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President Trump has accepted the recommendations from Commerce Secretary Wilbur Ross that steel and aluminum tariffs be implemented to prevent the dumping of foreign products at a discount. These cheaply sold products undercut the pricing of domestic (and other legitimately imported) steel and aluminum products.
Tariffs weaken markets, such as the market for finished steel and the appetite for scrap steel—a major base commodity for some finished steel. Tariffs drive prices down, and in the worst outcome can cause domestic steel mills to go out of business and jobs to be lost. Mainly, the tariffs are meant to target China, but the Department of Commerce memo announcing the findings recommended that 12 countries have top-tier (56%) tariffs on steel imports, and five countries have top-tier tariffs (23.6%) on aluminum imports.
This is about protecting American jobs and industry, and about keeping the U.S. steel industry profitable and fiscally sound. These are important and relevant decisions to be made and addressed properly. The imposition of tariffs raises many relevant questions such as:
- Is there additional U.S. capacity to replace the loss of tariff-impacted imported steel and aluminum?
- Will the impacted countries slap tariffs on other (non-steel) U.S. exports and industries?
- Will prices rise if the tariffs are implemented?
- What will happen to capacity and price if the infrastructure bill creates additional steel and aluminum demand?
- How many jobs stand to be added if the domestic steel and aluminum markets expand?
These questions (especially those regarding price) concern parties that lease, own, manufacture and operate railcars and locomotives. Virtually all railcars and much of their componentry are manufactured from steel. Any impact on steel pricing (positive or negative) is going to have an impact on railcar and locomotive prices. The railcar manufacturing business is in the tail end (hopefully) of a four-year cyclical downturn. The imposition of tariffs could cause an increase in the price of steel when builders and their customers are hoping for a surge in new car orders.
I asked Bob Pickel, Senior Vice President at National Steel Car, a railcar manufacturer based in Canada, what will happen if the tariffs are implemented. He told me, “Our expectation would be that prices will increase if the tariffs are put in place. The price impact will be driven by how much global steel is shipped by countries against which the tariff is being implemented. One potential offset might be that auto demand may decrease, and that might have a chance to hold [railcar] prices in check.”
One driver for steel and new railcar prices would be scrap steel prices in a post-tariff world. The Commerce Department notes that they would like to see the steel industry running at 80% capacity vs. today’s 73%. Industry sources told me that the last time capacity operated near those levels was right before the 2008 Great Recession. Current (February 2018) scrap prices are roughly $290 per ton for Chicago #1 Heavy Melt. In 2008, that price was between $550 and $600 per ton, almost twice today’s prices. That means an older railcar scrapping today for $8,000 would have fetched more than $13,000 ten years ago.
Sources also indicate that getting to $500 per ton for scrap steel might be an extreme scenario, but that a move from today’s prices to $425 per scrap ton could increase new car prices by as much as $3,000, as steel and scrap steel surcharges are priced into the cost of the steel and the componentry in those railcars. If the increase in the cost of materials and surcharges is combined with an increase in demand, the market could find that the price of new cars has rebounded, and prices will quickly begin to revert to levels not seen since 2014-2015.
Price increases due to increasing raw material or scrap surcharge prices are a direct pass-through to the customer purchasing the railcars. How will customers respond when the increases begin? One could expect that they will demand an already beleaguered manufacturing group to reduce their prices as steel costs increase. Any additional decreases would come out of the manufacturer’s margins—especially once price increases begin to set in. It creates a poor dynamic in the market.
For those buyers looking to buy new railcars, insult to injury may really begin when demand for new railcars increases and prices rise as a result of steel price and margin increases. Ouch, and ouch again.