Cleaning up steel on the road to net zero

5 min read 16 Feb 22

As major economies look to move towards carbon neutrality, steel is increasingly coming under the spotlight, with its production accounting for around 7% of global greenhouse gas emissions . The industry is gradually cleaning up its act and producers are slowly embarking on the pathway towards ‘green steel’ with significant capital commitments. However, there are still major long-term challenges to the widespread adoption of low-carbon production methods.

We believe it’s crucial to understand the industry’s roadmap to deliver sustainable changes. This should not only help us to inform our own ESG policies around steel exposure and improve our ability to meet climate objectives, but also to identify bond issuers with more sustainable business models and therefore, superior long-term investment potential.

Electric arc furnaces and hydrogen offer a route to carbon neutrality

Steel’s negative environmental impact can be largely attributed to the industry’s current reliance on blast furnaces for global steel production. Blast furnaces require coking coal as the reducing agent to convert iron ore into iron in the steelmaking process, which leads to large CO2 emissions. Although less carbon intensive than other materials, such as aluminium and concrete, the sheer volume of steel production means that reducing its environmental effects is a priority to help meet global climate change objectives.

“The route to sustainable steel and carbon neutrality is through electric arc furnaces.”

Encouragingly, many steel producers have begun to optimise their production methods. These include using higher-quality iron ore and scrap metal as inputs, reusing blast furnace gas by-products and recovering waste heat previously lost through inefficiencies. However, while these techniques offer the potential for incremental progress in the near term, there is unfortunately a limit to how much carbon can be removed from blast furnace steelmaking processes. To take one example, there is simply not enough supply of scrap metal to meet demand.

Instead, the route to sustainable steel and carbon neutrality is through electric arc furnaces (EAFs). Outside China, EAFs already account for just under half of global steel production2. This type of furnace can be potentially powered using renewable energy and, crucially, can also be adapted to replace coking coal with natural gas to produce direct reduced iron (DRI), which dramatically reduces CO2 emissions. 

Over the long term, the industry aims to replace natural gas with sustainably produced (‘green’) hydrogen. This technology has proven efficacy and can theoretically operate at scale. As such, it is seen as the most commercially viable route to carbon neutrality. However, steel producers still face a long road ahead.

Financial challenges are a roadblock

Alongside technical barriers, steel producers must overcome significant financial obstacles to implementing green steel. Given the limitations of blast furnaces, producers must ultimately replace them with EAFs if they are to achieve carbon neutrality. However, blast furnaces are long-term assets with typical useful lives of around 50 years3. This implies a significant proportion must be written down or written off to achieve more ambitious environmental goals.

Given that global steel production has mostly shifted to fast-growing economies, notably China and India, this presents a major challenge. Ninety percent of Chinese steel is produced in blast furnaces, compared to 52% in the rest of the world, while India is responsible for the highest carbon intensity4. The blast furnaces in these countries are relatively new due to the more recent development of their economies, which naturally leads to longer replacement cycles. To reach its 2060 carbon neutrality target, for instance, China may need to replace a large number of its blast furnaces before their useful lives have expired.

The most promising green steel projects are being piloted in Europe, where depreciated assets are more prevalent and growing amounts of capital are being invested in lower-carbon production methods. Thyssenkrupp Steel, for example, will begin to replace its four blast furnaces in Germany with EAFs that can operate using green hydrogen from 20255. Meanwhile, Europe’s largest steel producer6, ArcelorMittal, aims to reduce its European CO2 emissions by 35% by 20307

Reducing the carbon impact of European steel, which represents around 10% of global steel production, could reduce seaborne coking coal consumption by 3% within a decade, which would be a welcome step forward. Meanwhile, at a global level, it will play a key role in the ongoing shift towards more environmentally sustainable urbanisation through technologies such as electric vehicles and railways, both of which rely on steel as a major component .

Investors will play a major role 

While the steel industry’s journey towards low carbon intensity involves considerable timescales, we believe it has become increasingly pressing for investors to identify how supply chain members are leading this transition and to engage directly with them. 

Alongside regulatory requirements, including the European Union’s (EU) Sustainable Finance Disclosure Regulation (SFDR), many investors have ambitious ESG plans and policies that exceed regulatory responsibilities, which can directly impact their ability to invest in the steel supply chain. At M&G, this includes restricting our exposure to coal and transitioning to net zero across our investment portfolios by 2050. Meanwhile, the EU’s regulatory framework has underpinned the recent transition of many of our public debt portfolios to meet SFDR Article 8 requirements. 

Within the steel industry, we have sought to leverage our role as a major European asset manager by engaging directly with producers. This has involved not only gaining a better understanding of their pathway to green steel, but also broader considerations, including their policies on ESG-linked compensation, lobbying and diversity and inclusion.

The road to green steel may be long. However, by understanding the nature of the challenges involved and engaging with producers to help overcome them, we believe investors can better position themselves along the journey, with a view to delivering more sustainable potential investment returns.

1 J.P. Morgan, Green Steel Deep Dive: technically possible, economically challenging; significant supply not a short-term reality, 17 March 2021
J.P. Morgan, Green Steel Deep Dive: technically possible, economically challenging; significant supply not a short-term reality, 17 March 2021
3 Argus, A singular opportunity for steel decarbonisation, 3 November 2021
4 J.P. Morgan, Green Steel Deep Dive: technically possible, economically challenging; significant supply not a short-term reality, 17 March 2021
5 thyssenkrupp Steel, Transformation of the steel industry can become a successful model for the transition to climate neutrality (, 28 June 2021
6 Statista, Leading steel producers worldwide 2020, 7 June 2021
7 ArcelorMittal, Climate Action in Europe, accessed 12 December 2021 

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.