Joint Implementation and industrial energy efficiency

Alchevsk Steel Mill Modernization

Grzegorz PeszkoSenior Environmental Economist

Sustainable Development Department, Europe and Central Asia

The World Bank

Steel sector background

• Ukraine’s steel sector very competitive due to rich and cheap iron ore and coke.

• Steel products account for 36% of Ukrainian exports and 25% of industrial production.

• Ukraine 7th largest steel producer in the world and 3rd largest exporter after Japan and Russia.

• Export = 74% of output in 2004.• Historically high steel prices encourage

modernization investments in the sector world wide.

Project owner: OJSC ‘Alchevsk Iron and Steel Works’ AIWS

• Key employer in Alchevsk city (24 thousand employees from 118 thousand inhabitants).

• Typical post-soviet vintage of technologies and depreciation: high energy intensity and poor general environmental performance relative to comparable facilities in OECD countries.

• Main shareholder: Industrial Union of Donbas, one of the largest industrial groups in Ukraine

• IUD acquired steel plants in Hungary and Poland that facilitate access to EU export market

Project context

JI project is a part of the wider modernization program of the whole iron/steel production process which started in 2004

Objectives of modernization– More efficient technologies– improved environmental performance– Improved process efficiency– increased capacity

– upgrade the quality and range of steel

products

Generic steel mill production process

Alchevsk JI project focus

Baseline Scenario

Project Scenario

Project boundaries

Technical scope• Elimination of existing old Open Hearth Furnace and Blooming Mill• Installation of two LD Converters• Installation of a twin ladle furnace (300 t / 50 MVA)• Installation of a Vacuum Tank Degassing Plant • Installation of 2 Continuous 2-strand Slab Casters • Reconstruction and installation of new oxygen blocks

All this with 2 times increased steel output!

Emissions reductions

• Emission Reduction Units (ERUs) = 934 thousand tons CO2 eq./year (4.67 million tons over a five years )

• Sources of emission reduction: – reduced use of natural gas in open heart furnaces in

comparison with converters, – reduced use of blast furnace gas in blooming mill with

saved gas utilized in an existing on site combined heat and power plant to replace natural gas and grid electricity,

– reduced use of raw materials, energy and steel in converters and continuous casting.

Investment analysis: Financing• Total project cost $944 million• Financing: 30% equity, 70% loans• Evolution of the debt structure reflects a growing

confidence of financial institutions in AISW and its shareholder IUD: – 2003: Euro 140M trade finance package for new

equipment by the Swiss trading company, – 2003: Euro 350 million 3-years finance facility was

syndicated by Societe Generale – some for CAPEX, – 2004: long term US$100 million direct loan and $250

million syndicated lending facility for CAPEX – 2006: US$ 200 million raised from the consortium of

Ukrainian commercial banks

Role of carbon finance

• Sale of ERUs US$14 million per year, between 2008 and 2012 (US$70 million total).

• ERU = roughly 7.4% of investment cost (undiscounted), but less than 1% of total operational revenue

• Only 1 million ton (about 20% of total) will be sold to the Netherlands European Carbon Facility through the World Bank.

• NECF absorbs project development and determination risks; hence its price NECF lower than expected average sale price. Other buyers anticipated to pay more for lower risk once the project is successfully determined and ERPA signed.

Financial analysis

Alchevsk ISW financial indicators

FIRR NPV@15%

project asset Project

Project without carbon revenue 21.5% 29.2% $340.447.624

Project with carbon revenue 22.4% 30.0% $359.833.010

Baseline scenario 29.5% 32.6% $81.666.907

• Relatively high financial rates of return (FIRR) both for baseline and project scenarios

• FIRR for baseline (29.5%) higher than for project, with or without carbon revenues

• NPV of the project is larger than in the baseline • Volatility of slab prices have significant impact on financial

performance of the project (sensitivity analysis).• Carbon finance has small impact on FIRR, but its significance would

increase if slab prices fell (risk cusion).

Baseline is technically feasible, with less risks and higher financial return

• Implementation of the project is financially attractive to AISW, but rehabilitation of currently used older technologies (OHFs and ingot casters) is even more financially attractive and less risky

• Open heart furnaces (OHFs) represent obsolete technology by international standards, but are still a typical business practice in Ukraine and Russia

• So large-scale project has not been implemented in the steel sector of Ukraine before.

• Construction risks and operational risks high and well managed by project company

Barriers that would prevent project implementation

• Financing has been the main barrier for the project. With a total investment of US$943.7 million, the project ranks among the largest investments made by private investors in Ukraine,

• Domestic bank credit small and short term• Foreign finance of Ukrainian corporate entity on such a

scale still uncommon• Carbon finance revenue provide additional early cash flow

less dependent on commercial risks;• Additional comfort for lenders through due diligence by

the carbon investors and the World Bank. • Improved environmental performance also important

factor to undertake project (civil society and access to EU market)

Value added of carbon finance

• JI was crucial in making this project financeable

• AISW would not implement the project without considering carbon finance

Contact

Grzegorz Peszko Senior Environmental Economist, ECSSD

Europe and Central Asia RegionThe World Bank

1818 H Street N.W., Mail H5-503Washington, DC 20433 USA

gpeszko@worldbank.orgPhone: (1-202) 473-4767