Things You Should Know About China’s Steel Sector’s Potential Inclusion in Carbon Market by 2025

Bringing Steel into the Fold: A Crucial Step in China’s Green Transition

For the past two years, China has been actively engaged in its own green transition through the operation of a carbon market. This innovative system is strategically designed to mitigate the environmental impact of specific industries, starting with a focus on the power sector. As part of its visionary roadmap, China plans to progressively extend the scope of this market, encompassing industries known for high emissions, including steel, non-ferrous metals, and building materials.

The Steel Industry’s Weighty Emissions Contribution

The steel industry is a major contributor to China’s carbon emissions, accounting for around 15 percent of the country’s total. This makes it the largest emitter of carbon dioxide among all manufacturing sectors. The proposal to bring the steel industry under the national carbon market’s umbrella could mark a significant step toward China’s green transition. This transition involves encouraging companies to adopt production methods that produce fewer carbon emissions. This is done by incorporating the costs of carbon emissions into their operations.

Navigating Global Trade Challenges and Climate Goals

This move gains even more importance due to the upcoming implementation of the EU’s Carbon Border Adjustment Mechanism (CBAM). This mechanism will impose a charge on products entering the EU that come from countries with high carbon emissions. Chinese steel manufacturers are expressing concern about the added expenses they might face when exporting to the EU because they lack a domestic carbon pricing strategy.

To effectively address this challenge and align with China’s broader climate goals – like peaking emissions before 2030 and achieving net-zero emissions before 2060 – extending the coverage of the carbon market seems to be the most viable solution for the steel industry. The pressing question now is when and how this expansion will take place. This adjustment holds the potential to not only reshape the steel sector but also contribute to China’s larger efforts to combat climate change on a global scale.

China green transition affects the steel industry.

Preparing the Steel Industry for a Low-Carbon Future in China

By the end of 2025, an important change is on the horizon for China’s steel sector. The nation’s carbon market, a mechanism aimed at reducing carbon emissions, is getting ready to include the steel industry. This move is expected to push the steel sector towards adopting more environmentally friendly practices, thus contributing to a greener future.

Establishing Carbon Data Infrastructure in Steel Production

The process of integrating steel into the carbon market involves a careful consideration of data and emissions. In this market, companies receive “allowances” based on accurate data about their carbon emissions. While the power sector has already joined the carbon market due to its strong data infrastructure, the steel industry faces a more complex challenge. The intricacies of carbon accounting boundaries, workflows, and energy consumption patterns in steel production require thorough groundwork.

In recent years, government agencies have been taking steps to improve carbon emissions data in the steel industry. In 2021, the Ministry of Ecology and Environment enlisted the help of the China Iron and Steel Association to develop an allocation plan for carbon allowances in the sector. They also conducted a study on the monitoring, reporting, and verification of carbon emissions. Subsequently, in 2022, the Ministry issued a notice demanding greenhouse gas emission reports from various industries, including petrochemicals, building materials, iron and steel, non-ferrous metals, paper-making, and aviation.

Collaborative Progress: Industry and Government Efforts Towards Carbon Neutrality

Steel production involves several key processes like ore mixing, sintering, iron smelting, steelmaking, and rolling. Of these, six major processes have already been incorporated into the national carbon market’s monitoring system. This step has been driving gradual enhancements in the industry’s data infrastructure.

In pursuit of this transition, the Chinese Academy for Environmental Planning recently held meetings involving government bodies, industry associations, research institutes, and verification organizations. The discussions revolved around vital topics such as defining carbon accounting boundaries, determining allowances for different steel production processes, and refining monitoring procedures. As a result of these talks, a proposal emerged: to efficiently finalize the integration of the steel industry into the carbon market by identifying key production processes eligible for carbon allowances, setting benchmarks for allocations, and establishing a method for emissions verification.

Considering the ongoing trajectory of governmental efforts and insights from industry experts, it’s projected that the implementation of carbon allowances in the steel industry will be largely completed by the end of the 14th Five Year Plan (2021–2025). Following the power sector, steel will become a part of the second wave of major emitting industries entering the national carbon market. Additionally, the impending Carbon Border Adjustment Mechanism (CBAM) is anticipated to impact China’s steel exports and might expedite the industry’s assimilation into the national carbon market. This move aims to avoid the potential extra costs linked to a lack of domestic carbon pricing.

Understanding Carbon Allowance Allocation in China’s Steel Industry

When a company becomes a part of the carbon market in China, it’s provided with a flexible limit on its CO2 emissions for a specific time frame, known as a “carbon allowance.” These allowances are meticulously assigned and overseen by government authorities. To adhere to this system, companies are required to deduct an amount of carbon allowance equivalent to their own carbon emissions annually. The process of allocating these carbon allowances is a pivotal component of establishing the carbon market and ongoing discussions are shaping its implementation within the steel industry as it becomes a part of the national carbon market.

Allocation Approaches: Grandfathering and Benchmarking

  • The steel sector employs two primary methods for allotting carbon allowances: “grandfathering” and “benchmarking.”
    • Grandfathering: This approach sets carbon allowances based on a company’s historical carbon emissions or carbon intensity. Essentially, it compares a company’s performance against its own past records.
    • Benchmarking: In contrast, benchmarking determines allowances by considering the average carbon intensity across the industry. It entails comparing different companies within the sector. The benchmark value is derived from the top-performing companies. For instance, the European Union’s carbon market establishes its benchmark based on the top 10% of companies in terms of productivity.

While many carbon markets globally, including the EU, prefer benchmarking for carbon allowance allocation in the steel sector, China’s trial carbon markets have shown a leaning towards the grandfathering method, primarily due to data availability and other pertinent factors.

Current Landscape and Future Outlook for Steel Industry

The steel industry is actively involved in six of the eight regional carbon markets currently piloted in China. Among these, five have embraced the grandfathering approach, whereas Guangdong has implemented a combination of benchmarking and grandfathering for various steel-making processes.

However, a limitation of the grandfathering approach is its failure to encourage companies with outdated and inefficient practices to enhance their emissions reduction efforts. Companies that have previously achieved substantial emission reductions and are energy-efficient receive fewer allowances, while those with higher emissions and less efficiency receive relatively generous subsidies. Conversely, benchmarking favors technologically advanced companies, motivating others to improve and meet industry benchmarks. This stems from low-carbon-intensity companies emitting less than their benchmark allowances, whereas high-carbon-intensity companies surpass their budgets.

The foundation for implementing a benchmarking approach in the steel sector of China’s carbon market is gradually strengthening. Major steel producers like Baosteel, WISCO, and Shougang actively participate in China’s pilot carbon markets, gaining valuable experience. Furthermore, steelmakers emitting over 26,000 tonnes of CO2 equivalent annually are now providing emissions data to the Ministry of Ecology and Environment (MEE), bolstering the reliability of underlying data.

Given that China’s national carbon market presently employs benchmarking for carbon allowances in the power industry, establishing benchmarks for industries entering the national carbon market is a pivotal step in its evolution. Recent discussions have underscored the urgency of determining carbon allowance benchmarks for the steel industry. Considering the necessity of meeting the EU’s Carbon Border Adjustment Mechanism (CBAM) standards, benchmarking will likely emerge as the chosen method for carbon allowance allocation once the steel sector integrates into the national carbon market.

Exploring the Shift: China’s Steel Sector and Carbon Market Dynamics

China’s steel industry is a cornerstone of the nation’s economy, generating a substantial 5% GDP and over 50% global steel production. However, beneath these impressive figures lies a critical environmental challenge. Compared to counterparts in regions like the EU, where steelmaking predominantly employs recycled materials, China relies heavily on long-process steelmaking fueled by coal and coke, resulting in substantial carbon emissions. A staggering 90% of China’s steel output followed this carbon-intensive pattern in 2019, sharply contrasting to the 10% produced through more environmentally friendly methods. The discrepancy is even more pronounced compared to the global scenario, where long-process and short-process steelmaking is nearly equal at 52% and 48%, respectively.

Emission Revolution: China’s Vision for Steel and Carbon Market Convergence

China is now poised to revolutionize its steel industry’s carbon footprint. By the year 2025, the nation aims to incorporate the steel sector into its burgeoning carbon market – a strategic move with the potential to usher in a much-needed era of low-carbon practices. The mechanism of the carbon market revolves around allocating companies a finite number of carbon allowances, which can be traded. Initially distributed at no cost, these allowances will gradually shift to a larger proportion of paid allocations, exerting pressure on companies to curtail their carbon emissions.

A Dual-Pronged Transformation Strategy: Embracing Eco-Friendly Practices and Market Evolution

While apprehensions about increased production costs linger, the initial phase of integrating the steel sector into the carbon market is anticipated to yield modest impacts on steel manufacturers. During this period, allowances will primarily be allocated without charge. Over time, a measured transition to auctioned allowances is envisaged, directing the returns toward bolstering emission reduction endeavors and fortifying the carbon market’s infrastructure.

Benchmarking and Data Integrity in Carbon Trading

To ensure equitable and accurate carbon trading practices, the implementation of benchmarking and robust data infrastructure is paramount. Allocating allowances based on industry benchmarks serves to amplify transparency and credibility. This approach entails stringent regulations for emissions monitoring, regular audits, and third-party verifications, cementing the bedrock of the carbon market and paving the way for a sustainable future in China’s steel sector.

In essence, China’s audacious step toward integrating steel into its carbon market holds transformative potential. By incentivizing emission reduction and fostering sustainable methodologies, this strategic convergence stands poised to reshape the trajectory of the steel industry, charting a course toward a more environmentally conscious and economically viable future.

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