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Market Dynamics for Large Diameter Line Pipe in the U.S.

Prehearing Brief from Harry Vidas, ICF Inc. Investigation Nos. 701-TA-593-596 and 731-TA-1401-1406

November 6, 2018

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Introduction to ICF and Information Sources

• I, Harry Vidas, am a Vice President in ICF's energy practice and haven been working on matters related to oil and gas markets and infrastructure since 1979.

• ICF is consulting company working in energy and several other areas. We are a leading authority on North American energy infrastructure, having performed multiple nationally recognized infrastructure reports.

▪ We recently prepared a report for the Interstate Natural Gas Association of America (INGAA) entitled, "North America Midstream Infrastructure through 2035 - Significant Development Continues."

. The analysis presented in my prehearing brief is based on ICF's Midstream Infrastructure Report (MIR) that provides insights into oil and gas market dynamics and how they will impact the evolution of midstream infrastructure development needs in North America.

. Another source of information for my prehearing brief is the report "Feasibility and Impacts of Domestic Content Requirements for U.S. Oil and Gas Pipelines," May 16, 2017, prepared by ICF at the request of the American Petroleum Institute, Interstate Natural Gas Association of America, Association of Oil Pipe Lines, American Gas Association, and GPA Midstream Association.

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Main Conclusions Regarding Market Dynamics for Large Diameter Line Pipe in the U.S.

• The market for line pipe is distinct from the market from structural pipe in many ways.

• Demand for line pipe is driven by oil and gas drilling and production activity, which in turn is chiefly influenced by oil and gas prices more than general economic activity.

• Another important influence for the demand for line pipe is upstream technology advances and the emergence of new oil and gas plays that require new pipelines to bring new or larger hydrocarbon production sources to market.

• Because of the ongoing development of new plays (primarily the Permian Basin tight oil and Marcellus/Utica gas shale plays) with growing production, the U.S. market for line pipe is expected to remain robust for the next three years and longer.

- There are important distinctions among different kinds of line pipe related to the dimensions and quality of hot rolled coil and plate used as the inputs and the manufacturing and QA/QC processes they require. This means that there are submarkets where competition and market dynamics are dissimilar.

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Main Conclusions Regarding Market Dynamics for Large Diameter Line Pipe in the U.S.

• Many pipeline companies request line pipe with specifications that go beyond API 5L standards

• Particularly for large diameter line pipe and large (many miles long) projects.

• The "above 5L" standards include the quality of the product itself and the testing protocols to ensure that quality.

• This move to greater quality and more rigorous testing standards is driven by concerns for ensuring long-term pipeline integrity to comply with stricter PHMSA regulations for testing and repair and to address public concerns regarding pipeline safety.

• Because of differences in the required manufacturing and QA/QC processes for different kinds of line pipe and the API 5L standards, manufacturing capacity for large diameter line pipe and structural steel pipe is not fungible.

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Analysis of Line Pipe Price Dynamics

• I analyzed the historical sales volumes (market size) and unit value data from the Staff Report and other sources to determine: • Portion of unit value made up of steel plate/coil raw material cost

• Affect of sales volumes on unit value excluding raw material costs

• Affect of import market share on unit value excluding raw material costs

• Conclusions of this analysis • Raw material cost are highly correlated to unit values and average 68% of unit values in the relevant

period (2015 to first half of 2018)

• The size of the overall market (that is, the level of demand for LDWP) has a very significant impact on unit value excluding raw m-costs also goes up.

len demand goes up, unit value excluding raw material

• On the other hand, import market share does not have a significant impact on unit value excluding raw material costs. To the extent one can see a relationship it is in the "wrong direction" from the point of the petitioners. Higher import levels, in fact, occur when unit value excluding raw material costs also goes up. This patterns occurs as imports "fill in the gap" when demand is high and retreat when demand is lower.

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Analysis of Line Pipe Price vs. Cost Components

• Raw material costs make up 68% of average unit value for domestic line pipe manufacturers

• Among cost components, it is the most highly correlated to unit value (correlation coefficient = 0.911)

Average $/s.t.

2015 to 2018H1

Average 2015 to

2018H1 as % of

Unit Value

Correlation to Unit

Value

Cost of Raw materials $775 68% 0.911 Direct labor $109 10% 0.627

Other factory costs $127 11% 0.778

SG&A expense $81 7% 0.642

Interest expense $18 2% (0.549)

Unit Value $1,133 100% 1.000

Sources: Staff Report October 25, 2018: Table VI-1 LDWP: Results of operations of U.S. producers,

2015-17, January to June 2017, and January to June 2018,

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LDWP: Unit Value Excluding Raw Materials

vs. Apparent Consumption

$400

$350

$300

$250

$200

• • y = 0.0001x - 14.906 R2 = 0.9881

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2,000,000 2,200,000 2,400,000 2,600,000 2,800,000 3,000,000 3,200,000 3,400,000

Apparent Consumption (short tons)

• Avr. Unit Value Excluding Raw Materials ($/s.t.)

Linear (Avr. Unit Value Excluding Raw Materials ($/s.t.))

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Statistical Relationship between Line Pipe Price (exc. raw materials) and Level of Demand • In the 2015 to

2018H1 period, changes in the level of demand explained a very large portion of the change in the unit value excluding raw material costs.

• The statistical relationship revealed through regression analysis is very strong (R2 = 0.9881).

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LDWP: Unit Value Excluding Raw Materials

vs. Market Share of Imports

•

y = 1.574x + 206.83 112 = 0.0313

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• •

25 30 35 40 45 50 55

Import Market Share (%)

• Ayr. Unit Value Excluding Raw Materials ($/s.t.)

Linear (Ayr. Unit Value Excluding Raw Materials ($/s.t.))

Ave

rage

Uni

t V

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Raw

Mate

ria

ls (

$/s

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$360

$340

$320

$300

$280

$260

$240

$220

$200

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Statistical Relationship between Line Pipe Price (exc. raw materials) and Import Market Share • The statistical relationship

between market share of imports and unit value excluding raw material costs as revealed through regression analysis is poor (R2 = 0.0313).

- The relationship is in the "wrong direction" from the point of the petitioners. Higher import levels occur when unit value excluding raw material costs are high.

• This pattern indicates that imports tend to "fill in the gap" when demand is high.

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Appendix: Data for Regression Model Slides

ALL LDWP 2015 2016 2017 2018

(annualized) Apparent Consumption (s.t.) 3,133,643 2,271,947 2,337,583 2,240,608 US Market Share (%) 56.9 67.0 54.6 56.9 US Unit Value ($/s.t.) $1,194 $1,053 $1,074 $1,061 Import Market Share (%) 43.1 33.0 45.4 43.1 Import Unit Value ($/s.t.) $1,080 $922 $859 $1,046 Sum Market Shares (`)/0) 100.0 100.0 100.0 100.0 Average Unit Value ($/s.t.) $1,145 $1,010 $976 $1,055 Raw materials ($/s.t.) $799 $758 $730 $811 Avr. Unit Value Excluding Raw Materials ($/s.t.) $345 $251 $246 $244

Sources: Staff Report October 25, 2018: Table C-1 LDWP: Summary data concerning the U.S. market, 2015-17, January to June 2017, and January to June 2018 and Table VI-1 LDWP: Results of operations of U.S. producers, 2015-17, January to June 2017, and January to June 2018,

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Harry Vidas Vice President ICF, Energy Practice 703-218-2745 Harry.Vidas@ICF.com