TSLomberd with the note:
We buy a basket of five ‘green steel’ stocks: ArcelorMittal, ThyssenKrupp, SSAB, Fortescueand Voestalpine (MT NA, TKA GR, SSABA SS, FMG AU, VOE AV), equally weighted at 20% each relative to selling the SPDR S&P Metals and Mining ETF. While the green steel movement is still nascent today–saddled with high initial costs, hefty capex commitments and still-lagging regional policy frameworks–its use will become increasingly important to both green technologies and the next phase of infrastructure investment, as climate resilience and carbon accounting is prioritized this decade and beyond. Early movers will have an advantage over latecomers, especially when bolstered by public funding and ambitious climate legislation (as in the EU today), given the sector’s decades-long investment cycle. Joining forces with the GreenDeal, the EU Recovery Plan gives climate transition a central role in the continent’s blueprint for economic recovery and growth. The EU Recovery Plan’s additional stimulus for the period 2021–27 is expected to total around €1.85 trillion, roughly a quarter of which could be allocated to climate transition-related investments. Europe’s drive to green its economy will lead to a new range of opportunities in infrastructure investment.We therefore pinpoint green steel progress as a key leading indicator of longer-term industry growth fundamentals ahead, even if it will not beacore generator of company profits for several years.As for other steel industry metrics, earnings have been upgraded amid a rosy outlook for the sector, aided by a slow future supply pipeline. Valuations have derated significantly and have diverged from the overall market, offering an attractive entry point.
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‘Code red for humanity’ ratchets up the pressure on policy makers. Recent extreme weather events from the Pacific northwest to central Europe to China highlight the deficiencies of existing infrastructure (e.g.melting power lines, buckling asphalt roads, flooded subway stations and tunnels) and the need to ‘build back better’ with greater resilience and new architectural designs as well as more low-carbon construction solutions. The recently released IPCC report on climate change warns that unless drastic change is undertaken now, warming is not only on track to exceed 1.5–2°C above pre-industrial levels–the target of the 2015 Paris climate accord–but sea-level rise is likely ‘irreversible’ even in the best-case scenario. Although the G20 talks last month ended with a disappointing failure by key emitters, notably China and India, to commit to phasing out coal and fossil fuel subsidies, the IPCC report will exert newfound pressure on world leaders to step up their emissions reduction targets, as well as to pick up the pace of carbon capture and other green technologies. Still, even assuming that the upcoming UN climate conference in November (COP26)will fail to deliver big breakthroughs in global climate policy, our base case is that the growing frequency of extreme weather events will ultimately force even climate laggards to adopt bolder structural changes this decade, propelling the building of greener economies and cities over the next five to ten years.
Tomorrow’s smart and green cities will continue to be built on steel…Steel remains one of the most efficient materials in buildings and infrastructure given its high durability, strength, and infinite recyclability. The World Steel Association indicates that in 2019, 1.77billion tonnes of steel was consumed globally, of which just over half was used by the building and construction industry,while equipment manufacturing accounted for 19% and transportation 17% of the total. Global growth in infrastructure spending to ensure cities are greener than before and resilient to climate change will therefore demand increasing amounts of steel. As a case in point, the US$1.2trillion bipartisan infrastructure bill recently passed by the US Senate should substantially ramp up steel demand once it passes the House, with an estimated US$550 billion in new federal spending for roads and bridges to transit systems, water infrastructure and EV chargers. As the chart above right illustrates, steel is a core material in the electric vehicle transition, as well as a key input in many green technologies.
…but the rub is that the industrial sector has been the fastest growing carbon-emitting sector since 1990 (see the chart above left).With current production methods, for every tonne of steel produced, almost two tonnes of carbon dioxide (CO2) are emitted on average, totalling about 7–9% of global greenhouse gases. If the steel sector were a country, its CO2 emissions would rank third in the world, above India and behind China and the US. A key reason for this is that more than 60% of steel today is made using coal in heated furnaces; therefore, even steel used in greening the economy is in fact adding to the climate crisis as long as cleant echnologies are not deployed in its production.
While increasing adoption of current technologies such as electric arc furnaces (EAFs) using steel scrap can slash CO2 emissions,zero-emissions steel is the ultimate target, as there will only be enough scrap for an estimated 45% of total demand by 2050. We are therefore seeing pressure on steel manufacturers to move into green production from three key areas:1) tightening emissions allowances in the EU’s carbon market, in tandem with rising carbon prices (atover€50/tonne in H1/21) and momentum for a carbon border adjustment mechanism (CBAM) in the EU, US and other countries; 2) growing investor and public interest in sustainability as extreme weather events multiply; and 3) changing customer requirements for carbon-neutral. To bring the sector in line with a 2050 net-zero target, process emissions must fall by at least 30% by 2030 according to the Green Steel Tracker. Furthermore, steel manufacturers find themselves at a crossroads today, given that a midpoint of 14%of steel companies’ potential value is at risk if they are notable to reduce their emissions levels, according to a McKinsey study; the upper range estimate is 30%. Many analysts are already betting that the EU carbon price is likely to hit€100/tonne by 2030; BofA has estimated it could reach that level as early as 2025. If so, it will strand carbon-intensive assets sooner rather than later, making low-carbon steel the only way to mitigate risks ahead for heavy industry. Assuming that low-carbon steel innovation develops at the projected pace this decade, an estimated US$47–70 billion of carbon-intensive steel plants currently under development (most based in China) will face stranded asset risk, according to the Global Energy Monitor. Steel producers that recognize this are prioritizing the investment into green steel manufacturing, which involves switching to hydrogen-based vs coal-based smelting of iron ore and releasing no carbon emissions.
Green hydrogen is a key future fuel for the net-zero production of green steel. The cleanest way to produce hydrogen is the ‘green’ method through the electrolysis of water using renewable energy sources (rather than via grey[natural gas]or blue hydrogen[natural gas + carbon capture]which emit CO2 and methane). Current projections suggest that the rearrangement of the value chain from grey to green hydrogen is unlikely to occur at scale before 2030 since the cost of green hydrogen today (at US$5–6/kg) will not reach price parity with grey hydrogen (at US$1–2/kg) until the late 2020s at the earliest–unless carbon costs surge dramatically, altering economic incentives. According to an analysis by Thomas Koch Blank, a senior principal at RMI, at roughly average Northern European wholesale electricity prices ofUS$40–45 per megawatt-hour, the cost of steel made via carbon-free hydrogen is 20% higher than the current market cost. Yet with a carbon price of €50–60, there are already some projects that are increasingly cost-competitive.
Fuel costs (i.e.,low-carbon electricity sources) are by far the largest component in the cost breakdown of green hydrogen production using a water electrolyser, accounting for approximately 45–75% of production costs. The accessibility of green hydrogen is therefore linked to the availability of low-carbon energy sources (wind, solar and hydro power), which are being rapidly rolled out across the world and will be able to deliver the required amounts of hydrogen in the future. Key countries keen to lead the green hydrogen race include Australia,Brazil, Chile and Saudi Arabia, with their abundant renewables potential at low costs that can allow high load factors for green hydrogen output. The first two countries are also home to immense reserves of high-quality iron ore, which could aid their green steel ambitions down the road, as green steel is likely to be more cost-competitive to export than green ammonia in the nearer term. The eventual phase-out of coking coal as an essential input in steelmaking will reshape world steel trade dynamics, potentially paving the way for new green steel export powers to emerge as decarbonization accelerates.
Demand for green steel is on the rise, and pioneers in this space are likely winners given a strong demand pipeline and limited supply. Although the green steel market today is still in its infancy–owing to high green hydrogen costs, costly capex investments,commercial-scale plants set to begin output only by the mid-2020s, evolving technologies and still-uncertain regulations and subsidies–industry demand from European carmakers and construction firms is already putting pressure on steel firms. Volvo last week received the world’s first customer shipment of green steel from Sweden’s HYBRIT (a JV of Swedish steelmaker SSAB, state utility Vattenfall and miner LKAB), although it is only planning commercial use by 2026. Mercedes-Benztoois set to receive its first shipments of green steel before the end of this year (from German steelmaker Salzgitter) and is targeting 2025 for the launch of green steel in its vehicle models. Both Mercedes-Benz and Swedish truck maker Scania are investors in Swedish green steel startup H2 Green Steel. The economic rationale for automakersis compelling: green steel is projected to add less than 1% on average to the consumer price of a passenger car but can slash material-related CO2 emissions by roughly one-third, given an average of 900kg of steel used per vehicle. As carbon pricing, accounting and CBAMs develop to include more countries, more businesses are likely to follow suit. Ten European construction and property management companies have already committed to moving entirely to fossil-free steel by 2050 under the Steel Zero coalition, including big names like Lendlease, Ørsted and WSP UK.
We will focus on five companies targeting green steel production as part of their key strategy, namely ArcelorMittal, Thyssenkrupp, SSAB, Fortescue and Voestalpine. ArcelorMittal, the world’s second-biggest steelmaker by output, has a goal of producing 600ktpa of carbon-neutral steel by 2022 and up to1.6Mtpa by 2025 from its (and the world’s) first commercial-scale zero-carbon Sestao plant in Spain with an estimated €1 billion in investments (of which half could be state-funded); it has also said around10% of total output can be green steel by the next decade. Germany’sThyssenkrupp, collaborating with RWE, expects to generate 400ktpa by 2025 and 3Mtpa of green steel by 2030 but is also looking for generous state aid to do so. Sweden’s SSAB, as mentioned above, has embarked on a green steel JVpilot project (HYBRIT) that plans to be commercially viable by 2026, producing between 600 and 1,000ktpmand by 2030, 5Mtpa. Australian iron-ore exporter Fortescue aims to produce green steel by 2024 and is analysing green hydrogen projects in Brazil, India and New Zealand, while Austria’s Voestalpine has not published specific dates after commissioning the H2Future pilot in 2019 bu thas secured a patent to make industrial-scale steel using green hydrogen and biogas. The various projects undertaken are demonstrated in the table below left.
While other steelmakers are likely to join the race, these firms are part of the ‘green steel’ vanguard today.As of June, two-thirds of nearly 47low-carbon steel projects were located in Europe, aided by regional incentives, vs four in China and one in the US. Paradoxically, one reason for this may be that US firms today have a carbon advantage over key rivals, with nearly 70% of US steel already produced via lower-emissions EAFs in 2019 (vs 41% in the EU and just 10% inChina). Still, as new innovations and investments bring zero-carbon steel costs down, key producers today can be dethroned tomorrow if they fail to keep up.
We buy a basket of the five stocks: ArcelorMittal, ThyssenKrupp, SSAB, Fortescue and Voestalpine(AMT NA,TKA GR,SSABA SS, FMG AU, VOE AV),equally weighted at 20% each relative to selling the SPDR S&P Metals and Mining ETF(XME). Valuations have diverged strongly between the ‘green steel’ basket and the SPDR S&P Metals and Mining ETF; this divergence has not been at these levels in the past six years, with the green steel basket’s blended forward p/e ratio at 7.8x derating from extremely high levels, while the Metals and MiningETF has a forward p/e at 11.5x. Additionally,sector earnings have been upgraded significantly andgrowth has been double-digit on a year-on-year basis, further highlighting the rosy outlook for key players (see the five charts above).What stands out is that ‘green steel’ stocks have diverged in performancewith the aggregate Steel index, underperforming the index since 2020; this provides an additional rationale for entry at this point. Moreover, this space has recently seen ratings upgrades: Moody’s upgraded ArcelorMittal to investment grade,while analysts removed ThyssenKrupp’s credit risk so wing to its performance recovery.Finally, the returns of these stock sare not driven by most of the typical asset classes/indices, allowing for idiosyncratic factors–rising carbon prices and the surge in demand for green steel–to propel these stocks. This aids the long-term investment thesis.