Last week, President Trump vowed to impose a 25% tariff on steel imports in a bid to protect the U.S. steel industry. However, in favoring that group, he's potentially harming the country's energy industry, with the pipeline sector among the hardest-hit. The tariff could add $76 million to the typical pipeline project and over $300 million to a larger one like TransCanada's (NYSE:TRP) Keystone XL. That added cost could force companies like TransCanada to rethink their expansion plans.
Still on life support
In one of his first acts as president, Donald Trump approved the construction of TransCanada's Keystone XL pipeline early last year, reversing his predecessor's decision to block the pipeline. That allowed TransCanada to restart the mothballed project. However, the project was far from shovel-ready: The Canadian pipeline giant had to start much of the work from scratch due to the long delay.
First, the company had to revise its cost estimate, which ultimately came in at $8 billion, up from an initial $6.1 billion estimate. Next, it had to see if there was still enough industry interest in the project at the higher shipping rate needed to offset the increased cost. That process took several months, but TransCanada secured long-term contracts for 500,000 barrels per day of the project's proposed 830,000-barrel-a-day capacity, which was enough to make it economically viable. The company still needs to obtain the necessary rights of way and permits before it can begin construction, which won't start until next year at the earliest. However, with the potential of steel tariffs adding $300 million to the cost of a project that already experienced a huge price increase and didn't quite fill its proposed capacity, it's possible that TransCanada could decide not to move forward with Keystone XL.
Protecting one at the expense of others
One of the issues pipeline companies face in sourcing pipe for their projects is that domestic steel companies don't make the types they need. Many U.S. steel companies stopped making pipe products because it's a smaller market than automotive, for example, and has higher costs and therefore lower margins. So pipeline companies need to import foreign-made pipes to build their projects. While the tariffs could create an incentive for U.S. steel producers to invest in new pipe plants, that will take time, and likely won't yield a price break for pipeline companies.
It's not just pipeline companies that will face higher costs; the U.S. energy industry relies on imported steel for drilling equipment, liquefied natural gas terminals, and refineries. Therefore, they view the tariff plan as being "inconsistent with the administration's goal of continuing the energy renaissance and building world-class infrastructure," according to Jack Gerard, president of the American Petroleum Institute, the oil and gas industry's trade association.
The proposed tariff is causing companies to rethink their investment plans. Case in point: ExxonMobil (NYSE:XOM), which has pledged to invest $50 billion in the U.S. One investment Exxon has explored is the expansion of its Beaumont refinery in Texas, possibly adding a third unit at that plant that could transform it into the country's largest refinery. But given the added cost of steel, Exxon might choose not to move forward with that project if it can't find a way to bypass the tariffs. The higher cost of pipes, both in drilling wells and moving production, could impact the investment plans of Exxon and other producers, potentially resulting in them investing less money into their U.S. operations in the coming years.
Higher costs might mean lower dividend growth for energy stocks
A 25% increase in pipe costs could have a dramatic impact on the U.S. energy industry. Pipeline companies might choose not to move forward with projects if they can't pass the added expense on to shippers or they might need to absorb some of it, resulting in lower investment returns. As a result, companies like TransCanada, which is investing $7.5 billion to expand its U.S. pipeline business and potentially another $8 billion on Keystone XL, might not be able to raise its dividend as fast as expected in the coming years.