Weekly Overview: Ambitions and Markets Collide in UK

Tata Steel’s bleak assessment of its UK operations threw Downing Street into turmoil late March. Citing high energy costs and a distorted steel market as chief among its woes, the Indian giant said the UK operations could be sold off or closed down.

Senior government officials including the prime minister David Cameron returned to London for crisis meetings and there were questions asked about the need to renationalise the ailing business as the threat loomed of 40,000 redundancies. Last week, the government of Scotland bought two of Tata’s plants.

On the face of it, this should be a good time for energy-intensive industries in Europe: low carbon prices coinciding with relatively low wholesale gas and power prices. Both French Engie and German Uniper this week announced cuts in their purchasing costs, for example. And looking at the market fundamentals, the short and medium term prospects for spot LNG prices are equally weak as demand is not materialising. Europe is a likely destination for much of the supply, as UK government statistics illustrate this week.

But one reason energy and carbon prices are low is the lack of industrial demand; and in the steel sector what little growth in demand there is, is being met by China.

China's overcapacity for steel production, about 400mn mt, is about the same as the European Union’s actual capacity for steel production and accounts for about two thirds of the world’s total overcapacity.

But rather than lying idle in the national economic slow-down, Chinese steel mills are being rewarded for production, by an apparently negative price for carbon. Environmental externalities notwithstanding, the overproduction of what is not needed at home is shipped to markets the other side of the world and, it is alleged, sold well below cost. That explains how China has grabbed such a big market share in such a short period.

Because the US has erected high enough trade barriers, Europe is the natural home for it, and within Europe, the production costs in the UK are higher than elsewhere as energy-intensive industry can claim back less money than is the case in Germany, for example.

The UK has put in place compensation for industrial users that covers up to 80% of the policy costs that augment the bill, depending on what fuel and what process a given site is using, but the final bill per ton of output is still higher than elsewhere in the EU, according to the Energy Intensive Users Group (EIUG).

Then there is the European Union’s carbon trading scheme, which is indifferent about how the carbon is removed from the environment: whether through industrial failure, or through technical innovation.

A tax on the carbon content of imports at the EU borders would iron out the distortions inherent in the situation that allows the bloc to export carbon emissions across the globe, where they increase in less efficient and worse regulated industrial processes and return to the EU in the form of finished goods.

But that could trigger a trade war with China; as too would the UK, if it agreed with other member states in pressing for an upgraded trade defence instrument, which the EU steel industry would like it to.

The UK is in a difficult situation with regard to China: it wants the steel industry to survive but it also – for reasons that have not been accepted by many as sound – wants to allow French and Chinese companies to build a new kind of nuclear reactor at Hinkley Point.

And incidentally, rubbing salt in the wound, unlike Westinghouse’s established reactors, this plant will need components that are too large for UK steel manufacturers such as Sheffield Forgemasters to make, and so will have to be shipped in, contributing to the massive cost, the EIUG further points out.

In exchange for doing this by 2018-19, a long-term power purchase agreement was agreed some years ago in 2012 with a price that was well above the market at the time the UK government first announced the deal and is now even more anomalous. But the plant will not be built by that date; prototypes in France and Finland are years late and over budget; and French participation in the UK project still cannot be guaranteed.

The UK also wants China to invest in other nuclear plants to ensure a future where there is a healthy margin of low-carbon power supply, in keeping with its climate change commitments.

On the other hand the conditions could be right for the developers of gas-fired power plants to step into the breach, given the ever tighter supply margins. One coal plant, Longannet in Scotland, closed this week but another that was due to close in March, Fiddlers Ferry, won a last-minute reprieve, suggesting nervousness at National Grid about system resilience. The crucial question is for how long gas prices need to remain 'low' before they become 'normal' and investors take the plunge.

William Powell