Green steel and Europe’s natural gas challenge

Over the past two years, nearly all European flat-steel players have announced the gradual replacement of their coking-coal-based blast furnaces (BFs) with direct-reduced-iron (DRI) plants to decarbonize their steel production. The more than 16 DRI plants currently announced represent more than 25 million metric tons1Metric tons: one metric ton = 2,205 pounds. of capacity (Exhibit 1).

For many of the newly built DRI plants, the initial intention was to use natural gas (NG) as the feedstock or reducing agent to process ore into pig iron in an electric arc furnace (EAF) or submerged arc furnace. The iron would then be used in a basic oxygen furnace (BOF) to produce flat steel.

This NG-based DRI production route, used in combination with an EAF or submerged arc furnace using renewable electricity, would enable steel players to cut their Scope 1 and 2 CO2 footprints in half, on average—from around two metric tons of CO2 per metric ton of flat steel to approximately one metric ton of CO2 per metric ton of flat steel. Together with CO2 prices rising to above €100 per metric ton of CO2, decreased free CO2 allowances, and historical NG prices of some €7 per gigajoule (GJ) (average in Germany, 2019–21), this alternative production route would become cash cost competitive with the BF–BOF route within the next three to five years.

Taking Germany as an example, the announced DRI plants would almost double demand for NG currently used in the iron and steel industry to around 175 petajoules (PJ), from around 120 PJ (approximate demand in Germany, 2020), assuming that announced DRI plants in Germany run on 100 percent NG when they start production in around 2026. A single, large DRI unit of two million metric tons would consume roughly one-fifth of the NG currently used across Germany’s entire iron and steel industry (approximately 20 PJ) and increase industrial NG demand in Germany by around 2 percent.

A buildup of direct-reduced-iron plants using H2 or a resurrection of carbon capture usage and storage seem to be the most viable options for flat-steel players to safeguard their decarbonization efforts.

Looking ahead, NG-based DRI plants can be converted relatively easily to run on H2 (green hydrogen)—when available in sufficient volumes and at competitive cost—to enable a further substantial CO2 reduction that would allow flat-steel players to achieve CO2 footprints below 0.6 metric tons of CO2 per metric ton of flat steel. DRI plants are thus critical for European steel players to reach their carbon-neutrality targets.

The invasion of Ukraine in February 2022 is having deep human, as well as social and economic, impact across countries and sectors. The implications of the invasion are rapidly evolving and inherently uncertain. So far, the invasion of Ukraine has created additional considerations for those European steel players planning investment into the buildup of an NG–DRI production route. Particularly in extended disruption (scenario two) and significant disruption (scenario three) situations, as described in McKinsey’s article on the war in Ukraine, steelmakers could see continued impact of the following conditions:

In addition, coking coal prices rising to above €500 per metric ton (average hard coking coal price in Europe, March 2022), from €170 per metric ton (2019–21) for the traditional BF–BOF route. Together, these factors mean that the feasibility, timeline, and competitiveness of NG DRI investments need to be reassessed, acknowledging the impact on the decarbonization road map and ability to reach CO2-reduction targets set out by steel players.

We currently see four potential scenarios for the impact on the buildup of DRI plants:

In scenario A, flat-steel players could potentially face difficulties in meeting their decarbonization targets because of limited potential from incremental decarbonization measures. Scenario D is likely constrained because of insufficient additional (high-quality) steel scrap supply. Thus, scenarios B and C seem to be the most viable options for flat-steel players to safeguard their decarbonization efforts.

For scenario B, gaining timely access to sufficient H2 supplies would be the key success factor. The German flat-steel industry would need more than 14 terawatt-hours of green H2 in 2026 to substitute for the planned NG. In Europe, that number would increase to more than 32 terawatt-hours of green H2, which is likely to be challenging—it corresponds to around 66 percent of announced electrolyzer capacity in Europe.2Estimation excludes imports. This would mean that flat-steel players would need to double down on the sourcing of limited H2 while carrying out the required infrastructure buildup and potentially to accept a trade-off in securing supply versus the cost competitiveness of green H2. Some Nordic steel players, such as H2 Green Steel, have already been focusing on using H2 as the feedstock of choice for their newly built DRI plants. Securing early access to green H2 gets even more important now, with it being the one direct alternative to NG.

When examining the cost competitiveness of the NG–DRI–EAF, H2–DRI–EAF, and BF–BOF routes at different NG and CO2 prices, the H2–DRI–EAF path is already cost competitive at a NG price of €15 per GJ and a CO2 price of €100 per metric ton (Exhibit 4). The calculations are based on an H2 price of around €3 per kilogram, which industry experts indicate is a possible forecast for 2025 and later. The timeline for cost-competitive green steel using green H2 might shift forward and lead to a potential skip of NG as reducing agent.

With scenario C, the applicability for steel players will likely depend on two factors: customer acceptance for green steel based on CCUS and capital-expenditure efficiency to enable financial payback of investments within the likely limited window of customer acceptance. Our first estimates suggest that a CCUS investment would require a minimum time frame of five to ten years to support the required massive investments in this technology. However, it takes time to align stakeholders and obtain the required permits.

Whether a jump to H2 or a resurrection of CCUS would be better to safeguard the decarbonization of European steel players will depend on further development and the terms of trade of key market, technology, and cost parameters. These include the supply of NG from Russia into Europe, NG prices, government interventions (such as subsidies), and CO2 targets, and they likely vary from plant to plant. Although the NG market might balance out again in availability and price, the whole steelmaking industry now needs to take a step back and adjust its decarbonization strategies.

Frank Bekaert is a senior partner in McKinsey’s Brussels office, Marc-Daniel Halbgewachs is a consultant in the Frankfurt office, Christian Hoffmann is an associate partner in the Duesseldorf office, Bruno van Albada is a consultant in the Amsterdam office, and Marlene Weimer is a consultant in the Munich office.

The authors wish to thank Pradhuman Aggarwal, Karel Eloot, Wieland Gurlit, Philipp Radtke, Ole Rolser, Thomas Vahlenkamp, Michel Van Hoey, and Benedikt Zeumer for their contributions to this article.