Technological Prospects and CO 2 Emission Trading Analyses in the Iron and Steel Industry: a Global Model

Transcription

1 Technological Prospects and CO 2 Emission Trading Analyses in the Iron and Steel Industry: a Global Model Ignacio Hidalgo, LASZLO SZABO,, Juan Carlos Ciscar, Antonio Soria. Institute for Prospective Technological Studies (IPTS), Directorate General Joint Research Centre, European Commission EXPO Building, Isla de la Cartuja, E Seville, Spain Laszo.Szabo@jrc.es Abstract This article presents the Iron and Steel Industry Model (ISIM). This is a world simulation model able to analyze the evolution of the industry from 1997 to 2030, focusing on steel production, demand, trade, energy consumption, CO 2 emissions, technology dynamics, and retrofitting options. In the context of the Kyoto Protocol on climate change, the potential impacts of a CO 2 emission market (e.g. the gains in terms of compliance costs, the country trading position, the evolution of the technology and the energy mixes) are also addressed. In particular, three emission trading scenarios are considered: an EU15 market, an enlarged EU market, and an Annex B market. Keywords: ISIM, iron and steel industry; Kyoto Protocol; CO 2 emissions; emission trading; simulation model. JEL Classification: Q2, Q4, L61, H23. The ideas expressed in this paper are those of the authors and do not necessarily represent views of the European Commission. 1

2 1 Introduction In the last few years the discussion on mitigating anthropogenic greenhouse gas (GHG) emissions has gradually emerged as a key issue in the international agenda. The 1997 Kyoto Protocol (KP) to the United Nations Convention on Climate Change (UNFCCC) sets, for the first time, binding emission reduction targets for developed countries. GHG emissions of the so-called Annex B countries are to be reduced by 5.2% over the period, with respect to the 1990 emission levels. This protocol can be interpreted as a first step in a series of international agreements with the aim of stabilizing GHG concentration in the atmosphere, the long-term objective of the UNFCCC (Grubb [21]). The KP will enter into force after the ratification of 55 parties to the UNFCCC accounting for at least 55% of the 1990 CO 2 emissions of the countries listed in the Annex B of the protocol. Currently 100 parties have ratified the protocol, being the EU, the candidate countries to the EU, Canada and Japan among them. The KP would enter into force with the ratification of the Russian Federation, even after the withdrawal of the USA from the protocol in The adoption of the protocol, and particularly the implementation of its so-called flexible mechanisms 1, raises several questions and concerns, at regional and global level, about its effects on the energy-intensive industrial sectors, such as their future technological evolution and the possible leakage to the countries without GHG mitigation commitments. For instance, in the EU these sectors will have to face new stringent environmental regulations and, in particular, the CO 2 emission trading market 2 (expected to be launched in 2005), and the Integrated Pollution Prevention and Control (IPPC) Directive 3. The iron and steel industry is the largest energy consuming industry in the world, as well as one of the most important sources of CO 2 emissions and other pollutants. According to WEC [50] energy consumption of the iron and steel sector in 1990 accounted for 12% of the world energy consumption. The related CO 2 emissions were 1425 MtCO 2. World steel production increased from 200 Mt in 1950 to 847 in , and is expected to grow further in the future, primarily due to the increasing demand in developing countries. While production in OECD countries has been around 350 Mt since the eighties 5, production in the developing world, mainly China, India and South America, is now growing at almost 7% annually. Analysts commonly agree that such growth trends will continue over the next decades. In particular, the World Energy Council (WEC [50]) foresees a world production level of 1300 Mt by 2020, assuming a business as usual (BAU) scenario. The same foresight exercise predicts that by 2020 world energy consumption in the steel sector would reach 600 Mtoe, and consequently, CO 2 emissions would increase up to 1700 MtCO 2. With regard to the EU (see Table 1) the iron and steel industries accounted for 21% of final energy consumption and 27% of emissions in the total manufacturing sector in Almost the same shares are observed in the year 2000 (19% and 28% respectively). Production of crude steel grew from 148 to 160 Mt in that period. 1 Emission trading, joint implementation and clean development mechanism. 2 Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC: 3 Council Directive 96/61/EC of 24 September International Iron and Steel Institute (IISI): 5 EUROSTAT, New Cronos Database: 2

3 Table 1: Energy use and CO 2 emissions in the EU-15 industry Sector Final energy use (Mtoe) CO 2 emissions (MtCO 2 ) Final energy use (Mtoe) CO 2 emissions (MtCO 2 ) TOTAL INDUSTRY Iron and steel Non-ferrous metals Chemicals Glass, pottery and building materials Ore extraction Food, drink and tobacco Textile, leather and clothing Paper and printing Engineering and other metals Other industries Source: EUROSTAT 6 Various articles in the literature have studied the iron and steel sector. Among others, one should remark the reports prepared for the IEA 7 by De Beer et al. [11], which assess the emissions from the iron and steel industry and the possible abatement measures, and the emissions baseline study by Bode et al. [2]. Van Vuuren et al. [49] present a global system dynamics model to simulate long-term trends in the production and consumption of metals. Labson [32] carries out an econometric analysis of the global iron and steel market. Steel trade is also studied in US Department of Commerce in ITA [28]. Crompton [7]-[8]-[9] forecasts the steel consumption for US, Japan and South-East Asia. Gielen et al. [18]-[19]; Gielen et al. [20] and De [12], also follow a regional approach, focusing on the Japanese and Dutch cases. Ozawa et al. [40] analyze the energy use and the CO 2 emissions from the steel industry in Mexico. A similar study is made for China by Price et al. [41], while the energy and environmental performance of the US steel sector is studied by Worrell et al. [52]. Macedo Costa et al. [33] carry out an analysis of the energy and material flows in the steel production systems. Several national or regional studies on energy use and carbon emissions, not only focused on the steel industry case, have been carried out by the Environmental Energy Technologies Division of the Lawrence Berkeley National Laboratory 8 (EETD [13]; Martin et al. [35]; Price et al. [42]; Price et al. [43]; Schumacher et al. [47]; Worrell et al. [51]). Finally, Quirion [44] provides an assessment of the impacts on the steel industry caused by the implementation of the EC directive on emission trading. Other studies assessing the impact of greenhouse emission abatement strategies on industrial sectors from a broader perspective can be found in Böhringer et al. [3], and Capros et al. [4]. This article presents the Iron and Steel Industry Model (ISIM), which is fully documented in Hidalgo et al. [24]. ISIM has been conceived with the aim of integrating it into the Prospective Outlook for the Long-term Energy System (POLES) model, a world simulation model for the energy sector 9. The unquestionable importance of the figures do not include the German Democratic Republic. 7 IEA GHG R&D Programme: 8 EETD, Lawrence Berkeley National Laboratory: 9 The POLES model works in a year-by-year recursive simulation and partial equilibrium framework, with endogenous international energy prices and lagged adjustments of supply and demand by world region. Developed under EU research programs at the Institute of Energy Policy and Economics (IEPE) and the Institute for Prospective Technological Studies (IPTS), the model is fully operational since It has been used for policy analyses by EU- 3

4 steel industry in terms of energy consumption and CO 2 emissions, the prominent effect that the Kyoto Protocol could have on the sector, and the need of a reliable tool to support policymaking, have motivated the development of the ISIM model, which is, to the best of our knowledge, the first recursive world simulation model addressing these issues. The ISIM model projects the evolution of the steel sector in the period , paying particular attention to steel production, demand and trade, energy consumption, CO 2 emissions, steel technology dynamics, and retrofitting options. CO 2 emission reduction costs have been derived by simulating the introduction of a carbon value in the sector. The article has three sections in addition to this introduction. The second section briefly describes the model. The results are presented in the third section, which contains two parts. The "Reference Simulation" sub-section shows the model projections for production, consumption, trade, technology evolution and CO 2 emissions in the business as usual (BAU) scenario. Three emission trading scenarios are then compared with the BAU: an EU15 market, an enlarged EU market, and an Annex B market. The paper ends with the summary of the main conclusions derived from the study. 2 Overview of the model ISIM has been developed using a dynamic simulation approach 10. The world is divided into 51 regions, which can be grouped into eleven larger regions (four of them covering the Annex B countries). The model operates with a set of inter-connected modules: steel demand and supply, international trade, capacity planning, energy demand and GHG emissions. In each module behavioural equations calculate endogenous variables considering techno-economic constraints (e.g. production costs), time lags and trends. GDP and population are the main exogenous variables. Energy prices are calculated by the POLES model. Techno-economic characteristics of the industry for the period come from the historical databases, and for are made endogenous in the model through recursive simulation. These variables include production costs and quantities, steel consumption and trade, production capacities, retrofitting and investment costs, energy consumption and emissions, by type of technology and region. The ISIM database contains historical data about the variables mentioned above, as well as about emission factors, efficiencies, substitution factors and other parameters. The data sources are diverse, being the main European Commission [14]-[15]-[16]; Haworth et al. [22]-[23], WSD [53]-[54]-[55] 11, IISI [27], OECD [36]-[37]-[38]-[39], IEA [25]-[26], US Department of Energy (Margolis et al. [34]; Stubbles [48]), ENERDATA S.A. 12, INEDIS 13, and the POLES model database. Seven distinct technologies or production routes have been identified and included in the technology portfolio: Open hearth furnace (OPH). DGs Research, Environment and Transport and Energy, and by the French Ministry of Environment. The model enables to produce: 1) detailed long-term (2030) world energy outlooks with demand, supply and price projections by main region, 2) CO 2 emission marginal abatement cost curves by region, and emission trading systems analyses, under different market configurations and trading rules, and 3) technology improvement scenarios, with exogenous or endogenous technological change, and analyses of the value of technological progress in the context of CO 2 abatement policies. 10 The Vensim 5.0 software has been used. The size of the model is around 350 equations and variables per region. 11 World Steel Dynamics: 12 Enerdata S.A.: 13 International Network for Energy Demand Analysis in the Industrial Sector: 4

5 Conventional blast furnace/basic oxygen furnace (BOF). Advanced blast furnace/basic oxygen furnace (BOFA). Conventional electric arc furnace (EAF). Advanced electric arc furnace (EAFA) Smelting reduction process (SRP). Direct reduction process (DRP). The technologies are characterized by investment and other cost categories, energy, material and labour consumption, and available retrofitting options. The technical and environmental characteristics of the technologies are based on the Best Available Techniques Reference Document on the Production of Iron and Steel, by the EIPPCB 14 (European Commission [14]), and on other existing literature (Andersen et al. [1]; Considine et al. [5]-[6]; Crompton [7]-[8]-[9]; Das et al. [10]; Fruehan et al. [17]; Gielen et al. [18]-[19]; Jacobsen [29]; Macedo Costa et al. [33]; Martin et al. [35]; Ozawa et al. [40]; Price et al. [41]; Price et al. [42]; Price et al. [43]; Rábago et al. [45]; Ruth et al. [46]; Schumacher et al. [47]; Worrell et al. [51]; Worrell et al. [52]). The production routes labelled as advanced incorporate the best available techniques (BAT) in comparison with the routes marked as conventional. The open-hearth furnace (OPH) technology is obsolete but still largely used in the former Soviet Union, China and India. Two new alternative routes for steel making, SRP and DRP, have been considered in ISIM due to their growing potential. OPH, BOF, BOFA and SRP are integrated steelworks (ISW, also known as primary routes) that include all the stages for steel making, namely ore processing, coke making, iron making, steel making and rolling, and finishing. EAF, EAFA and DRP are the mini mills (MMS, also known as secondary routes) that skip the stages before steel making and use scrap or direct reduced iron as inputs. Iron, scrap, and coal (for coke making) have been considered as raw materials, in order to simplify the analysis. The prices for iron and scrap have been estimated and are exogenous inputs to the ISIM model. As already noted, the coal and other fuel prices come from POLES. Seven types of fuels are considered: natural gas, heavy fuel oil, steam coal and other solid fuels from coal, wood and waste fuels, electricity, recovered heat and coke. The economic characteristics (investment, operation and maintenance costs) of the routes have been obtained mainly from WSD [53]. Steel consumption is calculated from the relationship between the steel intensity (steel consumption per unit of GDP) and GDP per capita. Empirical research has found that intensity can be often described as a function of the national per capita income. This function varies among countries and materials, but usually follows an inverse U-shaped curve (also called intensity of use hypothesis, Van Vuuren et al. [49]). The global market is shared out among the producing countries according to their shares in the world production, which depend on their production costs and capacities. The idea is to produce steel in the cheapest possible way while fulfilling the capacity restrictions. Furthermore, ISIM provides with the net trading position of each country (either as importer or exporter). The related transportation costs are computed on a region by region basis. The capacity planning section considers two ways of adding new production capacity to the sector. The first one is by building new installations, and the second is by upgrading the existing capacity (retrofitting). Accelerated decommissioning is not considered in 14 European Integrated Pollution Prevention Control Bureau placed at IPTS (EC-JRC), Seville. 5

6 the model because of the high dismantling costs of the steel sector. Capacity is maintained during its entire lifetime, even if new and cheaper utilities are built. The requirements for new capacities are driven by the total expected production, determined by a backward-looking expectation function of national production and its change during the previous years. The technology choice for the planned capacity is made according to the long-term production costs of the various technologies, so that the investment costs are included in the planning decision. Note that this is different to the technology choice for production, where decisions only depend on the short-term costs, i.e. on the variable costs. Total production costs are the sum of the fixed and the variable costs. Variable production costs are the sum of the variable operation and maintenance costs, energy costs, and raw material costs. Energy costs by technology depend on the fuel prices and the fuel mix used in each country. Fixed costs are the sum of the fixed operation and maintenance costs, and the investment costs discounted through the economic lifetime of the technology. The fixed operation and maintenance costs are assumed to change at the same rate as the investment costs. The investment costs are assumed to follow a learning curve equation (Kouvaritakis et al. [31]), and depend on the previous investment costs, the change in cumulated capacity, as well as an elasticity. Table 2 shows the world average relative differences of the investment, production and variable costs for the different technologies in comparison to the BOFA costs (set as index 100), at the beginning of the simulation. These differences vary geographically. The investments required by integrated steelworks routes are much higher than those needed in the so-called secondary routes. In general, the cost differences induce a shift from primary towards secondary routes during the simulation period, continuing the observed historical trends. Table 2: Cost comparison among technologies Investment costs Production costs Variable costs OPH BOF BOFA SRP EAF EAFA DRP A retrofitting procedure has been modelled in detail as the second possibility of adding new capacity. Such a process periodically reallocates part of the remaining capacity among the various technologies. The retrofitting costs determine the amount of capacity to be upgraded. Table 3 illustrates the relative costs of the allowed retrofitting options to the corresponding investment costs (index 100) of the adopted technology. These ratios do not substantially change during the simulation period. It is clear that the industry has a great incentive to upgrade old steelworks instead of investing in building new facilities. The process intensifies when carbon taxes are applied, as the cost advantage of the new technologies increase. 6

7 Table 3: Retrofitting vs. investment costs Retrofitting vs. investment costs (100) BOF BOFA SRP EAFA DRP OPH BOF BOFA EAF EAFA On the other hand, the national average steel price is a function of the average production costs and the average transport costs to the customers, augmented by a profit percentage. Figure 1 shows the simulation results for the US steel price US Steel Price ( /t) Time Historical Forecasted Figure 1: Historical and forecasted price of US steel The national demand of each fuel depends on its fixed user costs, a function of the investment cost related to the use of the fuel, the fuel price, and the average efficiency. Energy recoveries (mainly electricity, gas and heat recovered at the end of some processes and reused in the same facilities or sold to others) can occur in most of the industrial processes, and are consequently taken into account in the model equations. The coverage of the iron and steel industry is defined as in the IEA statistics (ISIC 16 Group 271 and Class 2731), plus the coke oven plants (ISIC Class 2310). Coke imports and exports, and deliveries of coke oven gas and blast furnace gas to other industries and energy transformation sectors (electricity and CHP producers) are taken into account to properly represent the net energy consumption in the sector. 15 Historical values taken from the US Geological Survey: No other comparisons for other regions have been made due to lack of historical data. 16 United Nations, International Standard Industrial Classification of All Economic Activities (ISIC). 7

8 In certain processes (such as coke and iron making in the steel sector), fuels are also used for non-energy purposes (e.g., coal is transformed into coke in the coke oven plants, and coke is used in blast furnaces to reduce the iron). The total fuel consumption is the summation of the used (burnt) and the transformed fuel. A weighted sum of the specific energy consumption (SEC) for the capacity additions and that for the current facilities is used to compute the energy efficiency improvements. The weights are the ratios of the new and the remaining capacities (after retrofitting) to the total installed capacity. The performance of the capacity additions, as well as the initial SECs, are taken from the available literature and statistics (Figure 2). 45 Specific Energy Consumption (GJ/t) OPH BOF EAF BOFA EAFA SRP DRP Technology Figure 2: Specific energy consumption by production route (GJ/t) Only direct CO 2 emissions are computed by ISIM. Indirect emissions due to electricity consumption can be measured from the POLES model itself, which accurately accounts for the power generation industry emissions. The existence of numerous sources of CO 2 emissions within the steelworks complicates this calculation. Estimating the emissions source by source following a bottom-up approach is not feasible because it requires the measurement of the fuel input and the amount of process gases that are captured during each stage, as well as the carbon content and combustion efficiency of the process gases. Currently, this information is scarce and, the existing data are unreliable. ISIM uses a simpler and probably accurate enough approach, consisting of calculating emissions top-down. Fuel supply records are used to determine installation-wide energy consumption by fuel type, from which emissions are derived applying the appropriate emission factors. 3 Model simulation results This section presents two kinds of results derived from the ISIM model. The reference, baseline, or business as usual (BAU) scenario is discussed in the first sub-section. Please note that this scenario should not be interpreted as a prediction, but rather as a projection based on a series of consistent assumptions. In the second sub-section, a 8

9 series of emission trading markets is studied, providing with estimates of the gains in terms of lower compliance costs (relative to the baseline scenario) for them. 3.1 Reference simulation The effects of technological change (retrofitting and efficiency improvement) are embedded in the model. Producers shift from one technology to another via retrofitting when the economic logic forces them to do so. In building new capacities, rational behaviour such as investing in the long-term least expensive technologies, is followed. Consumption levels, energy prices, and technology availability are the driving forces in the scenario. Shape parameters for deriving long term consumption behaviour are calibrated on available data-sets, while price elasticity is parameterized according to previous studies and models 17. Table 4 summarizes the assumption considered in the BAU. Table 4: BAU scenario summary Time horizon. From 1997 to Carbon value. Set to 0. Exogenous variables. Endogenous variables. GDP and population. Energy prices. Technological characteristics. Price, income and activity elasticities. Steel demand, production and trade. Capacity building, retrofitting and retirement. Costs. Energy mix and consumption. CO 2 emissions. The 51 regions of the world considered in ISIM have been grouped in 11 relevant zones to present the simulation results (Table 5). Table 5: Geographical coverage of the reference simulation Region EU15 (European Union) North America (USA and Canada) Pacific OECD (Japan, Australia and New Zealand) EFTA and Turkey Economies in transition (Former Soviet Union, central and eastern Europe and Balkans) Latin America Africa and Middle East China India South Korea Rest of Asia Production In the reference simulation, world production is expected to increase by 75% in the period, from 752 Mt to 1316 Mt. Figure 3 represents the regional production levels from 1990 to Developing regions like China and other Asian countries 17 Shape parameters for steel consumption are taken from the previous POLES version. Price elasticities are taken from the STEAP model: 9

10 would get an important share of the global production. China becomes the biggest producer in 2030, reaching a production level of 302 Mt, i.e. 23% of the world total. The growth in South Asia is also very strong. In both cases the driving force of such increment is the combination of high consumption levels and moderate production costs. Other developing regions like Mexico, Brazil or India also increment their production level, but do not reach such world shares. The economies in transition would lose more than 50% of their production share in North America would maintain its position, increasing moderately the production and losing a small portion of its share, while Japan would keep only the production level. The EU15 follows a path similar to the USA, increasing only 8 Mt from 148 Mt in Most of the European countries are expected to undergo a significant decline in their production shares. Africa and Middle East China Economies in transition EFTA and Turkey EU15 India Latin America North America Pacific OECD Rest of Asia South Korea Production (Mt) Consumption Figure 3: BAU steel production Over the period (Figure 4) the largest world consumer region changes from the former Soviet Union to China, which is expected to absorb almost 26% of the world consumption, i.e. 291 Mt by Other developing regions such as the rest of Asia and India also get a significant portion of the market due to the industrialization process. In the OECD regions the consumption level decreases on average by 22%. This can be explained as a result of changes in the demand due to substitution effects (mainly by plastics and aluminium) and technological development (use of new materials, increasing of efficiency in final use, etc.). 10

11 Africa and Middle East China Economies in transition EFTA and Turkey EU15 India Latin America North America Pacific OECD Rest of Asia South Korea Consumption (Mt) Figure 4: BAU steel consumption Steel trade As a consequence of the mentioned regional evolutions of consumption and production, remarkable changes in the international steel trade structure would occur. North America is expected to become a significant exporter (reaching about 16% of total trade by 2030). The largest exporter in 2030, as in 2000, is expected to be the European Union, which would reach 21% of world total, but lower than the 1990 share of 48%. At the end of the simulation period Japan, the former Soviet Union, USA and South Korea remain behind the EU. In 2000 the developing world absorbs most of the exports. In 2030 the imports would concentrate in India (almost 28% of the total), China (17%), South Asia, Middle East and Africa Technology The reference simulation shows an implicit technological change consisting of the shifting from integrated steelworks (ISW) to the cheaper mini mills (MMS). ISW are expected to lose ground due to their higher costs (Figure 5). Almost 66% of the global installed capacity in 2000 corresponds to ISW. At the end of the simulation period the corresponding share would decline up to 55%. 11

12 70% 65% 60% 55% Share 50% 45% 40% 35% 30% Time Integrated Steelworks Minimills Figure 5: Steel technology shares in the BAU scenario The existing obsolete OPH route (in China, India and Eastern Europe) is expected to completely disappear (Figure 6). New SRP and BOFA steelworks would substitute the BOF facilities. The EAF mini-mill would shift to EAFA and DRP Capacity (Mt) OPH BOF EAF BOFA EAFA SRP DRP Technology Figure 6: BAU world installed capacity 12

13 3.1.5 CO 2 emissions 18 Global direct emissions from the iron and steel sector are expected to decrease by 15%, from 1461 in 1990 to 1248 MtCO 2 in 2030, as a consequence of the shifting from integrated steelworks to the mini-mills. In 1990 China emitted 319 MtCO 2, which amounted to 20% of the world total. The former Soviet Union and Eastern Europe, together accounted for 20%. Other important polluters were the EU with a 15% share, Japan (11%), India (10%) and USA (7%). Figure 7 depicts the regional CO 2 emissions for the period Chinese emissions follow the ascending path of the production, reaching 359 MtCO 2, i.e. 29% of the world total. The emission level in China drops significantly between 2000 and 2010 due to the dismantling of the OPH route by 2002 (WSD [55]) and the modernization of the remaining facilities. USA and South Korea increase emissions slightly. The economies in transition and the EU reduce emissions by 28% and 31% respectively. India and Japan are also expected to reduce their emissions. Africa and Middle East China Corea Economies in transition EFTA and Turkey EU15 India Latin America North America Pacific OECD Rest of Asia CO 2 Emissions (MtCO 2 ) Figure 7: CO 2 emissions in the BAU scenario CO 2 direct emissions basically depend on the consumption of fossil fuels, the energy mix, and the production level. World energy consumption by the steel sector falls by 29% in the period because of the shift to cleaner (and cheaper) technologies and fuels. Figure 8 shows the world energy mix and the consumption levels. While coal and coke dominate the energy input in 1990, coal consumption drops by 58% and coke by 54% in 2030, since energy efficiency improvements are expected to be achieved at the expense of solid fuels. Furthermore, technological improvements in the secondary routes avoid a higher increase in the consumption of electricity. Figure 8 shows the world energy consumption by fuel in the period. 18 CO 2 emissions in 1990 have been calculated using data from IEA [25]-[26], the only common source of information for all the regions covered by the model. 13

14 Consumption (Mtoe) GAS OIL COAL WWF ELE HEA COK Fuel Figure 8: World energy consumption within the steel sector in the BAU scenario 3.2 Emission trading scenarios Emission trading is one of the three international market mechanisms foreseen by the KP in order to meet the GHG reduction targets. Emission trading is cost-effective because it guarantees the achievement of an emission target with the lowest overall abatement costs. In the absence of transaction costs the initial allocation of emission permits, while having potentially large equity effects, does not change the final outcome, i.e. the emission reduction taking place in the most efficient way. The allocation of emission rights, e.g. grandfathering, auctioning, determines the financial burden put on the participants. A CO 2 emission trading market is currently being proposed in the EU, and is expected to be launched in The trading scheme will affect mainly the power generation and the energy intensive industries. This sub-section studies the effects of three possible emission trading markets (EU15, EU27 and Annex B) on the steel industry of each country. Under such systems trade would be allowed among all sectors and countries within the market. It is assumed that no specific emission abatement measures are undertaken outside the market boundaries. In order to simulate the emission permit markets, the sectoral marginal abatement cost curves for the steel industry have been calculated by introducing carbon values in the range from 0 to 250 /tco 2 into ISIM. This follows the same procedure as that implemented in the POLES model (Kouvaritakis et al. [30]). The introduction of a carbon value (tax) reduces the steel demand. As the carbon value increases, prices of the fuels used in the different processes rise according to their carbon content, inducing fuel substitution. Coal is the most negatively affected by the introduction of the carbon values, while natural gas becomes the cheapest option. Electricity price increases as well at a different rate in each country, according to the fuel mix used for power generation. The energy price increase translates into different increments in production cost for the different technologies and regions. Technology change and retrofitting 14

15 speed up according to these effects, as the fuel price will push forward to more fuelefficient technologies, through new capacities or retrofitting. The emission trade market is assumed to be perfect (i.e. no market distortion, and zero transaction costs), and will be cleared at the price where all marginal cost curves are equalized Emission trading within the EU15 The first emission trading scenario deals with the case of an emission trading market within the EU15 member states. Under the EU emission trading directive each member state will allocate the national emission permits to the various industrial sectors. In this article, the emission permit allocation to the steel industry is based on the so-called optimal allocation approach, which ensures that the national targets are achieved minimizing the overall compliance costs. National sectoral targets for the steel industry in each member state are calculated assuming that the EU Burden Sharing Agreement 19 (BSA) has to be fulfilled. The results from the POLES model have been used for this purpose. The procedure is illustrated in Figure 9. POLES computes for each member state the permit price reached under national emission trading regimes, given the national BSA target. The permit prices under national emission trading regimes are given by the intersection between the national marginal abatement cost curves (MAC) and the BSA targets. The intersections between the sectoral MACs and the national permit prices give the emission allocation among all the industries included in the trading regime. Such an allocation ensures the fulfilment of the BSA targets. Once the POLES-based national permit prices are derived, the sectoral marginal abatement cost (MAC) curves from ISIM are used to compute the targets for the iron and steel industry in each member state. 19 The KP sets different binding emission targets for a number of Parties, including the European Union. The EU agreed to reduce its greenhouse gas emissions by 8 % by , from 1990 levels. This overall target has since been distributed on a differentiated basis to individual Member States under an EU burden sharing agreement agreed upon by the Council of Ministers in June 1998 (EU Council Decision 2002/358/EC). 15

16 Sectoral MAC (ISIM) National MAC (POLES) Permit price ( /tco2) National permit price Sectoral target National (BSA) target KP reduction target (%) Figure 9: Optimal allocation procedure The prices and the BSA reduction targets with respect to 1990 emissions are listed in Table 6: National targets, sectoral targets and permit prices for the EU15-wide scenario. POLES estimates an EU15-wide permit equilibrium price of 28 /tco 2. Table 6: National targets, sectoral targets and permit prices for the EU15-wide scenario Country BSA Target (%) Sectoral Target (%) Permit Price ( /tco 2 ) Austria (AUT) Belgium and Luxembourg (BLX) Denmark (DNK) Spain (ESP) Finland (FIN) France (FRA) United Kingdom (GBR) Greece (GRC) Ireland (IRL) Italy (ITA) Netherlands (NLD) Portugal (PRT) Germany (RFA) Sweden (SWE) European Union (EU) Figure 10 illustrates in detail the advantages of an emission trading mechanism. With the implementation of an international market, the countries with prices lower than the international one will undertake additional reductions above their targets, in order to get revenues from the permit sales. The emission abatement cost for the sellers is the area limited by the sectoral MAC and the actual emission level. The gains of a country in a 16

17 seller position, with regard to the national trading system, are given by the surface limited by the international price, the target emission level and the sectoral MAC. On the other hand, the countries where the national price is above the international price will buy emission permits. The abatement costs for the buyers are given in this case by the area limited by the sectoral MAC and the target emission level that is below the international price. The surface between the sectoral MAC and the target emissions above the international price is the monetary valuation of the amount saved by the buyer thanks to the emission trading system. Notice that when focusing on a specific sector among those covered by the trading scheme, the sales and the purchases do not match necessarily, and the sector might be either a net seller or a net buyer. Only when the whole market is considered, i.e. all the sectors and all the countries, both amounts are the same, and the market clears. Buyer National Price Permit Price ( /tco2) Buyer Sectoral MAC Market Price Buyer National MAC Seller Sectoral MAC Seller National Price Seller National MAC Reduction (%) Buyer Actual Emissions Permit Purchases Overemissions Buyer Sectoral Target Seller Sectoral Target Permit Sales Overreduction Seller Actual Emissions Buyer BSA Target Seller BSA Target Buyer Savings Buyer Payments Seller Revenues Seller Payments Seller Gains Figure 10: Savings, payments and revenues from emission trading Table 7 summarizes the effects of the emission trading scheme described by Figure 10 on the steel sector for each EU15 member state. 17

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19 Country 1990 Emissions (MtCO 2 ) Target Emissions (MtCO 2 ) Table 7: Effects of an EU15-wide emission trading scheme on the steel sector 2010 BAU Emissions (MtCO 2 ) 2010 Emissions at 28 /tco 2 Trade 20 (MtCO 2 ) Savings 21 (M ) Revenues 22 (M ) Gains 23 (M ) Gross Compliance Costs 24 (M ) Net Compliance Costs 25 (M ) National Compliance Costs 26 (M ) Benefits 27 (M ) AUT BLX DNK ESP FIN FRA GBR GRC IRL ITA NLD PRT RFA SWE EU Target Emissions in 2010 minus emissions at EU permit price (buy<0<sell). 21 Only for buyers, areas under the sectoral MAC and over the EU permit price up to the target. 22 Only for sellers, the EU permit price multiplied by the traded amount. 23 Only for sellers, areas between the EU permit price, the emission target and the sectoral MAC. 24 For sellers: areas under the sectoral MAC up to the EU permit price, for buyers: areas under the sectoral MAC up to the EU permit price plus the bought amount. 25 For sellers: the gross compliance costs minus the revenues, for buyers: the gross compliance costs under national trading regimes minus the savings. 26 Gross compliance costs under national trading regimes, the areas under the sectoral MACs up to the national permit prices. 27 Compliance costs under national trading regimes minus the net compliance costs under an EU-wide scheme. 19

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21 The EU15-wide emission-trading scheme would reduce the compliance costs of fulfilling the KP targets (the BSA) in 2010 by half, from M, in the case of national emission trading regimes, to a (net) compliance cost of M. The EU15 global benefit for the steel sector amounts to M. The steel industry would be a net buyer of permits at 28 /tco 2. The EU15 steel sector would save M, mainly in the Netherlands (53.13 M ), Finland (40.71 M ) and Sweden (25.11 M ), where the sector would find cheaper abatement costs through the permit market. The steel industries of Germany (31.76 M ) and the United Kingdom (18.18 M ) would get revenues from permit selling. On the other hand, given that the implementation of the EU15 emission permit market would increase the production costs of the EU15 steel industry, there would be an emission and production leakage from the EU15 to the rest of the world. Figure 11 shows the size of the production leakage for permit prices ranging from 0 to 50 /tco 2. For instance, for a price of 20 /tco 2 the EU15 steel production would diminish by 3 Mt, while the rest of the regions would raise slightly their production levels, China having the highest increment. As the permit price rises, logically the size of the leakage effect increases. Africa and Middle East China EU Permit Price ( /tco2) Economies in transition EFTA and Turkey EU15 India Latin America North America Pacific OECD Rest of Asia South Korea Production Change (Mt) Figure 11: Production leakage as a function of the EU15 emission permit price Moreover, emission trading is expected to affect the technology mix in the steel sector. Figure 12 presents the production level for all technologies when the permit prices ranges from 0 (BAU) to 50 /tco 2. As the carbon value rises there is a slight shift towards the most advanced primary production route, i.e. SRP. The increasing prices of electricity would cause the stagnation of production levels in the secondary routes (EAF, EAFA and DRP). 21

22 70 60 Production (Mt) BAU 10 /tco2 20 /tco2 30 /tco2 40 /tco2 50 /tco BOF EAF BOFA EAFA SRP DRP Technology Figure 12: Effects of the trading system on the EU15 technology mix From the point of view of the energy consumption, this technology evolution leads to the stabilization of electricity consumption (see Figure 13). Sectoral energy efficiency improvement, and emission reduction, is achieved mainly because of the shifting to the less energy-intensive SRP route. The reduction caused by switching from coal to other fuels is negligible for this range of permit prices Consumption (Mtoe) BAU 10 /tco2 20 /tco2 30 /tco2 40 /tco2 50 /tco2 5 0 COAL COK OIL GAS WWF HEA ELE Fuel Figure 13: Effects of the trading system on the EU15 energy consumption 22

23 3.2.2 Emission trading within the enlarged EU This scenario studies the effects of an emission trading system on the steel industry in the member states of the enlarged EU, i.e. 27 countries. The hypotheses of the previous scenario are also applied in this case, i.e. no specific emission abatement measures are undertaken in the rest of the world and the trading scheme is expected to be launched in The steel industry sectoral targets in the 12 new EU countries are calculated taking into account that the KP targets have to be fulfilled. Given the POLES-based national permit prices, the sectoral marginal abatement cost (MAC) curves obtained from ISIM are used to compute the targets for the iron and steel industry in each member state. Table 8 shows the national and sectoral reduction targets with respect to 1990 emissions, and the national permit prices of the enlarged EU member states used in the following. Table 8: National targets, sectoral targets and permit prices for the EU27-wide scenario Countries BSA or Kyoto target (%) Sectoral Target (%) National Permit Price ( /tco 2 ) Austria (AUT) Belgium and Luxembourg (BLX) Denmark (DNK) Spain (ESP) Finland (FIN) France (FRA) United Kingdom (GBR) Greece (GRC) Ireland (IRL) Italy (ITA) Netherlands (NLD) Portugal (PRT) Germany (RFA) Sweden (SWE) Cyprus (CYP) Malta (MLT) Czech Republic (CZE) Hungary (HUN) Poland (POL) Slovak Republic (SVK) Bulgaria (BGR) Romania (ROU) Slovenia (SVN) Estonia (EST) Lithuania (LTU) Latvia (LVA) European Union (EU27) The national permit prices in the candidate countries are lower than those in the EU15 member states, or even zero, as in the case of Bulgaria, Romania, Slovenia and the Baltic states, due to the hot air effect. Because of the radical transformation process of these economies, and of the consequent economic decline, emissions in 2010 will be below the respective Kyoto Protocol targets. This implies that these economies at first will be able to sell large amounts of rights, without actually carrying out any costly effort to reduce emissions, and benefiting therefore from large financial transfers. Table 9 summarizes the EU27-wide scenario results. 23

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25 Country 1990 Emissions (MtCO 2 ) Target Emissions (MtCO 2 ) 2010 BAU Emissions (MtCO 2 ) Table 9: Effects of an EU27-wide emission trading scheme on the steel sector Emissions at 18 /tco 2 Trade (MtCO 2 ) Savings (M ) Revenues (M ) Gains (M ) Gross Compliance Costs (M ) Net Compliance Costs (M ) National Compliance Costs (M ) AUT BLX DNK ESP FIN FRA GBR GRC IRL ITA NLD PRT RFA SWE CYP MLT CZE HUN POL SVK BGR ROU SVN EST LTU LVA EU Benefits (M ) 25

26

27 According to these estimates the EU27-wide emission-trading scheme would reduce the compliance costs of fulfilling the KP targets by two thirds in 2010, from M in the case of national emission trading regimes to a (net) compliance cost of M. The widening of the emission permit market would reduce the equilibrium price up to 18 /tco 2. With this market price, the EU27 steel sector would be a net buyer of allowances, and would save M, mainly in the existing member states (EU15) due to the hot air effect. The steel industries of the candidate countries, Germany and the United Kingdom would get revenues from permit selling Emission trading within the Annex B countries The third emission trading scenario analyzes the impact of an Annex B-wide permit market. Table 10 shows the national and sectoral reduction targets with respect to 1990 emissions, as well as the national permit prices of the Annex B member states, used in the following. 27

28 Table 10: National targets, sectoral targets and permit prices for the Annex B-wide scenario Countries BSA or KP target (%) Sectoral Target (%) National Permit Price ( /tco 2 ) Canada (CAN) United States (USA) Austria (AUT) Belgium and Luxembourg (BLX) Denmark (DNK) Spain (ESP) Finland (FIN) France (FRA) United Kingdom (GBR) Greece (GRC) Ireland (IRL) Italy (ITA) Netherlands (NLD) Portugal (PRT) Germany (RFA) Sweden (SWE) Norway and Switzerland (ROWE) Cyprus (CYP) Malta (MLT) Czech Republic (CZE) Hungary (HUN) Poland (POL) Slovak Republic (SVK) Rest of Central Europe (RCEU) Bulgaria (BGR) Romania (ROU) Slovenia (SVN) Estonia (EST) Lithuania (LTU) Latvia (LVA) Russia (RUS) Ukraine (UKR) Rest of Former Soviet Union (RFSU) Japan (JPN) Australia and New Zealand (RJAN) Annex B The Annex B-wide emission-trading scheme would decrease the compliance costs of fulfilling the Kyoto targets by 70% in 2010, from M, in the case of national emission trading regimes, to a (net) compliance cost of M. The expected overall benefit is estimated to be M. The equilibrium price for the Annex B market would remain at 18 /tco 2, and the steel industry is expected to be a seller of allowances. For the EU27 member states, the compliance costs would be lower than in the case of an EU27-wide market. The steel sector in the EU27 would remain being as a buyer. Savings would amount to M, mainly in North America and the EU15. The Former Soviet Union and the Central and Eastern European countries are expected to be permit sellers, as well as Japan, Germany and the United Kingdom. Table 11 summarizes the scenario results. 28