing imports. But it is
unrealistic to expect steel buyers to sacrifice
margin in the name of buying American unless
stringent legislation compels them to do so.
Share prices for U.S. steel supply chain operators
had fallen in the weeks before Trump's directive.
Some have fallen again since, but we continue to
see considerable downside ahead under our
base case. The spread between U.S. prices for
hot-rolled coil and world export prices has
expanded rapidly as U.S. prices have remained
elevated amid a decline in world export prices.
Although a wider spread is partly justified by more
stringent import tariffs, this phenomenon has
historically led to rising import volume.
Bulls contend that this time is different, as higher
imports will be stymied by the bevy of steel
trade cases that have been levied in recent years.
We're skeptical. Even though trade cases targeting
key exporters across a variety of high-volume
product types have led to increased duties, imports
still account for roughly a fourth of total steel
consumption in the United States. Although this is
down from consistent 30%-plus levels in recent
years, the impact has been more modest than
many market participants would have predicted.
Additionally, trade cases can sometimes lead to
counterproductive results. First, weak duties
(typically 10% or lower as a general rule) resulting
from trade cases often have little impact on
import volume. At times, they can even inspire
sharply higher import volume by essentially giving
the green light to high-volume exporters.
When highly punitive duties are levied against a
targeted country, it isn't uncommon for other
countries to capture some or all of the forgone

tonnage. We saw this dynamic play out at the end
of 2015 when cold-rolled coil from China was
eliminated from the U.S. market but volume from
Vietnam and Turkey (which had previously
been minimal) entered the market en masse and
captured nearly all of the tonnage forgone by
China. This whack-a-mole phenomenon would be
rendered irrelevant if the investigation stemming
from the April 20 memo leads to a blanket
tariff against steel imports from all countries.
Although global steel prices far exceeded our
expectations in 2016, we contend that they were
driven in large part by elevated Chinese fixed-asset
investment stemming from stimulus measures.
Bulls have been quick to argue that higher Chinese
steel consumption and higher steel prices
represent a sustainable improvement to market
fundamentals. Bulls also contend that China's
promises to address rampant, persistent
overcapacity will take hold sooner rather than later.
We don't buy into either argument. Instead, we
view the rally as a stimulus-driven head fake along
the path of a more substantial downtrend.
Rhetoric from the Trump administration has
captured news flow regarding the attractiveness of
investing in U.S. steel supply chain operators. But
long-term investors should remain focused on
fundamentals. With Chinese steel prices and the
benefits of Chinese stimulus measures on the
wane, we expect steel, iron ore, metallurgical coal,
and ferrous scrap prices to decline. We think 2017
will be a cyclical peak for U.S. steel industry profits
as the benefits of trade protectionism are
overshadowed by a resumption of the hangover
from China's commodity supercycle.
Trump's memo follows a March 31 executive
order to enhance the collection and enforcement

TRENDS

Q4
2009
26

Q1
2010

Q2
2010

Q3
2010

Q4
2010

Q1
2011

Q2
2011

Q3
2011

Q4
2011

Q1
2012



Table of Contents for the Digital Edition of Morningstar Magazine - June/July 2017

Contents
Morningstar Magazine - June/July 2017 - Cover1
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Morningstar Magazine - June/July 2017 - 1
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Morningstar Magazine - June/July 2017 - Contents
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