Tenaris SA

MIL:TEN

Earnings Call Transcript 2018-Q3

[Operator]

Good day, ladies and gentlemen, and welcome to the Third Quarter 2018 Tenaris Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Giovanni Sardagna, Investor Relations Officer of Tenaris. You may begin.

[Giovanni Sardagna, executive]

Thank you, Carmen, and welcome to Tenaris 2018 Third Quarter Results Conference Call.

Before we start, I would like to remind you that we will be discussing forward-looking information and that our actual results may vary from those expressed or implied during this call.

With me on the call today are Paolo Rocca, our Chairman and CEO, Edgardo Carlos, our Chief Financial Officer; Guillermo Vogel, Vice Chairman and member of our Board of Directors; Germán Curá, Vice Chairman and member of our Board of Directors; Gabriel Podskubka, President of our Eastern Hemisphere Operations; and Luca Zanotti, President of our U.S. Operations.

Before passing over the call to Paolo for his opening remarks, I would like to briefly comment our results.

Our third quarter sales at $1.9 billion were up 46% compared to last year and 6% sequentially mainly reflecting an increase in average selling prices and higher sales of line pipe for complex projects including shipments for the second Zohr offshore welded pipeline in Egypt.

Our quarterly EBITDA at $394 million was up 8% sequentially and our EBITDA margin was close to 21%. Average selling prices were up 11% compared to the corresponding quarter of last year and 4% sequentially. The increase was mainly in North America where prices have reason to compensate higher cost including tariffs.

During the quarter, our cash flow from operations was $50 million and was affected by an increase in working capital. Inventory rose as we prepare to the final Zohr shipment and the Canadian winter rainy season as well as higher raw material costs and the impact of Section 232 duties. While the receivables were affected by higher sales and payment delays by some customers. Our net cash position declined slightly to $408 million after capital expenditure of $78 million during the quarter.

The Board of Directors approved the payment of an interim dividend, the same as last year of $0.13 per share or $0.26 per ADR to be paid November 21.

Now I will ask Paolo to say a few words before we open the call to questions.

[Paolo Rocca, executive]

Thank you, Giovanni and good morning to all of you. This was a good set of results in a quarter, which seasonally is not one of our strongest because of summer shutdown in Europe. It all goes so well for the next one. I will highlight that we were able to adjust pricing in a very competitive market sufficiently to offset cost increase. Including those of the Section 232 tariff in the United States and maintaining margin levels.

In addition, we were able to anticipate some shipments for the Zohr Project. This and other efforts, we were able to show a promising sequential improvement in net sales, in EBITDA, in operating and net income.

We are progressing in our deployment on various fronts. Our production basically continues to ramp up reaching a level of 26,000 tons in August, in support of our U.S. Rig Direct programs.

Currently, we are supplying 65% of our OCTG in the U.S. and around 90% in Canada with Rig Direct services.

In the Eastern hemisphere, we continue to position for important regional and offshore gas development, winning an award to supply 13 wells for the Ichthys project in Australia and entering into Indian and Chinese gas project.

In Mexico, where activity has begun to pick up, we are now supplying offshore project, which are being developed by major and independent pursuant to the energy reform program.

As far as the exploration activities are concerned, essential to sustain offshore recovery, we recently received a multiyear award from a major oil company to supply the casing for the global program on a Rig Direct basis including BlueDock connector, and Wedge and Dopeless premium connection technologies.

We've been active participants in the development of the Eastern Mediterranean gas provinces supplying offshore line pipe manufacturer to the very many specification for a number of pipelines in the region.

The preparation and delivery of the pipe for these pipelines within the requisite fast track schedule has been a major industrial and logistical achievement of Tenaris throughout the year. Yesterday, we completed the final production lot for Zohr, 40 days ahead of our contractual commitment.

During the fourth quarter, we expect to complete the final delivery schedule for Zohr. In total, sales for East Mediterranean pipelines will account for more than 10% of our annual sales volume for 2018.

These pipelines project have required a substantial outlay of working capital on our part, thus, we expect to see a reduction of working capital requirement in the first half of next year, once the associated inventories and receivables for this project fall out of our balance sheet.

As we look towards 2019, the gradual growth in demand for OCTG around the world, despite the temporary pause in growth in the U.S. and Canada, will allow us to compensate for lower sales for offshore pipelines.

There remain, however, a number of uncertainties, which make it difficult to have a clear and precise view today, on how our results through the year will develop.

Most significant is the new USMCA Agreement, which has been [ reached ] to replace NAFTA. This has not yet been ratified nor has there been an agreement on the application of the Section 232 tariff under its umbrella.

Any changes from the current situation could be relevant for Tenaris and our market strategies.

During the course of the coming months, we will have more elements to evaluate more clearly, a full perspective for the year.

Thank you, and we are now open to receive any of your questions.

[Operator]

[Operator Instructions] Our first question comes from Igor Levi with BTIG.

[Igor Levi, analyst]

Great results especially in a seasonally challenged quarter. My first question is about your flat first quarter guidance, which was better than we expected given the Zohr roll-off. Could you talk about the moving parts that will offset the drop-off in Zohr? And then if you could just touch on how you're thinking about the rest of 2019 playing out?

[Paolo Rocca, executive]

Well, as you see, we will phase out in the fourth -- the last lot of the pipelines. Then in the 4Q, I will say, on one side, we expect the Canada shipment to increase because the season will be at full. So this is first aspect of increase. We think that there could be also some upside in the U.S. that could also contribute to let's say reduce the imbalance and then in the rest of the world, that the gradual increase may also support sales in other countries. All in all, I think we should be able to basically stabilize the level of sales in the first quarter compared to the fourth quarter.

[Igor Levi, analyst]

And how are you seeing rest of the year play out? I mean, do you expect margins to improve and are you still expecting a pricing inflection? And if so, when?

[Paolo Rocca, executive]

Well, as we said in the introductory remark, there is -- there are uncertainties, clearly, in the visibility for 2019 to some extent is limited. On one side, the negotiation of the new NAFTA, let's say, has concluded but we still wait for ratification and we need to understand how this will play out in modifying the impact of the 232 tariff. This is one important aspect but also there has been change in government in Brazil, in Mexico, some financial tightness in Argentina. So what we -- in general, we may perceive that the growth of OCTG demand continues in the rest of the world while in the United States, as you know, the issue of limitation in the takeaway from Permian and in Canada are to some extent, stabilizing the number of rigs. In this environment, we expect at this point, prices to remain substantially stable in the United States after the increase that happens in the last quarters. As we said before, we have been able to recover margin during this period, but looking ahead in 2019, we expect pricing to remain stable. But as I said in the beginning, there are uncertainties here in the level of activity and in how the tariff related to 232 will evolve and will affect the American market especially in the -- starting for the second quarter of 2019.

[Igor Levi, analyst]

Great. And just as a quick follow-up on Mexico. Your request for the exemption on shipments of billets from Mexico, I think that got delayed, you were expecting to hear something in October. Do you think this request will ultimately be granted? And when do you think we would have an answer?

[Paolo Rocca, executive]

Well, on this, Germán, you may comment on the evolution of these and how our exclusion petition will fare.

[Germán Curá, executive]

Thank you, Paolo. Very briefly, October, was in a way, the process due date that we would expect and remember that DOC established process call initially for 90 days. Now, the number of exclusions request and some changes within the same process is pushing ultimately the conclusion of well over the initial 90 days. We remain confident that we will get the exclusion and in our view, a final decision should be taken some time before the end of the year.

[Operator]

Our next question comes from Michael LaMotte with Guggenheim Securities.

[Michael LaMotte, analyst]

Paolo, let me offer my congratulations on being recognized by the Harvard Business Review as the top CEO, I think it's one thing to make that list but to do it consistently during what has been really the worst macro backdrop in a generation is truly a unique accomplishment, so congratulations.

[Paolo Rocca, executive]

Well, thank you, Michael. As usual, this is a result of the team, of the quality and capability of the team. I can say it now, I will not say it more but...

[Michael LaMotte, analyst]

I'm sure they appreciate that as well. So 2 questions from me, if I can. I'm trying to understand and maybe we can use the third quarter as the starting point. The mix shift to welded versus seamless, I assume that was Zohr Project but the selling price up almost $90 per ton quarter-on-quarter, in your prepared remarks you mentioned more the pricing moves in the U.S. as opposed to mix. So really the question is, as Zohr drops out next year, how do you see that impacting margin in Q1, Q2?

[Paolo Rocca, executive]

I would say, as I mentioned before, in this environment, which we may expect the price level in U.S. to remain stable. The price outside the U.S. will continue to increase. But as you were saying, will also be driven by the change in the mix. So some project with more demanding product, reduction in the line pipe and some more volume of seamless is driving a change in the mix that will result in an increase in prices in international arena.

[Michael LaMotte, analyst]

Okay, that's helpful. And then, if I could follow up on the exclusion. Is it retroactive? I'm just trying to think about the impact of exclusion versus the timing of the USMCA and ultimate elimination of the 232 tariff.

[Germán Curá, executive]

Good morning, Michael, this is Germán. The answer is yes, it's retroactive to the date that the exclusion request was made public. In our case, it was first week of July.

[Michael LaMotte, analyst]

Okay. And so would that be, in effect, a onetime credit? I'm trying to think about the ongoing impact of USMCA versus the exclusion.

[Germán Curá, executive]

Yes, it will. And remember that when the exclusion is granted, typically it would grant an exclusion for 12 months from that point on and should credit back retroactively from that point down to the date that exclusion request was made public.

[Operator]

Our next question comes from Dave Anderson with Barclays.

[John Anderson, analyst]

You mentioned in the release, you haven't seen an uptick from the offshore markets yet but considering OCTG is such a long lead time item, I think you -- maybe you might have a little bit better insight on how the IOCs are thinking about offshore. We keep hearing about this lack of urgency on their part. I guess, could you just help us kind of understand how you characterize those conversations today? Has there been sort of any change in their, I guess in their planning and when do you think orders start coming through? Is mid-'19 a right kind of ballpark? Or is that -- or maybe -- or does it come a little bit later in the year, do you think?

[Paolo Rocca, executive]

Well, thank you, David, for the question. Let me tell you my sense in general on the action of the nation and then on the international companies. I see some reluctance in this environment to launch very big long-term project. They are considering, they are starting but especially the international company may not find the condition for approval of long large project. They are approving, [indiscernible] is more projects and we see more of these local projects. Now the national oil company, are probably more -- could be more aggressive in this but I would ask Gabriel, that lives in very close to the international marketplace to give his view on this.

[Gabriel Podskubka, executive]

Yes. Thank you, Paolo. As Paolo was saying, we haven't seen a major change in the majors regarding the sanction of large project, less capital project. We are still much focused on capital discipline and cost control, we're sanctioning small [tie-backs] as Paolo was saying, having a logical effect on the backlog of deepwater offshore pipeline, as we are seeing small demand of the large ones. So the growth in international market is mainly driven by the nationals. Middle East, as we always talked about, is a resilient market. We also see some drive for gas in China and India. And some of the areas, we have some independent dynamics in the North Sea but the large CapEx, especially, for example, in the area of Sub-Saharan Africa, these are areas that today are still operating today at very low levels than the broader rigs compared to the 40 rigs we have in 2014. And there is discussions of -- on new projects but these are getting delayed and is something that hopefully will happen during 2019 with impact in 2020, but it's not happening materially very, very soon.

[Paolo Rocca, executive]

Yes. We were seeing large projects like Exxon in Guyana, the Eni project in [indiscernible], [ giant project ] of tens of billion, but in my perception, they will consider possibility of this during 2019 but we will see something in 2020. And gradually, there is a sense that there is not enough exploration activity in this area and there will be the need of some large project but this will -- I don't think something very relevant will occur next year.

[John Anderson, analyst]

So a second question is -- probably, Gabriel, is probably your area as well. I was just hoping maybe you can expand a little bit on your plans for that Saudi mill you just recently acquired. I believe it's the first time you actually have manufacturing in country, I was wondering if you could talk about the current utilization of that facility? Kind of where you see those volumes trending? Does it need to be upgraded? Are you thinking about expansion? Just comment some of your kind of thoughts on what this acquisition means to Tenaris kind of longer term and being a local supplier now, I guess, is it fair to say that you should have a competitive advantage over, which I'm pretty sure the Korean and Chinese imports have traditionally supplied that base demand in the kingdom so if you could just kind of talk about that acquisition and what it means to you, it'd be helpful.

[Paolo Rocca, executive]

Sure, Dave. Yes, thank you, Gabriel, you can speak on this. And remember we just signed the agreement and there are some condition precedent that will need to be fulfilled.

[Gabriel Podskubka, executive]

Yes, yes, thank you, Paolo. Yes, David, this is an interesting acquisition or an agreement to acquire, let me put in that way. First, let me clarify that we started in manufacturing in the kingdom about 10 years ago. We have invested in 2 training facilities. Today, we have about 200 employees in the kingdom with a very high level of service station, actually, the highest level of service station in our space. So this will be the first acquisition if materialized. The agreement that we signed late September was to acquire a 48% controlling interest in Saudi steel pipe. This is a local listed producer of welded steel pipes with a very solid reputation and position in the market. As Paolo said, this transaction is still subject to a number of condition precedent that if fulfilled, we expect this to close by early 2019. And this will be a nice addition and complementation to our current offering in the kingdom as they produce typically larger OCTG and also line that complements our current offerings. So this is something important. If materialized, the current level utilization of this plant is around 50%, maximum 60%. So there is a potential for growth in the kingdom [indiscernible] region.

[Operator]

Our next question comes from Nick Green with Bernstein.

[Nicholas Green, analyst]

So firstly, you mentioned Bay City is running about 26,000 tons in August. So it's a run rate of about 312,000 or just over 50% utilized. Can you give us a time frame for continued ramp-up of the Bay City mill? That's the first one. Second one, can you talk a little bit about networking capital, particularly what you consider to be the normal level of networking capital days going forward in a Rig Direct world? And specifically, we have come off from the highs of 3, 4 quarters ago around 190 days or so, working capital is down around 170, should we be expecting it to normalize at the current level? Or do you think there's more efficiency to come there? And then the third question just relates to some of your earlier comments around the USMCA and Section 232. I think it would be helpful for investors just to get a sense of the scenario outcomes or if you remain under a tariff arrangement or if you get fully exempt from a tariff arrangement. May you just talk us through please, how you see your business performing stroke coping under those 2 scenarios?

[Paolo Rocca, executive]

Thank you, Nick. On the first, I think, the ramp-up is proceeding. Luca, maybe you can comment on how you see this in the coming months. If there are specific challenges or something that could interfere with the normal ramp-up of the mill?

[Luca Zanotti, executive]

Yes. Thank you, Paolo. As you said that always was in line with our expected level in December. So we may say that depending on mix, we are progressing towards the production levels we were expecting through the year. Now to your second part of the question, it is public that we reopened our cargo facility in Houston. This will work as a finishing line for the Bay City running pipes, which will add additional capacity to the capacity, the finishing capacity, we have installed right now in Bay City. So we don't see any reason or any impediment to Zohr and the way we were forecasting in our budget. Now, as far as your question is concerned, the plant is ramping up according to plan and frankly, we don't see any substantial obstacles to keep on ramping up according to plans.

[Paolo Rocca, executive]

Now the second question on the working capital, my view is clear that we need to use more efficiently working capital. We are gradually adjusting after a strong increase in our Rig Direct. We now could optimize very much from many aspects but to quantify what you think we can do, Edgardo, comment from you on this.

[Edgardo Carlos, executive]

Sure. Thank you for the question. Yes, I mean, we've been growing with the business in the working capital through the year, I mean following a very significant increase in volumes, tonnage-wise and also in sales. And as also we mentioned in the opening remarks, I mean, one component that has been affecting significantly was the big project, Zohr, that we're going to probably phase out in the first half of next year. So I will say that from now on, we need to reduce the days of working capital not only because of the elimination of this component of Zohr but also because the more that we're getting into the production into the U.S. with a short lead time in Bay City that will continue to reduce our inventory for the Rig Direct. So overall, we will see an improvement and I will say in the range of 15 to 20 days for the next 3 quarters.

[Paolo Rocca, executive]

On the third question, [indiscernible] on the -- which could be a possible outcome of the negotiation on the 232. Germán, you are working very closely to the team that is discussing this. Maybe you can give us some indication on where you see this going?

[Germán Curá, executive]

Yes. Well, as you know, that right now as we speak, negotiations are going on in Mexico and the United States. I would tell you that the position of the Mexican industry has been that there should be no quotas at all. The market has to be open, especially under the perception and the division that the U.S. grants, the steel industry and the U.S. runs have a very big surplus versus Mexico in terms of exports. On the other side, the position of the U.S. government has been that any solution has to include any type of chorus. And because the negotiations are going on right now, I wouldn't like, for obvious reasons, to go much deeper into these discussions. We also have a little bit the risk of what's going to happen with the USMCA ratification as Paolo said earlier in his conversation, but that is where we are today and I think that we should know the outcome in the near future.

[Paolo Rocca, executive]

Yes. As a general comment, I would say that Tenaris is very strong in any scenario because, in the end, we have production in different countries. We have a more global position compared to everybody else. So what is happening in these months, the Section 232, the safeguard adopted by different countries in containing the deviation of commerce, we are really positioned as a company to face any decision in the different regions because we can react properly and continue to satisfy the demand of our client because in the end, for us, the most important thing is to maintain the relation with the client, independently on this and to be able to continue to fulfill our obligation and satisfy their need. Everywhere, from different sources according to the decision that the authority may take.

[Nicholas Green, analyst]

But maybe just a very quick follow-up, would you agree that the risk seems asymmetrical on this? So in the sense that the exemptions come to nothing, the USMCA comes to nothing. Is it correct to say that you would continue paying the tariffs that you're currently paying? The caution that you've talked about in the last couple of conference calls, which is now quite well understood by the market, that is what would come from a failed negotiation on USMCA? But on the other hand, if the exemption comes through, it would be a material benefit to Tenaris, so it would seem from my perspective that the risk of reward isn't very symmetrical on this negotiation at the moment. Is that how you tend to think of it as well that you prepared for the downside and will benefit from the upside or is that a too simplistic way of thinking about it?

[Paolo Rocca, executive]

We are seeing things as you were saying. We -- even in the worst scenario, the new USMCA is not approved. And the situation remained exactly as it is. As you can see now, our result in this quarter, we are faring pretty well. And we have been able to recover from the market the increasing cost that we had. So I think Tenaris is well defended in both cases but if you ask me from my point of view, I really much would like to have the agreement to be approved, the Section 232 tariff related to Mexico and to Canada to be eliminated and to be able to operate into an open space for the future.

[Operator]

Our next question comes from Vlad Sergievskii with Bank of America.

[Vladimir Sergievskii, analyst]

Firstly, could you please provide some color on how your shipments could evolve into fourth quarter of the year? Am I right in thinking that Zohr project alone could add 70,000 tons, 80,000 tons to third quarter shipment, then Canada will do better? Are there any other moving parts up or down from between Q3 and Q4? And my second question is a broader one on your strategy in the Middle East. Do you think Rig Direct model could be applied with the national oil companies in this region or they will continue doing big open tenders, like the one recently announced by ADNOC?

[Paolo Rocca, executive]

Well, on the first question, we responded at the beginning. I mean, in the shift between -- the fourth quarter has been clearly supported by the increase in the line pipes for the Eastern Mediterranean. In the first quarter, we will lose some volume there, but as I was saying, we are recovering in North America, in large part, thanks to Canada because of the season. This is, let's say, a compensating factor. That is important in this area. But also, there is a pickup, a gradual pickup, in Latin America, in Colombia, in Mexico. These are not such big increases, but contribute to support our operation -- international operation. So we think that, as a whole, in the end, we should be able in the first Q, to maintain something lower volume in the first Q, but let's say, not very far from what we got to do in the fourth Q. As far as second question, the Rig Direct. It's clearly, we are expanding our Rig Direct operation in the eastern hemisphere. Gabriel, you may comment on the breakthrough that we did in the past and where do you think this way of working could be expanded.

[Gabriel Podskubka, executive]

Yes. Thank you, Paolo. Good morning, Vlad. I think you touched on a very interesting point on the deployment of Rig Direct in the Middle East, and in general, in international markets, which were, in the past, not necessarily operating under the Rig Direct. But this is changing in many parts of the world. For example, last August, we started Rig Direct in China with Shell. This is something that has been probably unheard of, but we are starting a new tight gas project with Shell and the Rig Direct conditions for the next 2 years. So this is something that we are discussing with the nationals in the Middle East. It will take some time, but as you mentioned, ADNOC, this is a company that is one of the -- the one that is most advanced, looking at how to create efficiency under a different supply chain management. So I think it will take some time, but eventually the benefits and the strength of the Rig Direct is something that is also applicable to the nationals.

[Vladimir Sergievskii, analyst]

That's very helpful. And can I quickly follow up, if I may? That's good to hear that your Q1 volumes are not significantly declining versus Q4. Would it be fair to assume a very substantial increase to your Q4 volumes versus Q3? Are we talking about something more than 100,000 tons increase from Q4 -- for Q4 versus Q3? Would it be fair to assume that?

[Paolo Rocca, executive]

No, it will be really no competition if we're lower than this. But there will be an increase. Will not be so high, but there will be an increase.

[Operator]

Our next question comes from Ian MacPherson with Simmons.

[Ian Macpherson, analyst]

So the Argentine peso devaluation was a positive effect for you in the third quarter. But I wonder, has it had any impact on the investment climate? And can you just talk about the outlook for growth in activity in 2019 as you see it today for Vaca Muerta?

[Paolo Rocca, executive]

Thank you, Ian. Well, let me tell you. For sure, the -- what's happened in Argentina, devaluation increasing the interest rate, will have an impact, in general, on the country. We hope that this will be a short reduction in the economic activity and then there will be a recovery starting in 2019. Now as far as Vaca Muerta is concerned, Vaca Muerta is perceived as something that Argentina should really defend and promote for the future because it's a key component of improving current account payment for the country's reducing LNG import. It's producing more gas domestically at a very competitive different price. It's essential for -- not only for the current account, but also for the fiscal -- reducing the deficit. Because at the end, it's reducing the subsidy that the government is pouring into the energy sector to reduce the cost of energy for the different sectors, the poorest sector of the population. So we think that the government is very keen in preserving condition for the oil company operating in Vaca Muerta, adjusting to some extent, but within limit that it may do -- will not affect substantially the development of Vaca Muerta. It will not be, let's say, 2019. We cannot expect a substantial and aggressive growth because also the interest rate is making more difficult for the country -- for the company to finance this growth. But there will be growth in Vaca Muerta. There will be increasing drilling during 2019. Obviously, if you think of a very substantial, aggressive development, we will need to wait for 2020 with a better visibility on the future and also on the future after the election of October '19.

[Ian Macpherson, analyst]

Understood. For my follow-up, just to connect the dots a little bit more on the outlook. The last question, I think you addressed on the fourth quarter outlook for volumes being up a bit, not up 100,000, but up a bit. And would we also assume that average selling price will be relatively stable as would be margins in the fourth quarter compared to the third quarter?

[Paolo Rocca, executive]

Yes, you're right. This is basically our...

[Operator]

Our next question comes from Amy Wong with UBS.

[Amy Wong, analyst]

I have 2 questions, please. The first one is on your comments and the general commentary in the industry where there is movement on tiebacks, but not greenfield projects. Could you talk about your opportunity set, other than the fact that probably tiebacks are smaller projects and there's less volume? But is there any difference to the kind of content that you can supply into a project and the timing of when those projects get sanctioned and how that converts into revenues for Tenaris? And then my second question relates to your pipelines business. As Zohr is rolling off, we understand that. But can you talk about the opportunity set out there in terms of tendering other gas export pipelines that you guys have an opportunity of winning, and the timing for that, please?

[Paolo Rocca, executive]

Yes. On the activity of the oil company and offshore, let me ask Gabriel again, which is your view of the time to market and what we can see, I mean, in -- according and depending from the development...

[Gabriel Podskubka, executive]

Yes. Good morning, Amy. Yes, in terms of what you mentioned, the tiebacks versus the greenfield projects, the greenfields that we are seeing. We see a substantial number of increase in the number of RFIDs during the year compared to last year. But these are smaller in CapEx, shorter in cycle. Smaller in CapEx requiring some OCTG associated with the drilling, but in general, tied up with smaller pipelines to existing infrastructure. So these are shorter cycles, which, in this environment, the majors are prioritizing over large-scale projects that are paid over 5, 10 years with several billion dollars of capital expenditure. Well-positioned as well for those delivery, compliance with technical requirements, service are still some of the key elements to be successful in those. And the global scale of Tenaris and our track record, also applies to tiebacks and also for large pipelines. But this will affect sensitively the backlog of pipelines offshore going forward as we conclude the sort of type of life of projects.

[Paolo Rocca, executive]

Yes. Basically, tiebacks require -- are realized through very short pipeline, very short riser that are connected to the existing facility. So we don't have the opportunity like Zohr of several hundred thousand tons, connecting a field that may be 300 kilometers outside the coast to the water. These are very relevant projects. We do not see this in 2019. Now we do not see this in Brazil. Brazil is a region that, in 2019, will remain, in term of drilling, [indiscernible]. So due to the -- so we do not see them in outside the world -- in the rest of the deep offshore or in the -- even in the more shallow offshore large pipeline. We will have shorter project with, let's say, shorter pipeline and limited demand.

[Operator]

Our next question comes from Marc Bianchi with Cowen.

[Marc Bianchi, analyst]

If I heard correctly the view for the balance of 2019 beyond first quarter assumes that volumes remain fairly stable, but the line pipe from Zohr is offset by growing OCTG. Under that scenario, what is the margin benefit that you would get just from replacing those lower margin line pipe volumes with higher margin OCTG?

[Paolo Rocca, executive]

As we said at the beginning, I think that it's difficult today to have a clear visibility on the condition of operation in the United States and, to some extent, also in some other region today. Many things need to be defined. There is the energy policy in Mexico, there is the recovery of Argentina, there is the energy policy also in Brazil and tariff issue in the U.S. Today, let's say, if you come -- we do not have clear visibility of the dynamics after the first quarter for 2019. Reduction in the large pipeline will be substituted by OCTG, but the stable price in the U.S. will probably also maintain our EBITDA margin. EBITDA, only generally voicing, in the range of where we are today.

[Marc Bianchi, analyst]

Maybe going back to the whole Mexico tariffs and what could come from the ratification. I think last -- we previously discussed $40 million of quarterly burden in the fourth quarter from all the tariff situation that's out there right now. Would you still say that's a fair number that if we get favorable resolutions, that would be the uplift that you would eventually realize?

[Paolo Rocca, executive]

I will ask Edgardo to comment on the number for -- that we are paying in tariff for Mexico.

[Edgardo Carlos, executive]

Yes, I mean, this quarter -- I mean, the third quarter we just finished, it was not fully reflected, the tariff, because there were some material that we shipped that were coming before the tariffs took place in the U.S. But I would say that, as commented in the last conference call, it's in the range of $50 million per quarter, the full effect. So that's going to be having an impact on the fourth quarter. And you are right. If we get the exception from this, that will be something that will improve our margins. The exclusion is only affecting around $10 million per quarter, the rest is affecting $40 million or [ the number in this ]. So if we get the exclusion, but we don't get elimination of the tariff, we will only save around $10 million per quarter.

[Operator]

Our next question comes from Stephen Gengaro with Stifel.

[Stephen Gengaro, analyst]

Two things, if you don't mind. The first, can you just give us a brief update on Bay City? How is it running? How is the efficiency? How has it been operating relative to expectations?

[Paolo Rocca, executive]

Yes. Luca, can you give feedback how we do?

[Luca Zanotti, executive]

Yes. Thank you, Stephen. As I already stated at the beginning, we are ramping up according to plan. We mentioned a number in August a production of 20,000 to 26,000 tons, which is in line with the running rate we were expecting by December. This will depend also on [indiscernible], of course. And so to cut a long story short, I believe that we are ramping up according to plans and we don't see any structural issue that could prevent one to move on, on this path.

[Paolo Rocca, executive]

Yes, actually, let me tell you that when we ramp up operation, we need to hire people to train. So we have all the issue that comes in the mail and make sure you have people with relatively low experience coming into it. And we are very careful, from the point of view of safety. So I mean, this is a process. It's not something that could go up pretty strongly. But the positioning in Conroe is opening up a finishing line that exceeds the capacity of the existing finishing line. So it's creating a condition for the facility to continue to grow during 2019.

[Stephen Gengaro, analyst]

Great. And then, as a second question, when you think about the balance sheet and sort of, can you give us a sense for CapEx needs in '19 and any plans to alter how much cash is being returned to shareholders? Obviously, the balance sheet is in great shape, but the Bay City CapEx is behind you. I'm just trying to sort of think about how to calibrate your views on where the balance sheet should be from a debt to cap and cash standpoint. How much maybe you continue to return to shareholders?

[Paolo Rocca, executive]

Well, thank you for your question. I think in 2019 our investment will be in the range of $350 million to $400 million. But I will ask to -- Edgardo to make additional comment on our balance sheet. Now we can -- which are the key point on which we are acting today on this.

[Edgardo Carlos, executive]

Sure. I mean, the -- for the point of view, as commented early on, we are going to be expecting to recover working capital in the first half of next year. So provided that we maintain the level of operating a generation that we have in our balance sheet, we're going to be able to maintain and pay our dividend at the level that we paid last year and we basically will be getting an additional cash -- I mean, bringing back to the cash, not that we have probably 2 years ago, but we're going to be probably improving the cash by $300 million by the end of June.

[Paolo Rocca, executive]

Yes. I would say that, obviously, we -- you are seeing the decision to pay the advanced dividend, then it will be up to the board and the shareholders to decide what to do for completing the dividend for this year. They will also depend according to our policy on how we see the perspective of the company during 2019.

[Operator]

Our next question comes from Rob Pulleyn with Morgan Stanley.

[Robert Pulleyn, analyst]

A few questions, if I may. I mean, the first one is when you talked about stable prices in the U.S. into 2019, could I just -- can we just talk a little bit about what you expect and see on the scrap steel prices, your input, and how that, of course, may impact margins? And the second one, if I can ask regarding international pricing as to whether you're actually seeing any pricing power with your customers outside of North America or whether that's a bit early. And the third one, we heard a lot I think earlier in the year about the impact of Section 232 leading to more U.S.-welded capacity coming back online. Have you -- any incremental plans to add more welded tons in the U.S. as we look into 2019?

[Paolo Rocca, executive]

Yes, thank you. And the first point, as I say in my remarks before, if the level of rigs into operation remains stable at around 1,050 or 1,060, I would expect the prices also in the market to stay more or less where they are today. As far as the scrap issue, also, I do not expect big changes in the price of scrap. There are different factors combining in the market for scrap: demand from Turkey, the level of electrical furnace operations in the United States. But basically compounding this, I would expect the level of cost of metallics worldwide to remain more or less where it is. Also following a limited increasing in the consumption and production of steel worldwide. On the third point, which is the welded capacity utilization for pipes, I would ask Luca if we have some indication or some opinion on this.

[Luca Zanotti, executive]

Yes. As far as the welding capacity, we are seeing some additional volumes coming in from the domestic industry. And as far as the question on our welded capacity in [ ICMA ], I think we are well-equipped to confront the demand that we have in front of us.

[Paolo Rocca, executive]

Just one additional comment. According to 232, also the demand for flat product in the United States has been pretty solid, as you have seen, and also the price of hot rolled coils in the United States has been pretty high. So in this moment, the -- I mean, increased welded, if there is stable price, is not really something likely, this condition for the time being. Maybe the hot rolled coils will -- the price of hot rolled coil will go down gradually during the coming months. But this is one of the uncertainties that is affecting North American market today.

[Robert Pulleyn, analyst]

Paolo, that's super helpful, as always. If I could just go back to the second question on international pricing, whether you are seeing any pricing power there. I'd love to hear your thoughts.

[Paolo Rocca, executive]

Yes. Gabriel?

[Gabriel Podskubka, executive]

Yes, thank you, Rob. Regarding pricing in the international market, the -- remains challenging. The competitive environment continues to be challenging and pricing remains under pressure. Having said that, during the last year, as you know, in the contract we have renegotiated according to the market and cost indexes, prices where we'd increases. And also, we have high graded our backlog. So this is something that we can possibly -- positively see the effect during 2019 in international market. And as I said, as we have lower level of welded line pipes, this will also have a positive effect on average pricing of those. Typically, pipelines have lower average price than the high-end OCTG.

[Paolo Rocca, executive]

Yes. Some recovery will come from a mix effect in international. It's pipeline that will be reduced, but also some additional premiums for more complex set of products will shift the mix into slightly higher prices.

[Operator]

Our next question comes from Alessandro Pozzi with Mediobanca.

[Alessandro Pozzi, analyst]

I have 2 questions. I think in Q3, we've seen the cost of raw materials going up a little bit. Just wondering whether that reflects the impact of tariffs or is the true cost of actually raw materials flowing through the P&L? And the second question on the quarter, Section 232. I think in January 2019, we're going to have [a reset] of those quarters. And was wondering whether potentially imports from Korea and Brazil could be overrun for prices in the U.S.?

[Paolo Rocca, executive]

Yes. On the first point, let me ask also to Edgardo to give a view how the price of raw material is also getting into our balance sheet, into our profit and loss?

[Edgardo Carlos, executive]

Yes. Especially -- I mean, in the third quarter, you're right. Basically, we saw the last part of the increase in raw materials, primarily the scrap ferroalloys, that accounts, to some extent, probably 50% of increase. The rest of the increase was primarily the duties that came into the picture in this quarter.

[Paolo Rocca, executive]

Yes. As far as, let's say, what we can expect starting in January when quota-affected countries may get back into the U.S., Luca, do you expect this to change something relevant for the market?

[Luca Zanotti, executive]

Well, of course, this will add additional supply. So this is one of the elements of uncertainty that you mentioned, Paolo, in your previous comment. Now we'll just have to remember that, for example, Korea, according to the preliminary determination, would be also affected by a significant increase on anti-dumping duties, if confirmed in the final determination. So I will go back to your previous statement concerning uncertainties. I mean, these -- there are different elements in play. And for us to give a firm, stable outlook on what is going to happen, we need to see a little bit how this develops going forward.

[Paolo Rocca, executive]

Let me add just one comment. In the last 2 quarters, we had a reduction in the stock on the ground in the range of 130,000 or 200 per quarter, around 130,000. Now there is some increase in the import, may also go the sector by the reduction in the -- the stop on in the reduction of inventory. So this, I think, is a factor that you need to consider. In the last 2 quarters, the market has been supplied by reduction in inventory. This could not go on forever, no? The quarter, you know very well. You know very well that the quarter will not be -- I mean, there is no -- will be distributed quarter by quarter, no. So even if Korea come back, whether it can come back, only with 30% of the annual quota in the first quarter, not 100% of the yearly quota. So will be gradual and there will be some -- and you have to consider also the absorption that has been provided by the inventory, no.

[Operator]

And our next question comes from James Evans with Exane BNP Paribas.

[James Evans, analyst]

I wondered if you could talk a little bit about the outlook for Mexico over the next 12 to 15 months. Obviously, there was some hope of a significant cash injection into Pemex. So I'm just wondering what you're hearing on the ground, when any such injection could start to be represented in your results and also what you're hearing and seeing from some of the newer entrants in the country at the moment.

[Paolo Rocca, executive]

Thank you, James. Guillermo, can you answer this?

[Guillermo Vogel Hinojosa, executive]

Sure, James. Well, you see, we are optimistic about developments in Mexico. And I would say there are 2 drivers that are moving right now. One is Pemex and there has been declarations by the elected President that he wants to increase the budget of Pemex, and in terms of drilling, he's talking about $4 billion to $5 billion of an increase. We are already seeing Pemex reactivating itself. In the fourth quarter, we're seeing a rig count of around 33 rigs versus the 20 that we are having last year. And then in terms of the new commerce, at the beginning I would say that there were some doubtful in terms of how the new government was going to face the energy reform, and the first good news we had is that all the contracts were going to be maintained. Then this was moving and we had also now a positive information that all the biddings that were in process, which was, as you know, Round 3.2 and 2.2 and 3.3, and also, the farm-outs, 7 farm-outs of Pemex, which were going to be assigned by September, October, they were stopped, but now they have said that this is going to be assigned by February. So it's -- the reform is moving on and what we are expecting is a gradual but consistent increase in the volumes quarter by quarter. We are already seeing in terms of our backlog that the new commerce are coming in. And today, we have 11 rigs already in Mexico operating under the new commerce. We expect this to increase to over 20 rigs by the end of next year. So we -- and we see this continuing to increase in 2020. So I would say that we are optimistic in terms of developments in Mexico.

[Operator]

And ladies and gentlemen, this concludes our Q&A session for today. I will turn the call back to Giovanni Sardagna for his final remarks.

[Giovanni Sardagna, executive]

Well, thank you, Carmen, and thank you all for joining us in our conference call and hope to see you soon. Bye.

[Paolo Rocca, executive]

Thank you very much.

[Operator]

And thank you, ladies and gentlemen, for participating in today's conference. This concludes the program, and you may all disconnect. Have a wonderful day.