From wind turbines to electric cars, a net zero carbon economy needs steel. But its production creates significant CO2 emissions that must be cut to mitigate climate change. With this in mind, we regularly engage with steelmakers on their plans to reduce direct emissions, as well as miners on the indirect emissions that arise from their steelmaker customers processing iron ore.
On the western edge of the Port of Hamburg, beside the cranes and container terminals dotting the banks of the Elbe, an experiment is underway to revolutionise one of humanity's oldest industrial processes. If successful, it could help eliminate 5 to 10% of global carbon dioxide emissions.
From outside, the former Hamburger Stahlwerke site appears the epitome of old-school heavy manufacturing. Clouds of steam roll down from chimneys and hang in the air above the dark buildings, before being slowly dispersed by the blades of a wind turbine.
This is the home of the H2Hamburg project. The company behind it is the world's largest steel producer, ArcelorMittal. It plans to build an industrial-scale demonstration plant that removes carbon emissions from the steel production process and that could one day be powered by renewable energy.
The need to decarbonise
H2Hamburg is just one example of the ways in which ArcelorMittal and other steelmakers hope to decarbonise the industry. Others include carbon capture systems and the creation of carbon-neutral steel via electrolysis.
The need is urgent. Every tonne of steel the world produces generates nearly two tonnes of carbon dioxide. Primary steel (made by refining iron ore rather than from recycling metal) is still expected to make up over half of production in 2050; so those companies that can develop effective, low-carbon production methods are likely to be the sector's long-term winners.
Getting to carbon neutral
We routinely engage with ArcelorMittal and its peers to quiz them on their decarbonisation plans. It's a collaborative process. We gain valuable insights about how companies are reducing emissions and the challenges they face. These engagements are also an opportunity for us to share trends and priorities we're seeing across the industry.
Last year, we attended ArcelorMittal's sustainability conference. The company's goal is to cut emissions by 30% this decade and become net zero carbon by 2050.
To hit the 2030 target, its ‘smart carbon' initiative will use carbon capture and storage (CCS) and circular carbon technology (i.e. greater use of recycled material and conversion of waste gases into inputs for other processes). The steel industry already recycles most of its by-products, with a material efficiency rate of over 97%. Circular carbon projects such as Carbon2Value, of which ArcelorMittal is a member, aim to get that to 100% by capturing CO2 and using it to produce materials like ethanol and naphtha, which can then be used to make plastic.
Longer term, ArcelorMittal hopes to use green hydrogen to produce iron through a process called direct reduced iron (DRI), which could then be refined in electric arc furnaces powered by low-carbon electricity, creating an entirely carbon-neutral production process. The goal of H2Hamburg is to prove this concept, initially using ‘grey' hydrogen from fossil fuels.
None of this will come cheap
Following the conference, we set up a call with ArcelorMittal's sustainability team to probe these plans - and what they will cost - in more detail, to help us understand how the sector will evolve.
The company estimates that smart carbon initiatives could add between 30 and 60% to production costs, while using green hydrogen to produce DRI would raise production costs by 80%. That is on top of the tens of billions needed in upfront capital expenditure.
Source: ArcelorMittal, June 2020.
During our call, the company acknowledged that some of its plans will need lawmakers to create a level playing field with imported steel. This could include carbon border adjustments that would tax steel imports based on their carbon footprint. The sector will also need abundant clean energy to make carbon-neutral steel a reality at scale.
Governments, more generally, have a role to play in setting policy frameworks and incentivising changes in corporate behaviour. As an example, decarbonisation was not a top-of-mind topic in China before President Xi announced the net zero 2060 carbon target, a move that surprised the market. Since that development, there has been a clear step change in Chinese steelmakers' efforts to address carbon emissions, which allows for more productive engagement. China's announcement has also arguably catalysed action in Japan and Korea. That doesn't change the need for policy support. The capital cost of decarbonising will need financing, while currently carbon-free technologies are not yet cost competitive.
Engaging up and down the value chain
At Fidelity, as well as speaking with steelmakers, we also engage with their suppliers - the miners of iron ore and coking coal. Miners have an interest in the production of carbon-neutral steel, because steelmaking represents a large part of mining's scope 3 greenhouse gas emissions - indirect emissions generated elsewhere in a company's value chain.[1]
Source: Fidelity International, March 2021. Data for BHP and S32 are 2020, others are 2019.
Efforts to tackle scope 3 are a big part of our discussions with miners. On a call with BHP's management, for example, we discussed its partnership with China's largest steelmaker, China Baowu. The two companies plan to share technical knowledge and fund research into low-carbon steelmaking. BHP has also invested in Boston Metal, a US start-up spun out of MIT. Boston Metal seeks to replace the blast furnace used in today's steel production with a process called molten oxide electrolysis, in which electrons, rather than carbon, remove the oxygen from iron oxide.
Acting as a beacon
Our engagements with steel and mining companies help us evaluate the prospects for individual firms in both sectors and also provide a read across to other heavy industries trying to tackle hard-to-mitigate emissions. Because we are vocal about environmental, social and governance (ESG) issues, we now get incoming calls from non-ESG leaders - including within the steel industry - who are looking to improve and want our input. This includes identifying the most material activities to prioritise and helping to interview potential board members.
The challenge of decarbonising steel will not be solved in a single 'big bang' moment. It requires the collaboration of several sets of stakeholders - steelmakers themselves, their customers, and policymakers. As investors, we play our part by ensuring the issue remains high on corporate agendas.
[1] Scope 1 emissions are those generated by sources a company owns or controls. Scope 2 emissions are those generated by company using electricity, steam, heat or cooling in its processes. Scope 3 covers emissions elsewhere in the value chain, for example those generated by customers using its product. - which dwarf those generated by miners' own operations.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of an investment in overseas markets. Investments in emerging markets can also be more volatile than other more developed markets. A focus on securities of companies which maintain strong environmental, social and governance ("ESG") credentials may result in a return that at times compares unfavourably to similar products without such focus. No representation nor warranty is made with respect to the fairness, accuracy or completeness of such credentials. The status of a security's ESG credentials can change over time. Reference to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority and Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM0921/36631/SSO/NA
