Who will pay the price of industry decarbonisation?

This week, equity research house Redburn released a report assessing the cost of decarbonisation in the cement industry. It concluded that the full cost of decarbonisation would cause cement prices to rise by 61 per cent, driven up by the cost of carbon capture technology. Redburn's analysts promptly downgraded both HeidelbergCement and LafargeHolcim to neutral and sell, respectively.

Pressure from investors
This is not the first time that the industry has been subjected to close scrutiny over its plans to decarbonise, but it does represent a growing tide of concern from investors who are now less willing to finance companies with perceived sustainability risks or considered direct contributors to climate change.

In this post-Greta Thunberg™ era, perception counts for a lot, and it is moving against the cement industry. Last year, the Institutional Investors Group on Climate Change (IIGCC) and Climate Action 100+ – which now includes BlackRock, the world's largest investor – wrote directly to the CEOs of CRH, LafargeHolcim, HeidelbergCement and Saint Gobain urging immediate action to reduce CO₂ emissions and demanded increased investment in tackling decarbonisation of the industry.

Share Action, a UK lobby group, has gone further in telling investors to engage robustly with 'climate laggards' within the cement industry, and to insist that bondholders resist renewing new bond issuances if cement producers fail to align with investor expectations and do not show willingness to change over decarbonisation.

Policy uncertainty
The cement industry finds itself in a highly uncertain environment. As investors heap their concerns onto the industry, the industry has been left to navigate a policy environment that lacks coherence.

In Europe the emissions trading system (ETS) is about to enter a fourth, more stringent phase. While many of the major cement producers are ‘long’ on emissions permits at present, some smaller operators may be force to close or sell up, exposed to competition from low-cost imports from countries with lower environmental costs.

Nevertheless, the European Commission added a further pressure point on cement producers in December 2019, when the new EC President, Ursula von der Leyen, introduced proposals for the 'Green Deal', which aims to dramatically increase the pace of carbon reduction in the 27-nation bloc, and ultimately achieve the creation of the world’s first climate-neutral continent.

A planned carbon border tax may be introduced to level the playing field for the energy-intensive industries, including cement, but the details are still unclear. Without such a mechanism, the regional cement industry would be exposed to low-cost imports, the net effect of which would be to displace local carbon emissions from Europe to north Africa or Turkey, beyond the reaches of the ETS.

What has not been resolved is a workable set of incentives and funding for accelerating investment into carbon reduction technologies.

The industry is working independently across multiple fronts in its drive to reduce carbon emissions through a mixture of approaches, ranging from conventional (clinker reduction, alternative fuels, optimisation) to full-blown breakthrough technologies, such as carbon capture.

As investment in such breakthrough technologies is ramped up, cost will rise dramatically and these will have to be passed on to the consumer.

By downgrading the cement sector, Redburn is effectively arguing that such large-scale investment will undermine Europe’s cement producers to the extent that they will be uninvestable.

What next?
The EU will have to decide between imposing environmental costs through the ETS onto European cement producers, with no border tax levelling mechanism, which would result in the offshoring of carbon emissions to regions of lower environmental compliance; or introducing a carbon border tax that will create a level playing field with any cement producers outside of the EU ETS but will result in high prices for cement to the end consumer.

Correctly calibrated, such a mechanism is preferred, as it would enable European cement producers to invest in the costly new technologies required to achieve carbon neutrality.

For this to succeed, society must be willing to pay more for its cement.