DR.CHENJIAZI ZHONG

Steel is one of the most sustainable materials in the world; however, decarbonizing remains a challenge because the steel industry is accounting for approximately 8% of total greenhouse gas (GHG) emissions. Investors are supporting the efforts to limit global warming to well below 2°C above pre-industrial levels in order to deliver the goals of the Paris Agreement. The three types of climate transition risks relevant to the steel sector are policy risk, technology risk and market risk. 

Policy Risk

Companies with production in markets where the introduction of carbon prices is likely (or existing carbon prices are likely to increase), will be exposed to additional costs unless such costs can be passed on to customers. The steel sector could see profits fall by 80% if higher carbon prices emerge.

Technology Risk

The type of production facilities owned by steel companies is an additional consideration of relevance in assessing exposure to climate-related financial risk, given that the two main types of steel production differ substantially in their energy intensity. 

• Basic oxygen furnace, accounting for around 70% of global production, produces new steel from iron ore and is highly carbon intensive because of the fuels required.
• Electronic arc furnace uses electricity to heat scrap steel to create new products and is 36% less emission-intensive than the basic oxygen furnace.

Steel companies mainly reliant on basic oxygen furnaces for production will therefore be more exposed to costs related to carbon pricing, or other policy interventions, than those whose production is mainly via the electric arc furnace.

Market Risk

Financial risk may also come from new or competing products driven by the changes in customer preferences for materials supporting the energy transition; for example, auto manufacturers may shift from heavier materials (e.g., steel) to lighter-weight materials (e.g., carbon fiber). This means that steel producers with a diversified range of end-use products are likely to be most resilient to climate-related market risks.

Given the constraint of scrap availability, R&D programs on innovative primary steel production routes should be intensified to accelerate the transition to a fully decarbonized iron and steel sector new steelmaking technologies that would result in substantially reduced carbon intensity are in early phases of development, lack either commercial or technical viability, and are unlikely to gain widespread adoption in the next 10 years.

In the ESG initiatives in the steel sector, investors’ expectations are generally on the governance transition plans and disclosures:

• Governance expectation: Clearly define board and management governance processes to ensure adequate oversight of climate-related risk and the strategic implications of planning for a transition consistent with 2°C and efforts to pursue 1.5°C.

• Transition-plan expectation: Take action to reduce GHG emissions across the value chain, consistent with the Paris Agreement’s goal of limiting global average temperature increase to well below 2°C compared to pre-industrial levels.

• Disclosure expectation: Provide enhanced corporate disclosure in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) to enable investors to test the robustness of the company’s business plans against a range of climate scenarios, including well below 2°C, and improve investment decision-making.

For steelmakers, five key actions can help guide the sustainable transition: 

• Assess and adopt clean technologies, promoting a balance of risk, capital cost and quality. Some of the emerging technologies to reduce emissions include carbon capture, innovations in product mix, hydrogen and alternative smelting reduction processes
• Increase production of sustainable steel to capitalize on growing demand
• Improve ESG performance to meet shareholder expectations
• Embrace digitization to unlock value
• Collaborate with all stakeholders to accelerate the transition to improve output quality

Steel Companies’ Sustainability Initiatives in the United States

Iconic United States Steel (NYSE: X), industry giant Nucor (NYSE: NUE), consolidator Cleveland-Cliffs (NYSE: CLF) and upstart Steel Dynamics (NASDAQ: STLD) are sizable steel companies in the US. The biggest thing separating these companies is the way they make steel. While steel is always a cyclical industry, with performance tending to rise and fall along with economic activity, US Steel’s earnings are much more volatile than those of Nucor and Steel Dynamics.

Nucor and Steel Dynamics use electric arc furnaces. Also integral to the steel-making process is scrap metal, with both Nucor and Steel Dynamics operating sizable scrap businesses. Electric arc mills tend to be smaller and more flexible than blast furnaces, allowing them to adjust more quickly to changes in demand. They can remain profitable even during periods of relatively weak overall demand. Electric arc mills are more consistent performers over time. This adds up to a better long-term performance for investors. That consistency of performance translates into other benefits for shareholders. Nucor has increased its dividend annually for 47 consecutive years. Steel Dynamics has increased its dividend each year for a decade. Most long-term investors would be better off sticking with Nucor and Steel Dynamics, both of which have more consistent core businesses built on electric arc mills. It’s an advantage that may not seem important today, but when the sector turns lower, it will be.

A meaningful portion of CLF’s successes is attributable to its prudent operational strategy implemented in recent years, including an increased focus on ESG. CLF is currently leading the steelmaking industry in decarbonizing operations. The company has spent more than US$1 billion to date in modernizing its production facilities and methodologies to reduce emissions. The investments have also made CLF more economically competitive within the steelmaking industry by protecting the company from pricing risks, increasing overall yield, and attracting new demand arising from the need for carbon-friendly steel. This makes CLF an attractive investment from a business standpoint, which effectively differentiates it from being a mere commodity-linked stock.