HVAC Industry Steels Itself for a 2020 with Tariffs
'Phase One' deal would not affect metal imports; most contractors have dodged fallout so far
“They’re having their worst year in more than 57 years, more than half a century. Their supply chains are cracking very badly, and they are dying to make a deal. We’re the ones that are deciding whether or not we want to make a deal. We’re close.”
President Donald J. Trump gave that assessment of China on November 12, in remarks to the Economic Club of New York about the ongoing U.S./China trade war.
Since the president announced the first of these tariffs in January 2018, the economic conflict has escalated steadily. China has consistently retaliated with its own tariffs.
While a recent "Phase One" agreement between the two governments did not address any of the underlying issues reportedly at the crux of the conflict, it did cancel "penalty tariffs" scheduled for December 15 and rolled back more recently applied tariffs on selected products. However, the agreement -- announced but unsigned as of December 15 -- does not appear to affect the 25% tariffs applied to Chinese steel and aluminum early in the conflict.
For the HVAC industry, the trade war’s effect depends on which part of the industry is being asked. However, three statements earn broad agreement:
- On the whole, the industry views the tariffs as bad for business and would like to see them disappear.
- The added cost of the steel and aluminum tariffs most relevant to HVAC pricing is being passed on to the consumer.
- American consumers, over the last several months, do not seem to be feeling this impact in a way that affects their purchasing decisions.
Customers are absorbing the brunt of these tariffs. Why isn’t their displeasure more noticeable?
After all, ACCA’s member survey last spring revealed that its members were already experiencing 10 to 20 percent increases in equipment pricing, and those hikes were passed to the consumer. Air Conditioning Heating & Refrigeration Institute’s (AHRI) member survey indicated that 70 percent of its manufacturers have been affected by the pertinent tariffs, according to the association’s vice president of international affairs, James Walters.
And yet ACCA’s own vice president for public policy and industry relations, Todd Washam, notes that “the market for our contractors did not seem to slow.”
A steady demand for contractors does not rule out a consumer tendency to postpone replacement in favor of short-term repair, as can happen in harder economic times. From the manufacturer side, though, Walters did not feel that that was happening, either. While he emphasized this wasn’t a matter of any specific hard data, Walters reported that “we’re not getting an avalanche of concerns from the contractors’ side.”
Similarly, Washam’s assessment that “there seemed to be enough money in consumers’ pockets that they could weather that pricing increase” has remained intact in the months since ACCA’s survey.
One other factor may be providing the HVAC industry with some inherent insulation from tariffs’ more chilling effects: the infrequent nature of purchasing heating and/or air conditioning systems.
Consider how different the landscape is in a business like hardware. On November 22, Ace Hardware CEO John Venhuizen told CNBC that the trade war is more of a “nuisance,” but also that Ace has “told our suppliers we’re not accepting price changes.” According to Venhuizen, the company’s goal is to keep any tariff-related price increases from reaching the consumer. That suggests a meaningful effect on buying habits if tariffs were passed on.
One difference, of course, is that people who buy hardware are making many purchases a year — replacing or upgrading some tools, often buying some supplies over and over. They develop a general awareness of what things cost, they can easily shop around, and they can put off certain projects or purchases altogether.
On the other hand, a typical homeowner with a failed furnace may have no sense of HVAC equipment cost trends over months or even a couple of years. Tariffs may make a new heating system 14 percent more expensive today than it was in 2017. That still might not affect the way a potential customer looks at pricing if they haven’t bought a unit since 2003. People in that situation know that the fix is relatively expensive but rare.
Walters agreed there may be something to HVAC enjoying an almost psychological buffer from buyer pushback, thanks to dealing in a product type that is used daily but is very rarely purchased.
NOT JUST FOR ‘ACTS OF GOD’ ANYMORE
While that may help contractors on the residential side, Washam noted that no such luck exists for contractors who work more extensively in commercial HVAC — or for their clients.
Commercial work often means more lead time and more of a delay between a successful bid and the work itself. That increases the chances for an interim price hike due to tariff-induced increases in the cost of steel and other materials. The resulting spike in project cost can make for a displeased customer and an uncomfortable conversation.
With no relief from steel or aluminum tariffs visible in the near future, this may be a good time for a quick review of force majeure as something contractors’ contracts should include.
“Force majeure events typically include acts of God, strikes, war or other hostilities, acts of the government or other third parties, and other similar events that are not caused by either [contractor or customer] party,” explains an eight-page bulletin issued by the Mechanical Contractors Association of America (MCAA). The publication is titled “Recovery of Material Escalation Costs Arising From Steel and Aluminum Tariffs.”
The concept protects a contractor from losses associated with price increases that are not the result of natural market dynamics.
Force majeure commonly comes up in relation to natural disasters, but it can represent some protection if the clause is included in a contract before a given tariff. As the bulletin points out, if the problem is an existing tariff, then the best solutions may be pricing the tariff in originally and/or creating windows of pricing with some shared burden in the case of unexpected costs.
Companies have booked plenty of business since last year’s tariffs, of course, but a boost in an existing tariff (or the possibility of one) represents a reason to keep the concept in mind.
CLOSER TO HOME
China isn’t the only international trade and tariff hotspot with HVAC relevance these days. The United States– Mexico–Canada Agreement has been signed by all three countries, but only Mexico has ratified it so far.
In a development that surprised many by coming amid impeachment proceedings, the President Trump and House Democrats announced an agreement on a revised version of USMCA in early December. House Speaker Pelosi touted the terms as an improvement for workers compared to earlier NAFTA terms, and the president also promoted the deal as a positive.
Internal political drama aside, traveling the last mile on USMCA particulars is so difficult in part because both parties feel that any USMCA deal will serve as a template for components of other trade deals waiting in the wings.
Some of those trade efforts will involve China, where the need to update intellectual property protections has long been cited as part of the rationale for the current U.S. tariffs. The likely domino effect of deals and details is how these issues converge. Washam said that in ACCA’s assessment, “we’re talking about trade deals because the tariffs are the hammer, or the stick, to bring people to the table to work with [the U.S.] on trade deals.”
Washam reported that in a recent meeting with ACCA, Vice President Mike Pence affirmed the administration’s view that the USMCA’s terms are critical for the precedent they will set, if and when ratified. Washam sees the administration as optimistic about prospects on the trade front in general, pointing to the way “the president is certainly putting a lot of his time, energy, and political capital into those efforts.”
ACCA remains hopeful regarding free trade agreements like USMCA. The House could vote on the proposed USMCA revision by December 18. Should that version pass the House, the Senate would then be free to take it up for consideration.
As 2019 draws toward a close, AHRI intends to “continue both individually and via coalitions and direct contacts to oppose the tariffs and urge their withdrawal,” said Walters.
ACCA continues with its own efforts, including coalition letters and highlighting price increases that its members have experienced whenever the topic of tariffs arises in discussions with members of Congress.
As his recent speech in New York illustrated, President Trump characterized the U.S. as having the leverage over China as it waits for the most favorable terms.
It is true that “there is pain in the industrial sector of China’s economy,” wrote ITR Economics president Alan Beaulieu in an October 24 blog entry on ITR’s website (“The China Trade War”). That country’s economic engine has dropped to its slowest growth rate in over two decades, wrote Beaulieu.
However, with an election year looming and his own political fortunes in some turmoil, President Trump may feel pressure to deliver more good international trade news to American voters. A more comprehensive rollback on the tariff spiral he started could provide relief to the manufacturing sector, along with a little extra in the wallets of homeowners who would appreciate it even if they didn’t necessarily notice the difference in the first place. Yet overcoming this impasse may prove difficult.
“China appears perfectly willing to continue experiencing pain,” ITR’s Beaulieu assessed, “if it helps them with the long game.”
Exclusion! Objection! HVAC Manufacturers in the Age of Tariffs
Jim Walters, AHRI vice president of international affairs, knows some things about how manufacturers try to thrive and survive in challenging trade conditions.
One maneuver companies can use in the face of unattractive tariffs: apply for an exclusion. And as it happens, that occurs a lot.
Citing an unofficial statistic that a Congressional source provided, Walter relayed that requests for exclusions since the beginning of the whole event (early 2018) for steel have totalled 190,000, and 32,000-plus for aluminum.
In that arena, manufacturers are not playing on an even playing field. Success on this front varies and depends, to some degree, “on the amount of staff they can devote to it.” Not even larger companies have staff sitting around waiting to fill out tariff exclusion paperwork, and smaller manufacturers may not have the staffing flexibility or the legal budget to pursue exclusions that would help them.
The exclusion application process, Walters said, is quite tedious. Once an application is finally submitted, the wait for a decision can be equally lengthy, if not more so. Looking at the latest data during his conversation with The ACHR NEWS, Walters searched for the longest time pending with no decision for an exclusion application. It was 556 days — in other words, nearly the entire duration of the trade war.
For the sake of argument, envision a company that has waded through the fine print of tariffs and tariff codes, navigated the application process, and waited for a response. Finally, the company receives the happy news that its exclusion has been granted … except for one thing. Walters delivers the kicker.
“Other companies can oppose the exclusion requests.”
That’s right — the exclusion process is not just about a manufacturer and the government. Competitors can also enter the fray. Walters points to a figure of 69,000 decisions posted one way or another on exclusion attempts. Of the approvals in that batch, there were 48,000 objections.
Walters did not offer a net result in how many exclusion applications made it through in the end. In a way, that hardly seems important in view of the administrative hours, headaches, and time lost to the process for those thousands of applications (and objections).
The reader may be further astounded to learn that, according to Walters, the consensus is that the exclusion process is the simplest workaround option for manufacturers.
Tariffs can create serious supply chain problems — to the point, Walters said, where a manufacturer can start asking, “OK, how can we make this so we’re not paying the tariff?”
Labyrinthine paperwork can start to look pretty straightforward compared to answering that question.
If a company’s supply chain has some links in China, they may look at trying to move that part of the sequence to Thailand or Vietnam.
“That’s not easy because, as you know, the ability to produce these products at (an acceptable) quality level is not intuitive,” he said. “If you have to set it up, you have to find the right talent, you have to find the right labor, the right machinery. I mean, it’s an extremely expensive and difficult process.”
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