Joint Implementation and industrial energy efficiency Alchevsk Steel Mill Modernization

1. Joint Implementation and industrial energy efficiencyAlchevsk Steel Mill Modernization Grzegorz Peszko Senior Environmental Economist Sustainable Development Department, Europe and Central Asia The World Bank

2. 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.

3. 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

4. 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

5. Generic steel mill production process Alchevsk JI project focus

6. Baseline Scenario Project Scenario Project boundaries

7. 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!

8. 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.

9. 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

10. 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.

11. Financial analysis • 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).

12. 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

13. 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)

14. Value added of carbon finance • JI was crucial in making this project financeable • AISW would not implement the project without considering carbon finance

15. Contact Grzegorz Peszko Senior Environmental Economist, ECSSD Europe and Central Asia Region The World Bank 1818 H Street N.W., Mail H5-503 Washington, DC 20433 USA gpeszko@worldbank.org Phone: (1-202) 473-4767