The Future of Steel
With the world becoming more and more environmentally conscious, heavy industry is having to find ways to adapt. Carbon spewing sectors like energy and manufacturing are beginning to adopt innovative technologies designed to reduce their pollution footprint and make their overall business “greener”. Even logistics, something not exactly associated with exciting technology, is becoming a sexy industry. The use of AI and EVs not only decrease carbon emissions but increase overall efficiency. This has shifted public perception of logistics from coal-rolling trucks to smart tech-driven solutions, and the market has begun to dish out rewards proportionately. Uber Freight, the logistics arm of Uber, raised $500 million at the beginning of October, bringing its valuation to $3.3 billion. Investors seem to appreciate both the conscientious and profit-generating boons of such firms pursuing ecological friendliness. This development, as most would argue, is the future of a green free market: companies will find being environmentally conscious makes both their emissions and revenues greener.
The allocation of sellable carbon credits further incentivizes companies to “go green”. In Q2 2020 alone, popular EV-maker Tesla received $428 million in carbon credits, a significant chunk of change (so significant in fact, that without it, Tesla would have had negative free cash flow). Furthermore, ESGs (environmental, social, and governance), funds which focus on ecologically sustainable businesses, have started to become popular investing vehicles. They cater to those who wish to invest in businesses that meet their financial and environmental standards. Elsewhere, traditional private equity firms like Apollo Global Management are meeting this demand with impact investing arms, and some funds like Triodos Investment Management are devoted exclusively to the sector. While the jury is still out on whether or not ESGs, carbon credits, and impact investing are really having their desired effects on the environment, one thing is certain: investors are starting to demand environmental accountability as they would a strong dividend.
As mentioned before, the goal of a green free market is to make it financially rewarding to put an emphasis on the environment. In a perfect world, this style of market would also naturally punish firms that do not conform to higher environmental standards without the need for legislation. Unfortunately, the world is far from perfect, and requires some slight infringements on the “free” aspect of the market by governments to ensure we do not tumble into a dystopia devoid of ecological prudence. Thus, heavily polluting industries (like logistics and automobile production) are “getting with the times” and beginning to focus on green initiatives (or at least pretending to). Slowly but surely the market is rewarding them, and the dream of a green free market inches closer. However, there are some noticeable laggards. Steel is amongst the most guilty.
Steel production is a massive creator of carbon dioxide, making up roughly 7% of global emissions. Scraping iron ore out of the earth, then transporting it on carbon-drunk ships, before finally pounding it with egregious amounts of polluting fluxes to separate steel from slag is not exactly a clean process. Alas, with the world being built on huge amounts of steel, the demand for quantity has historically outweighed the demand for environmental austerity. Until now, that is.
The world of steel is stuck between a rock and a hard place. The industry is plagued by overcapacity, but to shut down their basic oxygen furnaces (BOFs) means responding to future increases in demand becomes infinitely harder and more expensive (restarting BOFs is no small task). Thus overcapacity continues to occur. Like the oil and gas industry, steel has instead responded to this problem through consolidation. Thyssenkrupp is potentially entering a process to sell their steelmaking assets, while ArcelorMittal has recently sold their US operations to Cleveland-Cliffs. Even with increasing consolidation, one can expect there to be multiple quarters (or even years) of red and grey growth, and potentially for some steel monoliths to fall apart completely.
This period for discord in the steel industry is currently being caused mostly by issues of oversupply, but expect it to be exacerbated by future increases in environmental regulation. The EU and China both plan to go carbon neutral by 2050 and will surely drive legislatory stakes through steel companies’ revenues if they continue on their current path. If steel wants to be a profitable part of the future, it needs to sort out its identity problem and get a whole lot greener, now.
Furthermore, steel needs to cater to a whole new class of investor. Millennial investors are occupying a larger and larger share of the market and have been spurred on by the coronavirus rally. Even if this rally falls apart, and millennials become disenchanted with equities, it is still basic logic that they will become the dominating players in the market in the next few decades. To entice these environmentally savvy and tech loving investors firms will need to prove that they hold the same ecological values. For steel to flourish, it must change its identity from smog pumping corporate giants to tuned-in champions of sustainability.
Of course, changing identity is easier said than done. That being said, steel companies are indeed already attempting to get greener: green hydrogen powered plants have already been announced by Thyssenkrupp, and ArcelorMittal has pledged to go carbon neutral in 2050 (the same time as the EU and China). So if the industry is already becoming environmentally conscious and taking action, why does the market not seem to care? What more can they be realistically expected to do?
The answer is nuanced and complicated . The first part of the answer lies in understanding why anyone would want to invest in steel in the first place.
One of the most prominent reasons an investor might be attracted to the industry is that steel companies act as great proxies for the commodity itself. Understanding where steel goes is simple: take a look around you, and there will almost definitely be a steel product or subproduct. The commodity’s widespread and familiar application makes it seemingly easy to understand major price drivers as investors are more acquainted with consequences from major developments in the space. Large infrastructure bill passed? It obviously needs steel, so an investor might become bullish. Automobile sales projected to decrease? They won’t need as much steel, so our investor becomes bearish. This is in contrast to more complex companies where it requires almost a bonafide industry expertise to even begin to have an opinion on market trajectory. Superconductors, advanced medical technology, and data infrastructure all fall into this category of business. Steel’s relatively simple end markets and supply chain make it attractive to investors who like to have an intuitive understanding of the firms in which they invest.
Steel is also a legacy industry. Nucor and Thyssenkrupp are examples of old companies which many investors have perhaps held for decades, as the first equities where most investors place their money tend to be blue chips with high levels of understandability (a category “Big Steel” occupies perfectly). One steel company in particular is so well known it got itself into perhaps the greatest film of all time: the line “We’re bigger than US Steel” from the classic film “The Godfather” epitomizes steel companies’ position as a common knowledge standard to be compared against. With the average steel company holding vast factories and massive pieces of equipment, it makes sense to view them as the archetypal “big corporation”. For investors who want physical-asset driven stability in their portfolio, steel can seem a perfect solution.
Today, few investors continue to start their portfolios with the old “Big Steel” guard. Instead, investors looking for a stable and profit producing investment with (seemingly) high levels of understandability will look at firms like Apple or Alphabet (despite the fact that these firms are much more complicated than they may appear to a new investor). On the other hand, more experienced investors are unlikely to invest in the asset class in the first place due to its lower yield and inherent business model issues. For investors sitting in the middle of the park between novice and experienced, they might be cynical on steel due to unceasing news articles written about trade wars and tariffs. Concerns common to all investor classes is the shared apprehension for the primary subject of this article: the atrocious environmental effects of steel companies and the poor gains they return.
The original question of “what can steel companies do?” can now be addressed. There are three things which the industry must make a priority:
1. Invest in cleaner electric arc furnaces (EAF) and roll back development of basic oxygen furnaces (BOF)
2. Prioritize R&D into environmentally friendly technologies (like clean hydrogen)
3. Make clear the high level of urgency with which adaptations to the greener future will be made
The first of these three points is in fact already occurring around the world. The advantages of using EAFs are both financial and environmental in nature: they produce steel at a cheaper rate than BOFs (usually at around an 8% discount), and produce significantly less carbon dioxide. Of course, their reliance on global scrap markets in order to stay competitive is an inherent risk. If scrap prices rise, then so does the cost of EAF steel. They are also expensive to set up, and for an industry marred by overcapacity it makes little sense to invest precious cash in exacerbating the issue, even if it is part of a prudent long-term plan.
Do not write off EAFs quite yet. They have one extra advantage over BOFs that is especially relevant right now: the ability to respond to demand. A BOF cannot be shut off unless the owner wants to go through the lengthy, costly, and potentially structurally-damaging process of turning it back on again. For that reason, most producers prefer to leave their furnaces on for extended periods of time and simply stock steel in times of low demand.
The issue here is obvious. With the structural overcapacity now present in the steel market, and with the years it could take before steel demand grows enough to actually match supply, steel producers could be stuck stocking almost perpetually. That’s not exactly a cheap pastime.
EAFs solve this issue, as they are capable of being turned on and off over and over again, allowing them to respond to changes in demand with no fuss at all, unlike BOFs. In periods of overcapacity (like now) they can be shut down and thus emit nothing.
As it turns out, the steel industry has seen these advantages and has begun to focus on EAF development. In the US, around 70% of steel is produced through the EAF method, and the EU is turning more and more toward EAF as it attempts to meet its lofty climate goals. A noticeable outlier from the revolution is China, the world’s largest steelmaker. The country is still dominated by BOFs, and is seeing a sluggish conversion to EAF production. Even an overview of China’s steel market dynamics is beyond the scope of this article, but needless to say it offers high volume, high emissions, and low prices (in fact, prices so low that they incurred the wrath of The Donald and the EU in 2018 for flooding the market).
The second point, prioritization of R&D into environmentally friendly steel technology, is also already happening to an extent. Development of clean hydrogen electrolyzers seems to be the next step in the pursuit of green steel, and some major steel firms (see ArcelorMittal’s potentially carbon neutral Hamburg plant) are attempting implementation. Hydrogen is used in both BOFs and EAFs, and while it has historically been produced in a process that yields large amounts of carbon dioxide, an approach involving the electrolysis of water yields hydrogen in a carbon neutral fashion.
One would hope that as steel companies upgrade their facilities, they will continue to take advantage of technology such as this to improve their emission figures. One would also hope that the industry pursues clean technology at a more inspired pace. Both the EAF and BOF methods of producing steel are essentially geriatric, and could both certainly do with substantial innovation. Even an incremental amount of R&D spending would signal that the industry is at least considering the future (a sentiment that is rare in the steel world).
After reading about the first two points, an observation one might have developed is that the industry is already doing substantially everything this article recommends, even if it is at a lethargic rate. To that, this author would not disagree. However, the final point is perhaps the most important, and without it the first two actions have a much reduced effect.
Put simply, steel has been much too quiet. The market is a very loud place and technology has a tendency to steamroll other industries’ news to their detriment. Tesla is a prime example of this phenomenon: Elon Musk, its eccentric CEO, makes it impossible to ignore the company. Like him or not, his antics have made Tesla a front page stalwart and a huge disruptor to the automotive world. Automobiles are among the highest polluters in the world, and the industry was crying out for someone to take the helm and turn that statement on its head. Even though Tesla might not be as good for the environment as they may seem (its high use of lithium is not exactly environmentally sound, among other things), the market has embraced it at the vanguard of futuristic environmentalism. This is exactly what steel needs.
Steel is in a very similar situation to that of automobiles some decade or two ago: it is an industry fundamental to the running of the world, but one that is derided by emission issues and seen as unattractive by investors. The industry has space for a company to enter with a radical approach to change its identity. At this point, it matters little whether the innovation actually even has a profound effect on the industries’ emissions. Tesla certainly has not made a huge dent, but look at its valuation and excitement-generating capacity. The market must be alerted with a loud cry that the sector is not only prepared to adopt greener practices, but embrace them. This author fundamentally believes that a steel company that pushes the fact that it is revolutionizing the industry through extensive R&D and investment in cleaner EAFs will experience a receptive market.
