How can financing help China’s heavy industry to decarbonize? | News | eco business

China’s steel industry has pushed back its timeline for reaching its carbon peak from 2025 to 2030, highlighting uncertainties about its ability to cut emissions over the long term.

A guide on the development of the sector was released jointly by the Ministries of Industry and Environment and the National Development and Reform Commission on February 7th. It states that the industry’s CO2 peak must be reached by 2030. Previously, the target had been five years earlier, as published in a draft CO2 peak action plan by the China Iron and Steel Association and published on an official WeChat account.

The new guidance identified the main problems in the industry as overcapacity, environmental performance and “low levels of consolidation” – meaning there are many small, hard-to-regulate steel mills.

Reducing emissions from carbon-intensive industries like steel and cement making is critical to China’s efforts to meet its dual carbon targets of peaking by 2030 and reaching neutrality before 2060. But low-carbon restructuring and the adoption and commercialization of greener technologies will be difficult to accomplish on a large scale. Support from the financial markets is urgently needed.

A recent report by the Climate Bonds Initiative (CBI), which works to mobilize global capital for climate action, finds that China ties between 2.2 trillion and 12.5 trillion yuan ($346 billion – 1, $97 trillion) to fight climate change. State funding alone will not be enough: private sector and social capital must be mobilized.

However, green finance is hard to come by. The field has grown tremendously due to strong demand from emerging industries such as renewable energy. But high-carbon industries are not typically considered “green,” meaning green finance is out of reach for many companies.

Achieving ambitious goals often requires a tremendous amount of work for the company and it may not be confident that it will be successful. There may not be anyone at the leadership level who is willing to take responsibility for missing the mark.

Xie Wenhong, China Program Manager, Climate Bonds Initiative

So where will the money for decarbonizing heavy industry come from and where will it go? “Transition funding” could be the answer. There is not yet a universally accepted definition of the term, so standards and mechanisms need to be developed, consistent with top-level policies and sectoral roadmaps.

Industries under tremendous pressure need huge resources

China’s high-carbon industries have no choice but to change. According to the CBI report, crude steel production increased 31 percent between 2013 and 2020, from 813 million tons to over 1 billion tons. Although the carbon intensity of production fell by about 8 percent, total emissions still increased by 20.71 percent.

Steelmaking is a “pillar industry” that accounts for 5 percent of China’s GDP and produces 50 percent of the world’s steel. However, it is responsible for 15 percent of the country’s CO2 emissions – second only to the energy sector.

Industrial decarbonization technology is immature and not yet commercially viable. Figures from the CBI report show that achieving carbon neutrality will cost the sector a whopping 20 trillion yuan ($3.1 trillion). That’s 500 billion yuan per year by 2060, or 500 yuan per tonne of annual output.

The industry is working on three routes to decarbonization: reducing crude steel production; Switching from the basic oxygen furnace method of steelmaking to recycling steel in electric arc furnaces; and the introduction of more advanced or even disruptive technologies such as direct hydrogen reduction in the production of iron (the main component of steel). Developing new decarbonization routes and devices and expanding them to commercial use requires investment.

A report released last year by the Rocky Mountain Institute (RMI), a Colorado-based sustainability research organization, states that zero-carbon steel production will cost far more than traditional fossil-fuelled approaches. For example, at the current hydrogen price of 40 yuan (US$6) per kilogram, making iron using hydrogen direct reduction technology will increase the cost of crude steel by 80 percent.

Li Shuyi heads the RMI’s heavy industry decarbonization project. She said: “There are hydrogen metallurgy demonstration projects, but we need more investment to reduce costs. And when the steel industry starts to use hydrogen or even green hydrogen from renewable energy, investments in infrastructure will be required. The transition will also result in kilns being shut down early, which could result in significant asset stranding, and this process also requires funding.”

Sustainability Bonds: Transitional Aid or Greenwashing?

As mentioned, the problem is that high-carbon industries are not considered “green” and are therefore excluded from green financial markets. Such markets are relatively well developed and use ‘taxonomies’ to define and decide which investments are eligible for funding. This has created a new need for financial markets to develop new tools to provide finance to the sectors and activities where it is needed.

This gave rise to the idea of ​​transitional financing. Globally, the most important transitional financing product is the SLB, or sustainability-linked bond. The money raised through an SLB is typically earmarked for general operating expenses rather than a specific project, asset, or activity. However, the company issuing a bond must make sustainability commitments and set key performance indicators (KPIs) – such as emissions reductions – for those goals. The interest rate for the bond is linked to the KPIs. If the commitments are fulfilled or exceeded, the rate is reduced. If not, it will be increased or the deposit will be due earlier.

While a Green Bond must apply to an activity defined as “green”, SLBs only require a commitment to do so greenermaking them more suitable for high-carbon companies.

Ricco Zhang, senior director for Asia Pacific at the International Capital Market Association said, “SLBs are different. As long as a bond has environmental, social and governance considerations, investors can invest. Meanwhile, issuers that don’t qualify as either green or sustainable can still issue bonds to fund their transition. That can give us a win-win situation.”

Liuzhou Steel Group reportedly issued China’s first SLB for the steel sector last year. The associated target was to reduce nitrogen oxide emissions to 0.935 kg per tonne of product by 2022 – 0.188 kg less than in 2020. So far, however, the Chinese steel industry has not issued any SLBs with attached CO2 reduction targets.

And while SLBs have been welcomed, questions are also being raised.

Xie Wenhong, head of the Climate Bonds Initiative’s China program, told China Dialogue that companies issuing SLBs can currently set and achieve their own targets. It’s one of the reasons these bonds have grown so quickly, but how can we ensure companies are setting ambitious and credible targets rather than just greenwashing? And if the lender proposes ambitious targets, will companies go along with it?

“Achieving ambitious goals often requires a tremendous amount of work for the company, and it may not be confident of success,” Xie added. “There may not be anyone at the senior management level who is willing to take responsibility for missing the mark. This means that companies do not like to provide SLBs with ambitious goals and clear sanctions for failure.”

Urgent need for a single standard and more products

Many of these problems stem from the lack of a common definition and standard for transitional finance. This makes it difficult to assess whether or not the activities of high-carbon industries are in line with the net-zero emissions goal, and investors fear they will be accused of greenwashing or “transition-washing”.

Xie believes that financial regulators must provide the sector with a clear, ambitious and credible transitional financing standard to coordinate the financial world and the real economy with investment proposals, actions and measures for individual sectors.

CBI investigations into the steel industry have found persistent overcapacity, unbalanced product structures, high financial leverage, poor inventory management and environmental pressures. This has led financial institutions to be cautious in providing funding. Concerns about greenwashing would be greatly reduced if a clear roadmap for an industry transition was established, with a single standard, specific performance indices and tools to help investors track progress. If steelmakers can increase their environmental progress and improve corporate credit ratings while improving economic performance, investors will take notice.

In the meantime, other transitional financing products such as mutual funds and insurance could be developed. Ma Jun, chairman of the Green Finance Committee of the China Society for Finance and Banking, said in an interview with the 21st Century Business Herald that heavily leveraged firms, small and medium-sized enterprises and firms that need risky low-carbon technologies are more likely to require equity financing than they are loans or bonds.

Equity investment and M&A funds to support the transition are needed to allow capital markets to play a role in this process. Meanwhile, the uncertainties associated with the transition also require insurance products to offset these risks. According to Ma Jun, China’s steel companies are heavily leveraged and need financial institutions to develop innovative products, tools and mechanisms that give them the time they need to bear the costs of the transition and provide them with more financing options.

Ma Jun also suggested that transition finance products could incorporate the idea of ​​a “just transition” and require companies to consider employment impacts and take measures to preserve jobs. When developing new tools, financial institutions could use employment retention performance as a KPI.

This article was originally published on China Dialogue under a Creative Commons license.

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