Emissions Trading System exemptions betray the steel sector’s power and politicians’ lack of mettle

The steel industry’s strategic importance coupled with its strong lobbying power have combined to shield it from a tightening of the Emissions Trading System. This is harmful to the climate, unfair to taxpayers and hurts the sector’s long-term competitiveness.

Photo by Ludomił Sawicki on Unsplash

Under the reformed Emissions Trading System (EU ETS) agreed at the end of 2022, heavy industries are required to slash their emissions more than in the past decade but remain nevertheless shielded from the price signal. These energy-intensive sectors will continue to receive large amounts of their emission allowances for free until at least 2030 to the tune of over €400 billion, according to Climact’s open-source model for simulating the functioning of the system. However, at least a major reform of the benchmark system that regulates the allocation of free pollution permits is on the cards.

Product benchmarks, such as for “hot metal” (the output of blast furnaces), are set as the average emissions of the 10% least emission-intensive producers of a given product across the EU ETS. Every installation in the sector receives free allocation up to the benchmark level. As a result, those who are less emissions-intensive than the benchmark actually receive more allowances than they need, while those emitting more have to acquire additional pollution permits. Benchmark values should progressively evolve to reflect the progress made in ETS sectors in terms of emissions reductions and to support frontrunner cleaner installations.

Most notably, though, this benchmark reform will not include one of the most polluting industries: steel-making. While free allowances in the steel sector will be reduced progressively with the introduction of the Carbon Border Adjustment Mechanism (CBAM), reaching 48.5% in 2030, the steel sector, unlike the other sectors under the ETS, will not be subject to a benchmark adjustment. In other words, the 28 most polluting installations in particular, accounting together for an average of 129 million tons of CO2 pollution per year, will not see their free allocation further reduced to reflect the progress made in the sector and to include newer and cleaner installations.

The steel sector managed to obtain this special treatment because it is a key industry in Germany, which possesses the greatest number of blast furnaces amongst EU countries and steel feeds the German automotive industry, and the German government lobbied all the other 26 member states on the industry’s behalf. Can this exemption simply be attributed to the lobbying success of a self-interested industry? Or is it truly justified to help the European steel industry decarbonise?

Driving with the handbrake on

There is a precedent of the European steel industry being propped up because of its long history and its crucial role in Europe’s economic growth and development. It has faced significant challenges in recent years – global overcapacity (especially Chinese excess capacity leading to a flooding of the market with cheap steel, making it difficult for European producers to compete on price), rising costs, and intense competition from other regions, particularly Asia, but also the United States. The European Union has taken various measures to support its steel industry, such as imposing tariffs on imports of low-priced steel from countries like China, Russia, and Turkey, and allowing its member states to provide state aid to struggling firms.

However, public support measures seemed primarily aimed at preserving jobs and maintaining a strategic industry rather than promoting innovation for decarbonisation and longer-term competitiveness. Worse still, public support has often come without sufficient environmental controls attached. Global steel manufacturers have repeatedly exceeded the limits of air pollutants (fine particles, nitrogen dioxide, etc.), while receiving billions of euros in public funding, especially in France, according to the investigative news outlet Disclose. Perhaps the measures have, in fact, reduced the pressure on European steel companies to adapt and invest sufficiently in modernisation, efficiency and, especially, decarbonisation.

The steel industry’s exemption from the full brunt of pollution pricing under the EU’s Emissions Trading System has been subject to the same protectionist rationale and the industry has not delivered its necessary decarbonisation in return. Raising the decarbonisation bar for the steel industry with the latest ETS review while shielding it from the benchmark reform is, once again, like driving a car with the handbrake on. A climate policy tool continues to double up as a protectionist instrument.

Cashing in rather than bridging the cost gap

Nevertheless, there is widespread consensus that the European steel industry on the whole has got the message, especially with the introduction of the Fit for 55 policy package, that it must decarbonise. Most players now have serious decarbonisation plans. Some truly look to the ETS to provide an advantage to the innovators in the field. 

Yet there is also something to explain why others are keen to keep it a lenient system. Just over half of the EU’s primary steel-making capacity (37 mt out of 70 mt), where coal-based blast furnaces are coming to the end of their lives before 2030, is due to be replaced by Direct Reduced Iron (DRI) technology, according to ‘Global steel at a crossroadsby Agora Industry. This means that coal will eventually be replaced by green hydrogen as a feedstock, though until there is enough of that, fossil gas will be used. However, commercial-scale DRI is only due to come online gradually from 2025, according to company announcements, so the lifetime of some existing blast furnaces will be prolonged by up to five years, and it is in the short-term financial interest of their operators not to pay for the climate pollution they cause or even cash in on some free allowances.

The transition from blast furnaces to DRI steelmaking also requires a cost gap to be bridged (it reportedly costs around € 3 billion per installation), and steel companies argue that the ETS carbon price makes this gap more difficult to close. Yet exemptions from the EU’s carbon price, and from a more stringent benchmark definition, do not close the cost gap and have not historically incentivised private investments in new technologies and production processes. Other policy instruments, such as Carbon Contracts for Difference (a project-based financial instrument that guarantees a fixed carbon price over a given period and reduces the risk of investment in new technology), are needed towards this end. 

Moreover, for a significant chunk of capacity up for reinvestment (21 mt out of 70 mt), decisions in favour of low-carbon technologies have not yet been taken. So, in addition to a cost gap, there remains a transformation or ‘decision to invest’ gap, and the full application of the carbon price (plus additional forms of support) is needed as an incentive here.

Filling the transformation gap 

It is an optimistic scenario in which the European steel industry gains a competitive advantage globally by being first in low-carbon steel. Decarbonisation is not yet the political order of the day everywhere, and demand for more expensive low-carbon steel has yet to grow. Moreover, the demand for steel, especially in developing countries, but also for rolling out renewable energy infrastructure in established industrial countries, is expected to increase in the coming years. It is unlikely to be met with low-carbon steel and will make it difficult to meet emissions reduction targets globally. While the industry is gearing up for the rollout of low-carbon technologies, such as DRI for primary steel production, the cost of implementing these technologies is high, and production volumes are not likely to grow fast. The recycling of scrap steel with electric arc furnace (EAF) technology should gain in importance with increased efforts at making economies, especially the EU’s, circular, but many systemic hurdles remain to be overcome.   

For the optimistic scenario to prevail, or simply for a prospective decarbonised European steel industry to face a level playing field internationally, technological innovation, government support, and international cooperation will have to combine in a propitious way. The contribution of the carbon price signal from the EU emissions trading system and the Innovation Fund financed by its revenues can only be to help push the steel industry’s decarbonisation along – a contribution to ‘futuring’, i.e. exemplifying the desirable so as to make it true. In and of itself, it will not help the European steel industry to gain an advantage – but neither does obtaining exemptions.

Power play

Decarbonising the steel sector is no doubt expensive. The ETS should, however, not be interpreted as making it yet more expensive. Rather, the role of the ETS is to make it cheaper to have decarbonised and more costly to continue polluting. This logic hasn’t changed from the time when the steel sector made no serious effort to transition to low-carbon technologies to now when most steel companies have such plans. The ETS carbon price has not been (and will not be) a sufficient incentive to decarbonise, but neither does free allocation or exemptions from tightening the free allocation system solve the challenge of getting industry to invest in its own decarbonisation.

The lobbying success of the steel industry is therefore a demonstration of its power rather than a service to either sharpening a climate tool or to facilitating investment in the decarbonisation of steel plants. Yet cost avoidance is in keeping with industry behaviour. It is the political decision-makers who should have fended off the steel industry’s lobby in the interest of the common good. At the very least, the exemption from the ETS benchmark reform should have had strings attached – such as serious decarbonisation commitments by companies and robust plans to back them up.

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