Tomato Soup for the Pipeline Soul? What a 25% Steel Tariff Would Mean for the Pipeline Industry

President Trump's proposed 25% tariff on steel imports may make certain pipeline development opportunities uneconomic. Commerce Secretary Ross believes the impact will be "broad but trivial," which he illustrated by explaining that a 25% rise in steel prices will cause only a 0.6 cent increase in the cost of a can of tomato soup. But pipelines are not tomato soup cans.

For pipeline developers and shippers, an unexpected increase in the materials cost, could make a previously approved project uneconomic. Similarly, a 25% overall increase in project materials will make some future projects not viable. To gauge the extent of the problem, we take a dive into our data to explain why shippers supporting new projects might be staring down a 3.2 cent/dth price increase for new projects, which equates to more than a one million dollar increase for that shipper with a 100,000 dth/day contract.

The steel tariff should come as little surprise to those who recall the administration's memorandum requiring the use of American-produced iron and steel in the construction and expansion of American pipelines. In the March 12 issue of S&P Global Platts Inside FERC, the pipeline industry expressed its displeasure with President Trump's 25% tariff on steel. Comments ranged from it "creates substantial uncertainty," and "threaten(s) US pipeline construction jobs," to a conclusion that the tariff could lead to a "possible transportation rate impact on most larger projects . . . somewhere in the range of 20 cents/Dth to 30 cents/Dth."

Actual Impacts

To understand why there is concern, our team analyzed pipeline expansion projects in our platform that have entered into service and have filed their post-construction cost reconciliation reports. These reports reveal two key facts about the materials cost of a project. First, the materials are not usually the most costly portion of the project; that award goes to labor costs, which is why there is legitimate concern about how the tariffs will impact jobs. However, the materials are a major portion of the costs for any project and average about 11% of a project's total costs. Second, while there can be fluctuation in the costs of projects, the materials costs are not as subject to variation as are labor costs.

Comparison of Material Costs Variability to Labor Costs Variability for Pipeline Projects

These two facts explain why a sudden increase in the materials costs is a concern for current projects that have not yet purchased the pipe needed for the project. Materials are a major factor in the overall cost of the project, but not one that has experienced substantial changes in the past. As a result, the developer may not have built in sufficient contingency for such a large increase in this line item. Therefore, before proceeding with the project, the developer may need to revisit its own final investment decision or renegotiate the precedent agreements with its shippers to share this cost increase. Either one of these events could: (1) delay the project's in-service date; and (2) when combined with the cost increase, even threaten a project's viability. 

To assess the impact on the rates to be charged and the return on equity for a new pipeline, we took the following example from a recent project filing and increased only the materials costs for the project by 25%. As the table below indicates, a 25% increase in the materials cost led to an 8% cost in the overall project cost. This led to a comparable 8% cost in the initial recourse rate for the project.

Example Project Costs:

If the project applicant is unable to pass this additional cost on to its shippers, either because of existing precedent agreements or because the market simply wouldn't bear such an increase, then this change in cost would lead to a $17 million annual shortfall in revenue and reduce the project sponsor's ROE from 14% to just under 13%. These changes show why the industry is concerned about delays in projects that have already been signed and which are moving forward but for which the pipe has not already been purchased. The industry is equally concerned for the viability of future projects which would be viable without an 8% increase in the total cost, but which would not be marketable after such an increase.

Customer Benefits of New Cost Data Analytics

In order to provide our project developer customers, such as originators, with the ability to make on-the-run calculations to quickly determine the cost to build a pipeline based on select criteria, we have amassed cost data for every gas pipeline project. Commercial analysts can then dive into the line-by-line information to build out cost models from the bottom up. Our customers will be able to respond more quickly to highly competitive deals, and thus increase their odds of winning, meanwhile saving countless analyst hours poring over documents.

The value extends to financial analysts, who can now have complete line of sight into expected costs, so project returns can be modeled, accurately, up front. And as the project progresses, typically over many years, costs begin to vary, sometimes widely, and our dynamic cost modeling will offer an up-to-date view into how costs are impacting returns.

The LawIQ platform contains aggregated and project specific total cost data and the variance between expected and final costs, but analytics such as dollars per inch mile, and consumable budgetary line item data, along with dynamic probability simulation cost models, are coming soon.