After several decades of stable trade and diplomatic relations between two North American neighbors, the phantom of a trade war between Mexico and the U.S. is starting to show its ugly face. President Trump’s plans to build a wall between the two countries and to enact a 20% tax on Mexican imports to pay for it has driven the relations between the two countries to the lowest level seen this generation.
Most of the focus of the trade discussions these days has been on the $60 billion deficit the U.S. has with Mexico. But focusing on net figures obscures the vast amount of trade that takes place between the two countries. In 2015, the U.S exported more than 200 billion dollars of goods to its southern partner, which is the third largest destination of U.S. exports after Canada and the European Union.
Plastics are an important component of the U.S. exports to Mexico. In 2015 (the most recent year with total trade figures available), the U.S. exported 7.4 billion dollars or 3865 thousand tons of polymers into Mexico, about 3% of the total dollar amount of exports to the country.
Mexico has traditionally been a relief valve for the U.S. polymer industry. The free trade agreement and railroad connections between the countries, as well as the lack of investment in domestic production in Mexico, has resulted in a large amounts of exports of polymers form the U.S. into Mexico.
Soure: UN Comtrade Database, ChemPMC Estimates
Most producers have historically priced those exports at very competitive prices, in order to shed excess material and defend their domestic sales margins. For some polymers like polyethylene, exports have been priced at non-integrated cash cost levels, ensuring that the material leaves the U.S. market and keeps the domestic market tight and the domestic sales margins high.
The “wall/tax on imports” conversation is part of a much larger discussion, centered on the reform of the U.S. tax code. The Republican congress is considering a scheme known as “border adjustment”, as part of its program to update the country’s tax system. This scheme fundamentally reduces the incentives to import into the U.S., while making exporting products attractive.
As explained here, companies that export would receive a tax benefit, in the form of a top-line deduction of their export revenue. In addition, the scheme would present a larger tax bill to companies that import goods for consumption into the U.S., in the form of a bottom-line reduction of their allowable import costs. These two factors, considered independently of other factors, would in theory provide an incentive for polymer exports and for an increase in domestic consumption of polymers in the United States.
For example, the tax benefit for exporters could help offset the impact of similar countervailing duties enacted by trade partners, in this case Mexico. If Mexico were to impose a tariff or a border adjustment to imports of polymers into the country, U.S. producers could use their export tax benefit to reduce their prices and remain competitive in the Mexican market. The equation to establish export prices would get complicated, but it would still be feasible for producers to mark down prices to adjust and remain competitive.
On the other hand, companies that import finished plastic goods for consumption in the U.S. would be compelled to purchase those products inside the North American market, to be able to fully deduct their costs of sales. This, in turn, would likely increase domestic polymer sales, which as we have discussed in other posts are the main sources of income for U.S. based producers.
However, things may not be as simple as that. On one end, it is expected that the U.S. dollar could strengthen as a result of the border adjustment. The combination of a stronger dollar and countervailing duties by Mexico may force producers to further discount exports in order to remain competitive. This does not bode well for those companies that are currently starting or are about to start new polyethylene plants in the U.S. The prospect of global trade battles (or wars) between the U.S. and its trading partners was certainly not in the horizon when those export-oriented projects were being planned. The relative low cost of production of ethane-based polyethylene would provide enough cushion to resist, but export margins would definitively take a hit. Other polymers with strong ethane-based ethylene content may experience the same fate (PVC, polystyrene), that is, ability to export will remain in place but export margins would get compressed.
The other impact, which can be both a positive and a negative depending on how it is presented, is the decreased demand for polymers in the finished-goods export-oriented countries. As imports into the U.S. of say film get hit by higher taxes, there would be an incentive to source those products domestically. This presents a boom for domestic consumption (positive – higher margins) but a bust for export demand (negative – lower demand? Or positive – export margins lower than domestic margins?).
However, U.S. converters stand to lose as well; as you can see in the next table, the U.S. exports more finished plastic goods to Mexico (on a KT basis) than what we import. Incentivizing Mexican companies to consume Mexican products by means of tariffs or taxes could impact the U.S. converting industry as well. Again, the tax benefits for U.S. converters may be used to offset countervailing measures, but a combined strengthening of the dollar and countervailing duties may force converters to reduce export prices and margins to remain competitive, as explained before for raw material producers.
Soure: UN Comtrade Database, ChemPMC Estimates
The problem that the industry faces, particularly polyethylene producers, is that the timing of these measures is simply bad. The wave of ethylene and polyethylene projects planned for the U.S. is coming, regardless of whether or not border adjustment measures are enacted. If they are enacted, the market will have a hard time adjusting quickly to the new market conditions. This will indubitably result in some, if not a lot, of new material backing into the U.S. domestic market, presenting an alarming prospect for producers. The issue is that the domestic U.S. market, which has traditionally being isolated from global trends, is the main source of income for polymer producers. Any increase in domestic supplies that goes beyond the expected demand growth in the region, will increase the degree of competition and will likely have a negative impact on margins. This was already expected to be the case, without border adjustment measures. If enacted, those measures would only exacerbate the problems.
Finally, one aspect that nobody is touching on yet, is the impact on consumers. Because, ultimately, it will be consumers the ones that will pay. Adjustment measures increase domestic consumption, but also increase costs for consumers. What will happen when inflation (in prices and wages) starts showing its face? This is a discussion for other experts; that said, we as an industry must remain closely attuned with those experts and their expectations.
And Canada… Oh, Canada… Nothing has been said about Canada (yet), but watch out. Both U.S. and Canadian polymer markets are intimately linked to each other; anything that would disrupt that (say, for example, border adjustment measures against Canada) will definitively break havoc in both countries’ polymer industry.
Today marks a week since the new administration inauguration and our lives have become definitively more interesting in this period. Let’s keep tuned to see what the next weeks bring…
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Thank you for the well written and informative article. While it is a lot to process, it does give us some ‘much needed’ facts to consider with regards to how companies and consumers may be impacted.