The world is stepping up its efforts on a momentous project – the fight to limit the damage from climate change. Pre-eminent among the battle objectives is the call to reduce CO₂ emissions for energy-intensive industries in order to meet climate objectives. Nowhere is this more apparent than in the steel sector, which, according to the World Steel Association, accounts for up to 9% of all direct fossil-fuel emissions globally.¹

The European Union has traditionally been at the front line. As the bloc follows a path toward net-zero emissions by 2050 the process of “greening” the steel industry has gained more urgency. And other major steel producing economies are proceeding along similar lines: both Japan and Korea have announced net-zero targets and even China is now on a zero-carbon deadline.²

A major step for the industry was announced on 31 October 2021, when the United States and the European Union committed to negotiate the world’s first carbon-based sectoral arrangement on steel and aluminium trade by 2024.³ According to the White House, the United States and the European Union “will work to restrict access to their markets for dirty steel” while encouraging other countries to participate in the agreement as well.

Only a few days later, the UK, India, Germany, Canada and United Arab Emirates have committed to supporting new markets for low-carbon steel. At the 26th UN conference on climate change (COP26) in early November, the five countries pledged to achieve net zero in major public construction steel and concrete by 2050. Specific interim targets by 2030 are expected to be agreed by mid-2022.⁴ Both these announcements can be seen a clear signal for the steel industry that moving to green manufacturing is essential – otherwise companies will over time become competitively disadvantaged.

But with the industry still feeling the effects of faltering demand and disrupted supply chains, how can it achieve the significant funding needed to make this vision a reality? The emerging sustainable-finance market has a key role to play.

A concerted, global effort to decarbonise the economy is underway – one that aims to shift the energy mix away from fossil fuels in moving toward a renewable future. As part of this journey, several ambitious targets have been laid out by governments and corporations alike. The biggest of these is the Paris Agreement, a legally binding international treaty on climate change. Adopted by 196 parties, the agreement aims to limit global warming to well below 2°C  – preferably to 1.5°C – compared to pre-industrial levels.

To ensure sustainability efforts stay on track, Europe has laid out a comprehensive roadmap to prepare the continent for a net-zero future. In December 2019, the European Commission announced the European Green Deal – the bloc’s most ambitious attempt to date to counter climate change and environmental degradation.⁵ In line with the Paris Agreement, the initiative targets net-zero emissions of greenhouse gases by 2050 and is underpinned by a series of interconnected goals covering almost every element of the economy, including energy, construction, agriculture, and transport.⁶   

“Meeting the aims of the Green Deal involves a massive funding injection for every part of the economy, in every industry and across every sector”
Claire Coustar, Global Head of ESG for Fixed Income & Currencies at Deutsche Bank

Meeting the aims of the Green Deal involves a massive funding injection for every part of the economy, in every industry and across every sector. At least €1trn in funding is needed for the coming decade and while a large share of this will come from the EU budget and national governments, a contribution worth €279bn is required from the private sector.⁷ Looking only at the steel sector (but taking a global view) the International Energy Agency (IEA) has projected a cumulative need for investment of around US$1.4trn until 2050.⁸

This presents a huge challenge for banks, but also a huge opportunity. Capital will need to be allocated, and banks – those best positioned to support sustainability – can be there to provide it. But how exactly will the funding be achieved?

The shift toward sustainable financing – with tools linked to ESG criteria: environment, social, and governance – has already begun. It is best illustrated by the recent, exponential growth of the green-bond market. Ten years ago, it had yet to develop, yet fast-forward to today and total market capitalisation recently surpassed US$1trn.⁹ In the past decade, the market for both green bonds and green financial instruments in general has expanded significantly (see Figure 1). For example, social bonds have seen a significant surge, especially since the onset of Covid-19, while the market for sustainability-linked instruments (which tie the cost of the financing to performance on ESG metrics) has also grown substantially.

Among the largest contributors to carbon emissions is the steel industry. And even Europe, with all its modern assets and infrastructure, has much remedial work to do. Recent statistics from industry group Eurofer show only around 40% of the 160 million tons of crude steel produced in the EU comes from electric arc furnaces.¹² The rest involves traditional blast furnaces – a good indication as to why carbon emissions run so high in this industry.

Indeed, after the power-generation sector, iron and steel is the largest industrial producer of CO₂ emissions in Europe – with the industry currently generating 221 megatons of greenhouse-gas emissions annually, representing 5.7% of total EU emissions.¹³ Reducing CO₂ levels for this energy-intensive industry will, therefore, be central to meeting the EU’s climate objectives.

“Over the past year, major mining and steel companies have put a significant focus on climate-change disclosure”
Claire Coustar, Global Head of ESG for Fixed Income & Currencies at Deutsche Bank

Toward this goal, over the past year major mining and steel companies have put a significant focus on climate-change disclosure – with many corporates having now adopted the major voluntary reporting guidelines, including the Global Reporting Initiative and the Financial Stability Board's Task Force on Climate-related Disclosures (TCFD).¹⁴

At the same time, individual companies are stepping up to the fold. In September 2020, ArcelorMittal, the world's largest steelmaker, became the first to pledge net-zero emissions by 2050, with plans to combine small amounts of hydrogen with coal in a blast furnace, as well as substituting wood biomass for coal in processes. Unfortunately, these efforts will prove costly. The company estimates that decarbonising its facilities in Europe alone – in line with the EU’s Green Deal – will require between €15bn and €40bn and won’t be profitable before the 2030s.¹⁵  And the price is estimated to be just as eye-watering for others in the industry, with a July 2021 Deutsche Bank Research paper, titled “Can Mining & Steel sustain in a low carbon world?,” reporting that the capex bill for European carbon steel over the next 10 years could reach US$20bn for the already capital-constrained sector.¹⁶

European steel has been struggling in recent years, hit by the trio of stagnating demand, international-trade distortions, and the impact of Covid-19 on supply chains. At the same time, the industry is expected to turn its attention to a complete rethink of its existing processes to facilitate substantial reductions in emissions – something it has to do quickly and at great expense. As explained in the European Commission’s report Towards Competitive and Clean European Steel, these headwinds, combined with the cost and urgency of upgrades “makes for an exceptionally challenging business environment and illustrates many of the challenges that EU industry at large faces.”¹⁷ So how exactly can the struggling industry meet these capex demands? One potential route is through the sustainable-financing market.

As noted, financial products that meet ESG criteria have enjoyed increasing demand for several years – not least within the steel industry. Given the high levels of emissions produced by its members, the prospect of reconciling the desire for returns with personal or institutional values is particularly resonant. Interest in the markets has been building rapidly in recent times.

For example, US Steel launched its inaugural, US$60m green bond issuance in December of 2020 to finance a new electric arc furnace.¹⁸ In early 2021, Hyundai Steel received US$1.9bn in orders for its green bond issue.¹⁹ And Indian steel company JSW recently raise US$1bn with sustainability-linked bonds (SLB), becoming the first company in the steel sector to issue an SLB in hard currency.²⁰ These are just two examples of how steel companies are integrating ESG into their finance strategy (see Figure 2).

Sources

¹ See https://on.ft.com/3loN6fD at ft.com
² See https://bloom.bg/3I9VqcH at bloomberg.com
³ See https://bit.ly/3G4Ubdb at whitehouse.gov
⁴ See https://bit.ly/3EaGE30 at spglobal.com
⁵ See https://econ.st/3EbjUQm at economist.com
⁶ See https://bit.ly/32FHZAZ at ec.europa.eu
⁷ See https://bit.ly/3EaAEaH at theguardian.com
⁸ See https://bit.ly/3d1VT2f at iea.org
⁹ See https://bit.ly/32G1qK1 at institutionalassetmanager.co.uk
¹⁰ See https://bit.ly/3EcbkRq at ec.europa.eu
¹¹ See https://bit.ly/3d6LKBD at eco-act.com
¹² See https://bit.ly/3pdXMyD at eurofer.eu
¹³ See https://bit.ly/3G1LOiA at ec.europa.eu
¹⁴ See Deutsche Bank Research, “Can Mining & Steel sustain in a low carbon world?”
¹⁵ See https://bit.ly/3xB6QBz at arcelormittal.com
¹⁶ See Deutsche Bank Research, “Can Mining & Steel sustain in a low carbon world?”
¹⁷ See https://bit.ly/3G1LOiA at ec.europa.eu, page 2
¹⁸ See https://bit.ly/3I6MGEs at investorschronicle.co.uk
¹⁹ See https://bit.ly/3I9a83A at kedglobal.com
²⁰ See https://bit.ly/3G5emrq at argusmedia.com
²¹ See https://bit.ly/3xDxxW2 at db.com
²² See https://bit.ly/3xlB8I0 at db.com