We know how to make the electricity supply renewable. We know how to make land transport electric. Both are on track. But there are four problem industries where things are not so clear.
These estimates are not all for the same year and not strictly comparable, but they are good enough to make the point that to reach net zero emissions, the four sectors (together 20% of global fossil emissions) cannot be ignored.
The challenges are distinct but they have common features.
- Very plausible technological pathways exist to decarbonise. But these are not mature, and for the moment they are far more expensive than BAU.
- There is no guarantee or strong expectation that technical progress will ever eliminate the cost barrier, in contrast to electricity and land vehicles.
- The industries are typical of modern capitalism: they are international and oligopolistic, with a lot of trade, a handful of large companies, and a myriad of small ones.
- Their products and services rarely have plausible substitutes. (We shall see later on why this matters).
Points 1 and 2 mean that the issue for public policy is not R&D (pace all the Democratic presidential hopefuls) but early deployment.
Recall how we got to cheap wind, solar and batteries. It wasn’t a carbon tax, since that does not exist anywhere in the pure form. Partial cap-and-trade exists in the EU, but it has only just started to bite, after giveaway initial allocations. It was done by subsidies for early deployment to create economies of learning and scale:
- In the USA, tax breaks for wind, solar, and electric cars; renewable obligations at state level.
- In Europe and China, tax breaks, subsidies, and regulatory privileges for electric cars.
- FITs and ringfenced auctions for wind and solar generation in Germany, other European countries, China and India.
The costs of FITs have been large in the past, though the cumulative liability (in Germany for instance) has now almost stopped growing as the few surviving FITs are near market rates. Well worth it of course, especially if you aren’t a German consumer.
The same principle holds for our four problem industries. Carbon taxes are politically toxic, and a coordination nightmare in globalised industries. So what’s the workable second-best kludge?
I’d like to float a possible solution. I’ll take steel as the example. The principle extends to the others ceteris paribus.
Steelmaking has two stages. Step 1 is reducing the iron oxides found in nature to pig iron, typically by heating with coke in a blast furnace, a Han-dynasty Chinese invention. Take hematite. In multiple chemical steps,
2.Fe2O3+ 3.C → 2.Fe + 3.CO2
Step 2 converts the brittle pig iron to more versatile steel by adding a small percentage of carbon in an electric arc furnace. This can also be done with scrap iron and steel, 25% of all steel production today. Since Step 2 can be done with renewable electricity, the carbon emissions problem is all about Step 1, pig iron.
Electric arc furnaces are distributed all across the globe in industrial cities with a good supply of scrap metal. Blast furnaces are found in monstrous coastal integrated plants, run by the largest companies. The 15 largest steel producers:
These 15 are responsible for a third (32%) of global steel production, but more – I suppose over 40% – of the new pig iron we are interested in.
The technology for decarbonization of ironmaking is direct reduction (DRI). Iron ore is heated up with natural gas (CH4), reformed to a mixture of carbon monoxide and hydrogen :
3.Fe2O3 + 6.CO → 6.Fe + 6.CO2
and 8.Fe2O3 + 24.H2 → 8.Fe + 24.H2O
This is done at reasonable scale today (100 mt/yr), mainly in India.
However, the process works fine just with the hydrogen:
Fe2O3 + 3.H2 → 2.Fe + 3.H2O [equation corrected]
Two pilot plants for hydrogen DRI are being built in Sweden and Austria by SSAB and Voest respectively with EU research funding. ArcelorMittal are also building a pilot hydrogen DRI plant in Hamburg. These are major and long-established steelmakers; the process almost certainly works.
Technically, but not yet financially. The price of catalysed hydrogen will have to drop a lot for that to happen. The steelmakers are saying “we can do it, but it’ll cost you”. None will move at a large scale – decommissioning a blast furnace is an expensive decision – without an incentive. Collective action problem! So we need early deployment subsidies once again.
Here’s my Cunning Plan (Baldrick™). There are many proposals floating around for fiscally neutral general carbon taxes: the revenue is typically rebated to low income taxpayers. The main objections to this are (a) it’s still a carbon tax (b) it’s too clever by half. But also (c) nobody knows how effective it would be. Relative prices shift (good) but you are also throwing in an uncertain income effect on those who don’t get the rebate, and you are hoping for a cultural nudge too.
HOWEVER these difficulties mostly go away with a sectoral levy-and-rebate scheme.
The early German FITs for renewable energies tried to remove the incentive to waiting for prices to come down aka the penalty for early adopters. The aim was to maintain a roughly equal ROI over time, steadily lowering the FIT rate in line with installation prices. It wasn’t perfect but basically worked. In particular, it was seen as fair, and SFIK there is no significant resentment of the early adopters who got the high FITs.
My scheme would try to identify the current excess cost over 10 years of a hydrogen DRI plant, estimate the likely total volume of subsidised investment, and set subsidy and matching levy rates on carbon-emitting iron. As hydrogen gets cheaper, the rates would fall. You would need a working fund or equivalent budget guarantees to cope with the inevitable errors.
It’s fiscally neutral for the industry. But there are no free lunches. Hydrogen steel is more expensive to make than the carbon-emitting variety. Consumers will pay a slightly higher price for all steel to fund the transition. Most of them will hardly notice. The lack of substitutes for steel means that the industry as a whole will not lose significant business to say aluminium.
The scheme depends on negotiation with the leading producers, that is my top 15, but it should be open to anybody. For holdouts and smaller players, governments would have to be prepared to impose the levies as taxes. It also presupposes a lot of coordination between governments. This does not have to be universal. You need a “coalition of the willing” covering a significant proportion of the industry (as a minimum China, India and the EU, if possible Japan, Korea and the USA), and prepared to impose border taxes on holdouts.
Still too clever by half? Maybe. What’s your alternative?
Exercise for the next session of the Public Policy seminar: work up a proposal on the same lines for aviation, shipping or cement, with the pros and cons. Tip on shipping: flag-of-convenience states are tiny and in no position to stand up to serious diplomatic pressure from big players who mean business. You can stop well short of sending an aircraft carrier to intimidate the Marshall Islands.
BTW, if my scheme works in more than one sector, you are growing a global carbon tax from the bottom up.