Tariff turmoil: The ever-changing playbook

USMCA rules of origin now under the microscope

It is particularly important to pay attention to the March 6 White House statement about the suspension of duties. Goods must satisfy USMCA rules of origin.

The rules of origin rules are primarily directed towards automotive products, chemicals, steel-intensive products, textiles, and apparel plus other manufactured goods subject to declaration. These rules were embedded in USMCA because of pressure from US trade unions, who made this a condition of their support for the adoption of USMCA as a successor to NAFTA.

There are 4 different qualification tests to determine if good can come in duty-free:

1. Materials from North America, such as American lumber, Mexican produce, or Canadian mineral ores.
2. Products manufactured from originating materials in North America.
3. Products manufactured from non-originating materials that undergo “substantial transformation” in North America.
4. Products assembled in North America without substantial transformation but meeting a product-specific regional content/costs requirement. Automotive manufacturers and suppliers face additional regional content requirements for passenger vehicles, light trucks, and heavy trucks. As of 2024, a vehicle must contain at least 75% regional content to qualify.

Since USMCA came into effect July 1, 2020, enforcement of the rules of origin has been inconsistent. The covid-19 pandemic effectively meant no enforcement took place in 2020 and 2021. Once covid-19 passed, there have been statements made that stepped-up enforcement would commence. It is questionable whether the automotive sector or any other sectors have been subject to serious scrutiny.

In President Trump’s February 10 Executive Order on a revision to Section 232, paragraph 8 alluded specifically to this: “I understand that Mexican producers are comingling aluminum from China and the Russian Federation with primary aluminum from other countries to produce downstream aluminum products”. Paragraph 10 stated that “Chinese producers are using Mexico’s general exclusion from tariff to funnel Chinese aluminum to the United States through Mexico while avoiding the tariff.”

These assertions Do seem to run counter to the qualification test 3 which provides for substantial transformation. We know of specific examples where Chinese sheet/plate is being used in Mexico to produce a completely transformed, different product entering the U.S. under a different HTS code. (Harmonized Tariff Schedule).

What is the solution for Mexico to forestall the April duty implementation?

The Execution Order takes a clear shot at Mexican tariff structure, which presently has no import duty on primary aluminum, but does impose 25-35% duties on aluminum sheet, plate, and extrusions. The question is, how well are these duties being enforced?

Mexico does itself no favors by still refusing to publish detailed trade statistics on aluminum and other products. This lack of transparency fuels the suspicion that Chinese and Russian aluminum continues to flow into Mexico with impunity.

Mexico has bought itself another month to address these assertions. At the very least, Mexico needs to start publishing its import trade statistics to demonstrate what is or is not flowing into the country and indirectly to the U.S.

The bigger burden of proof now falls on U.S. OEM operating in Mexico under the IMMEX (maquiladora) program. These companies will have to step up their traceability of raw materials to comply with the rules or origin. While the test of “substantial transformation” would seem to allow non- North American origin aluminum to still be used, reality says the aim here by the Trump Administration is to slam the door on Chinese and Russian imports.

This should foster a major rotation of sourcing to U.S. sheet mills, extruders, and other semi-fabricated suppliers. It should also boost sales for the U.S. primary producers.

What is the solution for Canada to forestall April duty implementation?

On paper, the rules of origin stipulation should be good for Canada, as a signatory partner to USMCA. Canada primary aluminum should be a big winner in Mexico, displacing imports from China, Russia, and the Middle East. The problem is that the Trump Administration still has a problem with Canada and may not allow Canadian origin metal to qualify under USMCA. In essence, he may tear up the USMCA agreement.

Overnight, Trump threatened massive reciprocal duties on the Canadian dairy interest and keeps taking shots at Canadian softwood. It is far from clear what is the ultimate “ask” of Canada to maintain duty free status under the USMCA.

The reality is that Canadian aluminum is crucial to supplying the U.S. downstream market. Primary aluminum from Canada is as critical as crude oil and potash, which have qualified for reduced duty treatment. I expect Canadian aluminum to eventually earn the 10% duty as a critical mineral.

Imposing country of origin duties plus the upwardly revised Section 232 duties would create an untenable value of Midwest P1020. Modeling the extreme outcome of 25% of the country of origin plus 25% Section 232 duties could put Midwest physical premiums as high as $0.65 per pound. No, that is not a typo…$0.65 per pound.

Primary aluminum supply chains would rotate from importing Canadian aluminum to importing it from India, the MiddleEast or other very distance origins. That is worrisome for manufacturers.

Premiums at this level would blow a hole in domestic aluminum downstream competitiveness. …and at the same time, not do anything to solve the structural problem with domestic primary production. That is still a power problem.

How does Canada escape this nightmare?

Canada has demonstrated in the past a willingness to align its import tariff structure on aluminum to those of the U.S. That must happen.

At the same time, it may need to acquiesce to reciprocal tariffs on these other products such as dairy to appease Trump.

Canada exports a fair amount of electricity to the U.S. Northeast; Trump may be looking for a good deal on bloc power pricing and “might” use that as leverage to help struggling domestic producers find domestic power at a decent price.

Finally, I think the Trump Administration is looking for a grand deal that supplies other critical minerals to the U.S. at fair prices. Given the fact that these minerals are privatized in Canada, the cynics amongst you will say “good luck with that one. However, we must bear in mind that these tariff battles are as much about symbolism as solid economics. This Administration wants to demonstrate it is in control and any deal is a deal worth reporting and hyping.

Stay tuned for next week’s update. I am sure it will change.