POSITION PAPER
Ref. Ares(2020)7208148 - 30/11/2020
COMPENSATION OF INDIRECT CARBON COSTS IN
THE POST 2020 EU ETS
OUR KEY MESSAGES
The steel industry (NACE code 2410) is at very high risk of carbon leakage and should remain
eligible for financial compensation after 2020;
The very high risk of carbon leakage is due to a combination of factors: high trade and energy
intensity; exposure to global overcapacity and unfair trade practises; low profitability;
Both steel production routes should remain eligible for financial compensation, notably:
o The electric arc furnace (EAF), which uses electricity to melt and recycle scrap;
o The integrated route, which consumes electricity produced from the combustion of waste
gases generated unavoidably by the steel making process. Financial compensation for this
case is explicitly mentioned in recital 13 of the post 2020 EU ETS Directive;
The aid intensity should be 100% (of the benchmark) and not be digressive; the carbon leakage
risk faced by the sector is not digressive as long as there is no comparable climate legislation
in competing countries;
The most appropriate way to address intra-EU competition is a mandatory implementation of
compensation schemes in all member states. On the other hand, any option that involves a
reduction of the amount of possible compensation is clearly not acceptable;
Compensation should not be made conditional because it does not distort incentives for
energy efficiency investments, since it is based on very strict benchmarks. Such conditionality
would penalise early movers and overlap with other pieces of legislation;
Company specific assessments on the basis of the Gross Value Added (GVA) present several
important limitations because the GVA is highly dependent on the companies’ structure and
may lead to unintended results in case of early movers;
The CO2 emission factor must reflect the actual CO2 cost passed through into prices. The
approach of using historical empirical data on the emission factor in the relevant regional
market should be maintained in order to ensure a consistent and stable framework;
Several sectors (industrial gases, mining of iron ores and pipes) belong to the same value chain
and need to be eligible for compensation since they contribute to the carbon leakage exposure
of the steel industry.
EUROFER AISBL • Avenue de Cortenbergh, 172 • B-1000 Brussels • Belgium
+32 3 738 79 20 • x.xxxxxx@xxxxxxx.xx • www.eurofer.eu • EU Transparency Register: ID 93038071152-83
STEEL INDUSTRY AT VERY HIGH RISK OF INDIRECT CARBON
LEAKAGE
The steel sector (NACE code 2410) has been considered at risk of carbon leakage under EU ETS
phase 3, both for direct and indirect costs. As no major element has reduced such risk (on the
contrary, higher carbon prices have increased it), it should clearly remain eligible also for financial
compensation, as done with free allocation.
The main raw materials used in the production process (iron ore, coke, and scrap) as well as the
steel products are globally traded goods that can be easily transported. Hence, very small price
differences play an important role on the market.
The bulk of carbon leakage in the steel sector occurs as a result of the slow but persistent loss of
sales to the advantage of competitors who all operate in countries where there is no such
internalisation of carbon costs. The most marginal sales in terms of contribution are the first to be
lost, for instance in export markets. The resulting loss in sales volumes pushes up average fixed
costs, thus reducing the contribution of the remaining sales, so that more business “falls off the
cliff” as no longer being profitable. Thus competitors from third countries progressively gain EU
market share at the expense of EU producers’ as an increasing proportion of the latter’s’ sales
become marginal. Statistics on imports and exports of the last years provide indication of this
trend, with the EU that became a net importer of steel finished products while traditionally it was
a net exporter.
The high carbon leakage risk of the steel sector was also underlined in the
“In-depth analysis in
support of the Commission Communication COM (2018) 773- A Clean Planet for all- A European long-
term strategic vision for a prosperous, modern, competitive and climate neutral economy”. In the
tables 13 (page 221) and 16 (page 225), ferrous metals is the energy intensive sector with the highest
impact both on output and on investments from the increased unilateral climate ambition in line
with 1.5° objectives. As an order of magnitude, the additional downward impact is estimated at 10.1
% for steel, while the second impacted sector (non-ferrous metals) is estimated only at 3.5%.
Market characteristics of the steel industry
The main market characteristics that determine its very high exposure to carbon leakage are:
Combination of both high trade and energy/electro intensity: according to the Commission
data used for the post 2020 carbon leakage list the trade intensity is 25.7% and indirect electro-
intensity is 1.414 kg CO2/€ GVA.
Global overcapacity (sections 1.1 and 1.1.2 NERA study): the gap between global production
and demand was 650 million tonnes in 2017, which is almost three times the European capacity
of around 220 million tonnes. EU industry has reduced both capacity and production over the
last decade. The EU market share in the total production decreased from 15% in 2008 to 9% in
2018.
Exposure to international trade and unfair trade practices such as dumping (sections 1.2.1 and
3.1 NERA study): imports have been steadily increasing in volume and value since 2012 reaching
the highest levels despite the measures implemented by the EU in reaction to such unfair trade
practices. As a result of the combined effect of increasing imports and decreasing exports, the
trade balance has worsened significantly. The EU became net importer in terms of quantities
in 2013 and in terms of value in 2015.
Low or negative profitability (section 2 NERA study): the EBIT margin estimated with Eurostat
figures remained between 1% and 2% in the reference period 2014-2016 (and was even negative
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STEEL INDUSTRY AT VERY HIGH RISK OF INDIRECT CARBON
LEAKAGE
in 4 out of the 6 preceding years). The steel sector is the third lowest for the ratio Gross
Operating surplus/turnover among all (35) sectors addressed by the targeted consultation.
Steel production routes
Two processes are employed in the EU for producing steel. One, the electric arc furnace (“EAF”),
uses electricity to melt scrap to produce new steel. This process contributes to the sustainable use
of natural resources as it recycles scrap (‘old’ steel which is in principle 100% recyclable).
The other process is called integrated route (“BF/BOF”) and produces steel using mainly virgin raw
materials (iron ore, coal and limestone) with the addition of some steel scrap. Since there is a finite
amount of scrap available and due to quality constraints, the integrated route is indispensable to
meet the demand of an ever growing steel market.
The iron ore-based steel making sites are characterized by the production of waste gases (coke
oven gas, blast furnace gas, basic oxygen furnace gas) which due to their residual calorific value
are recovered to generate heat and steam (replacing natural gas) but also electricity (depending
on the energy balance of the site). The most efficient way to treat exceeding waste gases is to use
them in power plants for electricity production. The main characteristic of this waste gas-based
electricity production is that it is not demand driven but depends exclusively on waste gas
availability related to the production of steel.
According to
the Commission Delegated Regulation 2019/331 on post 2020 free allocation rules
(consistently with the pre-2020 Benchmarking Decision), recital 18, “
for the determination of the
benchmark values for products of which the production generates waste gases, the carbon content of
those waste gases should be taken into account to a large extent;[…] where waste gases are exported
from the production process outside the system boundaries of the relevant product benchmark and
combusted for the production of electricity, no additional allowances are allocated beyond the share
of the carbon content of the waste gas accounted for in the relevant product benchmark”.
As a result of this principle, the steel plant generating waste gases transferred to power plants
faces a structural shortage in free allowances corresponding to the natural gas emission factor that
is subtracted from the benchmark value. Due to this free allocation shortage, it is essential that the
integrated steel plants remain eligible for financial compensation of indirect costs. This element is
acknowledged and stressed also in the post 2020
EU ETS Directive 2018/410 (recital 13): “
It would
be desirable that Member States partially compensate, in accordance with State aid rules, certain
installations in sectors or subsectors which have been determined to be exposed to a significant risk
of carbon leakage because of costs related to greenhouse gas emissions passed on in electricity
prices, including inter alia for the consumption of electricity by the installations themselves produced
through the combustion of waste gases”.
According to the Commission staff working document accompanying the latest Report from the
Commission on Energy prices and costs in Europe, electricity consumption in the EAF route was
around 0.53 MWh/t in the period 2014-2016 and in the BF/BOF route 0.35 MWh/t.
In addition to direct electricity consumption, it should be noted that steel sector uses also
significant amounts of industrial gases such as oxygen for unavoidable purposes which have an
important embedded electricity consumption. On the basis of the data from the Best Available
Techniques Reference document (BREF), the embedded electricity consumption related to oxygen
is estimated at 24 kwh/t crude steel in the EAF route and 92 kwh/t in the BF/BOF route.
Both routes are indeed facing fierce competition from countries with no CO2-related constraints,
not only on the upstream market but also in electro-intensive downstream processing activities
(e.g. rolling, coating).
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STEEL INDUSTRY AT VERY HIGH RISK OF INDIRECT CARBON
LEAKAGE
Global and intra-EU competition
The steel sector is in high competition both within the EU and vis a vis third countries’ producers.
Considering the relatively low market share of EU production in total global production as well as
the high exposure to international trade and unfair trade practices related to global overcapacity,
the extra-EU competition puts the whole EU market under great pressure and risk of carbon
leakage.
The rules on financial compensation should prioritise the objective of mitigating the risk of carbon
leakage against third countries as clearly set in the EU ETS Directive. This is consistent both from
the environmental viewpoint and industrial competitiveness. Indeed, any leakage of production
outside the EU to constituencies that do not have a comparable cap and trade mechanism will
result in higher emissions and leakage of investments, production and jobs.
The intra-EU competition is indeed a relevant element of any industry that cannot be ignored. The
most appropriate way to address it is a mandatory implementation of compensation schemes in all
member states. On the contrary, any option that involves a reduction of the amount of possible
compensation is clearly not acceptable, as it would weaken during the implementation phase the
only instrument foreseen by the ETS Directive to defend the sectors most exposed to indirect
carbon leakage.
Conditionality
Compensation should not be made conditional on energy efficiency requirements. In fact, energy
efficiency improvements are a must for industries with high energy costs in order to remain
competitive. Compensation of indirect costs does not distort incentives for energy efficiency
investments because it is still based on very strict benchmarks reflecting the best performance in
the sector. Furthermore, such conditionality would penalise early movers that are close to technical
limits. Finally, other pieces of legislation, such as the Energy Efficiency Directive, include provisions
in this regard.
Aid intensity and digressiveness
The steel sector is highly exposed to carbon leakage risk linked to indirect costs and is unable to
pass through unilateral regulatory costs without genuine risk of losing market shares. This risk is
even more relevant in the context of much higher carbon prices compared to the ones experienced
until 2017. Furthermore, affordable and competitive electricity prices are essential to facilitate the
transition to breakthrough technologies which require even larger amounts of electricity.
Therefore, it is important to set the aid intensity at 100%; existing and further reductions of the aid
intensity undermine the effectiveness of the carbon leakage provisions because actually the risk
faced by the sector is not digressive as long as there is no comparable climate legislation in
competing countries.
Even 100% aid intensity would not mean full compensation of indirect costs, as it would still be
capped by the very strict benchmarks. For instance, in fall back benchmarks, it would still be
reduced by 20% compared to the baseline electricity consumption; i.e. with the current 75% aid
intensity level fixed in 2020, the installations in fall back may receive compensation only for 60% of
the indirect costs (75% of 80%). This is far below the maximum aid intensity level according to EU
state aid rules.
Limitations of company’s specific assessment
Modulating aid intensity on the basis of the Gross Value Added (GVA) of individual companies
presents several important limitations. The GVA of companies is highly dependent on their
structure, including the configuration of the production steps where the higher share of value
added is generated. Furthermore, company-specific assessment on electricity consumption may
lead to unintended results in case energy efficiency measures that have been already implemented.
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STEEL INDUSTRY AT VERY HIGH RISK OF INDIRECT CARBON
LEAKAGE
Emission factor
As a matter of principle, the CO2 emission factor must reflect the full indirect CO2 burden, i.e. the
actual CO2 cost passed through into prices. The approach of using historical empirical data on the
emission factor in the relevant regional market should be maintained in order to ensure a
consistent and stable framework. The calculation of this factor should be based on reliable and
transparent sources in order to reflect the real costs faced by the industry.
Sectors closely linked to steel industry: pipes, industrial gases and iron ores
In the EU ETS phase 3 seamless steel pipes were also included in the list of eligible sectors as they
are closely linked to the steel sector. Therefore, they should remain eligible.
In addition to direct electricity consumption, it should be noted that steel sector uses also
significant amounts of industrial gases (NACE code 2011) for unavoidable purposes such as oxygen
which have an important electricity consumption embedded. On the basis of the data from the Best
Available Techniques Reference document (BREF), the embedded electricity consumption is
estimated at 24 kWh/t crude steel in the EAF route and 92 kWh/t in the BF/BOF route. The lack of
compensation for the indirect costs linked to these gases further exposes the steel sector to carbon
leakage risk. Therefore, the consumption of industrial gases should also be considered as eligible
for financial compensation. This provision is also important in the context of the medium to long
term transformation of the sector, whose breakthrough technologies will need large consumption
of industrial gases like hydrogen.
Finally, it should be noted that also the NACE code 0710 (Mining of iron ores), which is eligible for
financial compensation in the EU ETS phase 3, is very important for the steel sector as it is within
the same value chain because it covers the material “sintered iron ore”. Since it contributes to the
overall exposure to the indirect carbon leakage risk of the steel industry, it is important that it
remains eligible for the post 2020 period.
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