The link between high steel prices and carbon emissions

The post-pandemic world is strangely marked by high demand for metals and shortages of materials, but there is more.

The waiting list for hot rolled or galvanised steels and other industrial metals is getting longer and longer and pricing will be increasing.

Meanwhile, we read that companies such as Tsingshan or Nippon Steel Sumitomo announce a remarkable reduction in their steel production and others in Europe report that they are not producing at full capacity. What is going on here?

Take a close look at the following graph:

The coal emissions futures market is at record highs. Each unit on this graph, gives the holder the right to emit one ton of carbon dioxide. The escalation coincides, and not by chance, with the entry of Phase 4 of the Revision of the Emission Trading System for the next decade. The European Green Deal establishes new, stricter limits on carbon emissions that directly affect steel mills. The new EU target sets an emissions reduction of 55% by 2030. This has serious implications. Steel companies are obliged to change their production methods and replace coking coal with electricity. This raises the cost of steelmaking and reduces their profit margin, or alternatively, some steelmakers may choose to reduce production as a result. So after the supply disruption caused by this pandemic, we find the situation where not all the tools can be used to be able to supply the market. We are now into the transition period to climate-neutral production, where steel mills need to buy expensive emissions certificates if they want to produce at full capacity.

Derivatives of this shift.

China moved quickly since May 1 to issue tax exemptions to favor steel imports and focus only on higher quality steels. It is an effort to move the emissions problem away to other countries by reducing production and imports of iron ore and coal in particular. They want the year 2023 to be the peak of emissions and then achieve carbon neutrality by 2050. To this end, they propose a plan to replace old-school blast furnaces, which use coking coal, with efficient electric arc furnaces that use more scrap. Primary steel production consumes more energy than secondary steel production using scrap by intensive recycling. In short, China is going to export its Co2. This is being watched very closely as it is a very big move for countries like Australia. It has also opened up a speculative way, with the launch of a scrap futures market, also this May 2021, the Davis Index Fe scrap Futures. See the scrap metal price chart. It coincides with the announced launch of this index but also with the skyrocketing consumption of electric arc furnaces scrap in China.

Meanwhile the price of iron ore, especially the higher purity Fe, which allows for higher yields, is rising steadily.

All these movements are forcing European steel mills to make a move at an extremely complex time, where they are presenting now profit accounts not seen in decades thanks to high steel prices, but forced to go green, something that is going to require considerable investment.

Implications of the above

Perhaps by now it is becoming clear to you who will pay the costs of the energy transition. In order to meet the European Union’s climate targets, by 2030, industry must reduce its CO2 emissions by 30% and by 2050, the entire economy should operate without CO2 emissions. At the same time, the technologies needed to drive the change, Natural Gas or Hydrogen, are already available and will help mitigate the problem. But no disruptive technological substitution has yet occurred over the known physical and chemical reaction of coking coal as a fuel and reducing agent. Producing an iron-carbon alloy without emitting carbon dioxide is not going to be easy. Certainly the investments costing billions of Euros and clearly beyond the financial possibilities of the companies have yet to be seen. The industry urgently needs subsidies from the European Union for the period 2025–2030, in order not to be wiped out by the Chinese advance in this field, which means that we will soon see a sort of climate protectionism (or carbon border tax), which is the same as saying that prices will be high to save the investment. So don’t be surprised if you hear that steel prices will have to go up because they are already going up.

The German Steel Federation (WV Stahl), for example, plans investments of around €30 billion to decarbonise the entire German steel production. However, this does not yet take into account the additional costs in ongoing operations that will be incurred, for example, by switching from coal to climate-neutrally produced hydrogen. There are market experts who expect additional costs of up to 300 euros per ton of steel as a result of this changeover, if operating and investment costs are taken into account. These costs are expected to be borne by all participants in the value chain, from the steel companies to the automotive industry and, of course, to the end customer.

On the other hand, we know that, according to the logic of the market, it is legitimate to leave the business of coal and scrap emissions in the hands of hedge funds. This may help to secure future supply, but in the end, they are essentially manipulable markets. Like the experience of nickel and stainless steel, a highly speculative market handed by speculation.

Finally, the disturbing news that some steel mills would be willing to leave the business, we refer to news like this or this, are samples of the curves to come, where producing climate-neutral steel is a challenge for manufacturers. In other words, we are facing a complex change that transcends Covid and that is not going to be solved this year or next year. Tata Steel Europe has already implemented a carbon surcharge of €12/tonne that shifts the cost of carbon allowances to the buyer and the rest of the steel mills are likely to follow.

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Disclaimer: The content of this article is non-binding and reflects our view and is not a recommendation to buy or sell any asset, and you cannot take as indication of future results. Each buyer must do his own analysis. Although we took all reasonable care in writing this post, it is possible that the information in it is incomplete or incorrect or may differ of what you know. Please remember that the indicated data and our views are subject to change without notice and we have no obligation to update the information contained herein.

Posted before in Pulse.

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