H1 Case Study Question 1 Answers

Question 1 The market for steel Figure 1 Global composite steel price index Note: Global composite steel price is a weighted av erage of the lowest transacted cost of all steel products converted into US dollars. 2004 = 100. Source: www.bloomberg.com Extract 1: Global steel market The recent Eurozone sovereign debt crisis has created a lot of uncertainty in the steel market. This uncertain macroeconomic environment – with distressed financial markets and large government budget deficits – has led to countries implementing a number of austerity measures . In fact, certain parts of the world have suspended investment in large-sc ale infrastructure projects. As a result, steel demand has not rebounded as strongly as predicted. Meanwhile, growth in Chin ese steel production has changed the country from a net importer of steel to a net exporter of steel. Other emerging economies, such as South Korea and Taiwan, are also installin g newer steel capacities. There is now significant over-capacity in the global steel sector. Source: Global steel outlook 2011 and 2012; Ernst & Young’s Global Mining & Metals Center Extract 2: Environmental aspects of steel production The primary process of steel production fr om iron ore involves three basic steps: First, the heat source used to melt iron ore is produced. Next the iron ore is melted in a furnace. Finally, the molten iron is processed to produce steel. This production of steel from ore is the most energy intens ive and emits the most carbon dioxide. The main source of pollution comes from the use of coke - a solid carbon fuel – to melt

and reduce iron ore. Water pollution also come s from the water used to cool coke after it has finished baking. Source: www.steel.org and www.oecd.org Extract 3: The Kyoto Protocol The Kyoto Protocol is an international agreement to reduce greenhouse gas (GHG) emissions. The major features of the Kyoto Protocol are summarised below: 1. Binding targets are set for 37 industrialized countries and the European community to reduce GHG emissions by an average of 5.2 per cent (based on 1990 levels) by the year 2012. 2. Recognising that develope d countries are principally responsible for the current high levels of GHG emissions in the at mosphere, the Protoc ol places a heavier burden on developed countries. 3. Countries must meet t heir targets primarily through national measures. However, the Kyoto Protocol offers them an additional means of meeting their targets by way of Emissions Trading – known as “t he carbon market". The countries are allowed to trade amongst themselves ri ghts to emit six greenhouse gases. If a country reduces emissions below its agr eed limit, it will be able to sell the additional reduction as a credit. So if a country is finding it difficult to cut emissions, it will be able to buy these credits from other countries. Source: United Nations Framework Convention on Climate Change and J. Sloman, Economics Extract 4: Is emissions trading effective? Some of Europe's largest industrial com panies gained billions of euros from the carbon emission rules they lobbied fierce ly against, new analysis reveals today. Europe's top 10 steel and cement companies have amassed 240m carbon pollution permits from generous allocations. The fr ee permits, granted to companies with a market value of €4 billion, can be sold or kept for future use. The European commission estimates that the entire energy -intensive sector will have accumulated allowances worth €7 billion to €12 billion by the end of 2012. The European Union emissions trading scheme (ETS) puts a cap on the carbon pollution emitted by energy and industrial companies. Those reducing their emissions can sell their spare permits to those who do not. But a combination of initial over-allocation by national governments and the economic decline has left the steel, cement, chemical, ceramic and paper sectors with many more permits than they need. For instance, it was estimated that if the steel sector did not sell any of its surplus, it would not have a need to purchase emissions until 2023. Analysis also revealed that 9 of thes e top 10 steel and cement companies bought between them 24.4m permits from the ch eaper international market, mainly from companies in China and India. These can be used within the EU's trading scheme, enabling companies to retain the more valuable European ETS permits. Furthermore, despite the European companies claiming that tougher emissions rules

would drive business overseas, some we re paying overseas steel and cement companies for their international carbon permits. Source: The Guardian, 19 June 2011 Extract 5: US Protectioni sm of steel industry Steel has traditionally been among the most protected sectors, especially because of the political and regional clout it commands in many countries and intense lobbying that often takes place by steel companies. For instance, the American Iron and Steel Institute (AISI) had, on several occasions, successfully lobbied for the introduction of protectionist measures. It is estimated that these measures cost the US steel consumers around US$16.8 billion between 2000 to 2007. Analysis further revealed that these measures were meant to save a dying industry in t he US rather than countering unfair trade, which was the reason often advanced by the US when restricting steel imports. Source: Indian Institute of Management Questions (a) (i) Summarise the trend in the global composite steel price between 2008 to 2011 as shown in Figure 1. [1] Global steel prices were falling between 2008 to 2011 (ii) Extract 1 refers to recent changes in the global steel market. Using a supply and demand diagram, explain how you would expect the recent Eurozone sovereign debt crisis and the growth in steel production in emerging economies to have impacted the world market for steel. [4] Growth in steel production in emerging economies  Increase in the number of sellers  Increase in supply of steel (optional: and increase in price elasticity of supply due to increased spare capacity) [1] Eurozone sovereign debt crisis  Suspended investment in large-scale infrastructure  which requires steel (derived demand)  Fall in demand for steel [1] With use of diagram, explain SS curve shifts rightwards and DD curve shifts leftwards  resulting in fall in price but quantity indeterminate. [1]. Give a possible reason to weigh extent of shift and conclude on net effect on equilibrium quantity [1] Q 0  Q1  P1  S1  P0  0  Quantity of steel  Price  D1 S0  D0

(b) (i) Explain what is meant by negative externality. [2] Negative externality is the external costs [1] borne by individuals in society who are not directly involved [1] in the production or consumption of a good. They are also known as third party costs or external marginal costs. (ii) With reference to the data, explain how the production of steel gives rise to negative externality. [4] Production of steel  Emits carbon dioxide and causes water pollution [1] Identify and explain third party effect – e.g. global warming which leads to extinction of species  loss for future generation / Fishermen downstream who loses livelihood [1] Illustrate with diagram [1] and explain divergence between marginal private cost and marginal social cost by the amount of marginal external cost [1] (c) Discuss the extent to which emissions trading can curb global greenhouse emissions. [8] Emissions trading can curb global greenhouse emissions Explain how emissions trading works:  Sets a quantitative limit on level of greenhouse emissions for each country and then for each factory/industry  Ideal position would be at the perceiv ed social optimal level of emissions  i.e. wh