Will President Trump's Steel Tariffs Slow Permian Takeaway Capacity Buildout?

President Trump fully implemented his 25% tariff on foreign steel on June 1. This action was disappointing to the oil and gas industry as a whole and particularly to those companies in the business of building pipelines to move oil and gas around the country. In a recent Wall Street Journal article quoting LawIQ, the CEO of Plains All American Pipeline, L.P. (PAA), Greg Armstrong, was quoted as telling his investors the steel tariffs are unjust because "we shouldn't be penalized for basically buying foreign what we can't buy domestically."

As we reported in Tomato Soup for the Pipeline Soul? What a 25% Steel Tariff Would Mean for the Pipeline Industry, the problem with the tariffs is that they impact a portion of the project costs which are historically fairly predictable. The cost increases caused by the steel tariffs and the lack of clarity on their duration and applicable countries of origin creates uncertainties that could not only impact project costs, but also project timing and even ultimate viability. As stated by Mr. Armstrong, if these tariffs remain in place, they could very likely "delay and extend the growth ramp" for takeaway capacity in the Permian. Those interested in basin differentials, project revenue timing and project profitability should watch this issue to determine its impact.

Don't Punish Me

Four pipeline projects on the leading edge of this problem are PAA's Cactus II (a Permian crude line), Kinder Morgan's Gulf Coast Express (a Permian gas line), Williams' Northeast Supply Enhancement, and Shell's Falcon (a Marcellus/Utica ethane line). All four of these projects are seeking an exclusion from the steel tariffs with all essentially arguing - as Kinder Morgan does - that some or all of the pipe needed for their projects has no domestic source that meets "the strict product specifications and tight deadlines."

At last count, there have been over 12,000 requests filed for an exclusion from the 25% steel tariff and the Commerce Department has issued decisions on only 117 of the requests. More troubling for the applicants is that 75 of those 117 decisions were denials and all of the approvals were for requests that were unopposed. The history of the exclusion requests by these four companies is summarized below:

Buy American

Both PAA and Kinder Morgan claim the pipe they need for their projects is not available from domestic producers, but the domestic producers and their trade group have vehemently disagreed with those statements. In the objections filed by the American Line Pipe Producers Association (ALPPA) in response to these two requests, ALPPA asserted that there was ample supplies of the type and grade of steel pipe needed for these projects from domestic sources and that granting the requests would "encourage the use of unfairly traded imports of steel pipe in the United States, discouraging the use and growth of U.S. steel pipe production capacity and undermining U.S. national security." With respect to the Kinder request for Gulf Coast Express, Berg Steel Pipe stated that the decision to obtain the pipe from a Turkish steel mill "was based on price and price alone."

Given the strenuous objections from domestic suppliers, it seems likely that both the Kinder and PAA exclusion requests will be denied.

Will the Steel Tariff Delay Projects?

While PAA has stated the project can bear the costs of the tariffs, neither PAA nor Kinder Morgan have indicated whether their projects are moving forward with scheduled pipe deliveries while they await the exclusion decision. In PAA's application, it stated that the first delivery of pipe was scheduled to begin last month. It asserted that delays in the commencement of construction could delay the creation of 2,650 construction jobs. Similarly, Kinder Morgan claimed that its project was to begin construction in May of this year, with the first delivery of pipe scheduled for this month, and emphasized that "material delivery schedules are critical to successful pipeline construction."

PAA's CEO believes the steel tariffs could very well "delay and extend the growth ramp" of projects needed to solve the Permian takeaway constraints, which he said could benefit PAA because it is further along in the development process than the others. In its application for an exclusion, PAA concluded that such delays in the "Permian Basin infrastructure would perpetuate capacity constraints thereby diminishing the ability to bring additional barrels to market which help support the overall U.S. economy."

What is the Impact on Cost?

The exclusion application by Kinder Morgan indicates that its material costs may be as high as 50% of its total costs. Kinder says that the $1.75 billion pipeline will be built using $500 million of U.S.-manufactured steel, which would clearly not include the 47% of the pipe for which it seeks an exclusion. If only $350 million of the U.S. steel products constitute the 53% of the pipe being sourced domestically, then this suggests that the total material costs amount to nearly half of the $1.75 billion project. Therefore, it would not be surprising to find that Kinder Morgan or its shippers have at least hit the pause button while the Commerce Department considers its request.

According to PAA in its application, the process of putting together a major pipeline project is approximately five years from initial conception to the estimated completed construction date. The process is a complicated balancing of the rate the shippers are willing to pay versus the return on investment needed by the developer to proceed. For a project that has progressed past the initial customer contract phase, a sudden change in a major cost factor can require a complete reassessment of the shippers' and the developer's commitment to the project. The continuing commitment to the project will typically turn on the magnitude of the cost change, the cost sharing arrangements in the shipper contracts, and the willingness of the parties to bear such a cost change.

Our data shows that for FERC projects that have yet to begin construction and are at least 60 miles in length the range of material costs as a percentage of total costs varies from 8.58% to 39.30%. The projects with the higher material costs may be more exposed to just this sort of reassessment.

We believe that PAA's CEO is correct in his assertion that the uncertainty about the steel tariffs will work against many projects coming in on time. We are watching for additional filings at the Commerce Department seeking exclusion from the 25% steel tariffs to determine which projects are struggling with this issue.

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