Chapter 7: Capital-Intensive Industries: Energy Transition, Carbon Markets and Stranded Assets

The blast furnace at a coastal steelworks in Hebei runs at 1,500 degrees Celsius around the clock, consuming iron ore, coking coal and limestone in proportions refined over decades. It cannot be switched off without damage that costs more to repair than to avoid. When the plant's environmental manager received the first internal carbon budget for the coming compliance period, he did not think about green competitiveness. He thought about the furnace. A ton of crude steel made through the blast furnace–basic oxygen route releases roughly 1.8 to 2.0 tons of carbon dioxide; a ton made through the electric arc furnace route, fed with scrap and low-carbon electricity, releases perhaps 0.3 to 0.5 tons. The gap is not a management failure. It is metallurgy, chemistry and capital structure compressed into a number. That number is now the central fact of his working life.

In the labor-intensive furniture clusters of Chapter 5, green governance arrived as a series of documentary requirements layered onto a flexible production system; a factory could change its glue, its board supplier or its coating line within a season. In the technology-intensive battery and electronics sectors of Chapter 6, green governance arrived as an innovation frontier, and firms that moved early could plausibly capture a premium. Steel, cement, chemicals, nonferrous metals, pulp and paper and flat glass share a set of features that make the green transition both unavoidable and structurally difficult: very large fixed assets with service lives of twenty to forty years; process emissions chemically embedded in the production route rather than generated by fuel choice alone; high energy intensity and therefore high exposure to carbon pricing; concentrated output in a small number of very large plants; and deep integration into global value chains as upstream suppliers of the materials that every other sector uses.

In capital-intensive sectors, green governance capability is not primarily a compliance function, though compliance is where it begins. It is a capital allocation capability: the organizational capacity to decide, under conditions of deep uncertainty about carbon prices, technology performance and policy trajectories, which assets to retrofit, which to replace, which to retire and when. Firms that build this capability climb the value chain by becoming the low-carbon suppliers of choice to downstream customers who themselves face carbon constraints. Firms that do not build it accumulate assets whose economic value depends on a carbon price that is trending in one direction. The stranded asset is not a metaphor. It is a balance-sheet entry waiting to be written down.

Electricity generation accounts for roughly 27 percent of global greenhouse gas emissions, the single largest emitting sector, and heavy industry—steel, cement, chemicals, nonferrous metals—accounts for a further substantial share once process emissions and high-temperature heat are counted. In China, the industrial sector consumes about two-thirds of national energy, and the production of steel, cement and chemicals alone dominates that figure. These are not marginal contributors that can be addressed after the easy wins. They are the center of the problem, and they are also the foundation of the material economy that the rest of this book's value chains rest on. A furniture factory in Foshan cannot be green if the steel in its tools and the chemicals in its coatings are not.

7.1.1 Energy Transition Pathways in Heavy Industry

7.1.2 Why Heavy Industry Is Different

Begin with the physics, because the physics constrains the strategy.

In cement, roughly 60 percent of carbon dioxide released during production comes not from burning fuel but from the calcination of limestone: calcium carbonate decomposes into calcium oxide and carbon dioxide, and no change of energy source can eliminate that reaction. In steel, the blast furnace uses carbon as the reducing agent that strips oxygen from iron ore, and as fuel; the chemistry of ironmaking is a chemistry of carbon. These emissions are embedded in the transformation of matter, and eliminating them requires changing the transformation itself—new routes, new inputs, new chemistries—rather than switching to a cleaner power source.

Temperature is the second constraint. Cement kilns run at around 1,450 degrees Celsius; steel furnaces at 1,500 and above; glass furnaces at 1,500 to 1,600. At these temperatures, direct electrification with current technology is either impossible or extraordinarily expensive. The credible low-carbon options are green hydrogen, biomass, or carbon capture—each of which carries its own cost, infrastructure and energy-penalty problems. This is why Bill Gates's observation that electricity is the linchpin of the clean-energy transition runs into a hard limit in heavy industry: you can decarbonize the grid, but you cannot yet run a blast furnace on it.

Then there is time. A blast furnace relined in 2020 will operate into the 2040s. A cement kiln built today has a technical life of thirty to forty years. Decisions made in this decade lock in emissions profiles for decades, and the assets are so large that they cannot be retired early without significant financial loss. The International Energy Agency's net-zero scenarios imply that some existing heavy-industrial capacity will need to be retired before the end of its technical life, or retrofitted with carbon capture, or operated at reduced utilization. Each of these outcomes has a cost, and the cost falls on whoever owns the asset when the carbon price arrives.

These three features interact. Because process emissions cannot be eliminated by fuel switching, because high-temperature heat resists electrification, and because assets are long-lived, the transition in heavy industry is capital-intensive in a way that the transition in power generation is not. A power utility can add renewables incrementally and retire coal plants one at a time; a steelmaker must choose a route and commit billions to it. The strategic question is not whether to decarbonize but which pathway to bet on, and the penalty for betting wrong is measured in stranded capital.

7.1.3 Steel: Three Routes and a Sequencing Problem

Steel is the cleanest case for analysis because the technological options are relatively well defined and the economics are becoming visible.

The electric arc furnace (EAF) route fed by scrap is the most mature low-carbon option. Steel made from scrap in an EAF requires roughly one-third of the primary energy of the blast furnace–basic oxygen furnace (BF-BOF) route and produces a fraction of the carbon dioxide, provided the electricity is clean. The constraint is scrap availability and quality. Global scrap supply is finite and traded; China's scrap-to-steel ratio has risen but remains below the levels of mature steel economies, and scrap quality degrades with recycling cycles, limiting its use in high-grade flat products. The EAF route can decarbonize a large share of long-product steelmaking, but it cannot by itself replace primary steelmaking at current demand levels.

Hydrogen-based direct reduced iron (H2-DRI) represents the more ambitious bet. Green hydrogen replaces natural gas or coal as the reducing agent, producing sponge iron that is then melted in an EAF. This is the route that has captured the imagination of European policymakers and steelmakers—SSAB's HYBRIT project in Sweden, ArcelorMittal's various DRI announcements, thyssenkrupp's tkH2Steel—because it can produce primary steel with near-zero emissions. Its economics depend overwhelmingly on the price of green hydrogen. At hydrogen prices above roughly 3 to 4 US dollars per kilogram, H2-DRI steel struggles to compete with conventional steel plus a carbon price in the range of 50 to 100 euros per ton. The cost gap is real, and closing it requires either cheap renewable electricity, massive electrolyzer scale-up, or a carbon price high enough to make the conventional route pay.

Carbon capture and storage (CCS) applied to conventional routes is the third option, capturing the process emissions from the blast furnace or the reformer. CCS is technically feasible in steel but energy-intensive and capital-intensive, and it captures only a portion of emissions unless combined with other measures. Its economics depend on storage availability, transport infrastructure, and the capture energy penalty, which can be substantial: the physical laws governing separation set a minimum energy requirement, and current technologies operate well above that minimum, leaving room for improvement but also a persistent cost floor.

What does this mean for Chinese steel? China produces roughly half the world's steel, and the overwhelming majority of it comes from the BF-BOF route. The average age of Chinese blast furnaces is younger than in Europe or Japan, which means the stranded-asset problem is larger, not smaller: a furnace built in 2015 has decades of technical life remaining and cannot be retired early without writing off a large fraction of its value. The plausible Chinese pathway is therefore a sequence rather than a single bet. Maximize scrap-based EAF production where scrap quality and electricity prices allow, particularly for long products. Prepare for H2-DRI by co-locating pilot capacity with renewable hydrogen projects, using the pilots to learn rather than to produce at scale. Deploy CCS where the geology and infrastructure permit, particularly in coastal clusters with access to offshore storage. And improve energy efficiency and yield throughout the existing BF-BOF fleet, which reduces emissions per ton at negative or low cost and buys time for the more expensive transitions.

That sequence is a governance choice. A steel firm that treats decarbonization as a compliance cost will do the minimum required by the ETS and defer capital decisions. A firm that treats it as a capability question will build a portfolio of options—scrap procurement relationships, hydrogen offtake agreements, CCS pilot participation, efficiency retrofits—and manage that portfolio against a range of carbon-price and technology scenarios. The first firm accumulates stranded assets. The second accumulates optionality, and optionality is what allows a firm to climb the value chain when the carbon price arrives.

7.1.4 Cement: The Hardest Case

Cement is harder than steel. The calcination reaction releases carbon dioxide as an unavoidable byproduct of making clinker, the intermediate that gives cement its binding strength. Roughly 60 percent of cement's emissions are process emissions; the remainder comes from fuel combustion in the kiln. There is no scrap-based route that avoids clinker, because the chemistry requires calcium oxide. The decarbonization options are therefore narrower: substitute clinker with supplementary cementitious materials (fly ash, slag, calcined clay), improve kiln efficiency, switch fuels to biomass or alternative fuels, and capture the remaining process emissions with CCS.

Clinker substitution is the most cost-effective lever and is already widely practiced. China's cement industry has substituted a significant share of clinker with slag and fly ash, which is one reason its emissions per ton of cement are lower than the global average. But substitution has limits: the supply of high-quality fly ash and slag is finite and tied to coal power and steel production, both of which are themselves declining in a decarbonizing economy. Calcined clay offers a scalable alternative, and the technology is mature, but it requires investment in calcination capacity and changes to product standards that are slow to move.

CCS is the backstop for the process emissions that remain. The first large-scale cement CCS projects—Norcem's Brevik plant in Norway, Heidelberg Materials' various projects—are demonstration-scale, and their costs are high. The capture energy penalty is significant, and the economics depend on a carbon price or a subsidy that covers the gap. For Chinese cement, which is produced in thousands of relatively small plants scattered across the country, the aggregation problem is severe: CCS requires scale and infrastructure that individual plants do not have. Cluster-level solutions, in which multiple plants share capture and transport infrastructure, are the plausible pathway, and they require coordination that goes beyond the firm.

The cement case illustrates a general point about capital-intensive decarbonization: the unit of analysis is not always the firm. In some sectors, the efficient unit of decarbonization is the industrial cluster or the region, because the infrastructure—hydrogen pipelines, CO2 transport and storage, shared capture facilities—has economies of scale that no single plant can capture. The firm's green governance capability includes the ability to participate in and shape collective infrastructure, not merely to manage its own emissions.

7.1.5 Chemicals: A Heterogeneous Sector

Chemicals resist generalization because the sector is a family of very different processes. Ammonia and methanol production are the largest single sources of process emissions, and both are relatively tractable: ammonia is made from hydrogen and nitrogen, and if the hydrogen is green, the ammonia is green; methanol can be made from green hydrogen and captured carbon dioxide. Both routes are technically proven and economically dependent on hydrogen price. Olefins—ethylene and propylene, the building blocks of plastics—are harder, because they are produced by steam cracking at high temperature, and electrification of cracking furnaces is at an early stage. Chlor-alkali, soda ash and other segments have their own profiles.

The heterogeneity matters for governance because it means there is no single chemical transition pathway, and firms with diversified product portfolios must manage a portfolio of transitions. It also means that the carbon market's incidence falls unevenly across the sector: ammonia producers face a very different marginal abatement cost curve than olefin producers, and a uniform carbon price will produce very different responses. This is a design problem for the ETS, and it is also a strategic problem for firms deciding where to invest.

7.1.6 The Common Structure of the Pathways

Across steel, cement and chemicals, the pathways share a common structure. Each sector has a set of abatement options arrayed along a marginal abatement cost curve, from negative-cost efficiency measures through moderate-cost fuel switching to high-cost route changes and CCS. The transition is a matter of moving along that curve as the carbon price rises and as technology costs fall, and the pace is set by the interaction between the two. Firms that understand their own curve—and that invest ahead of the price rather than behind it—capture the transition. Firms that wait for the price to force their hand find that the capital has already been committed to assets that the price will penalize.

There is a temptation, in discussions of heavy-industry decarbonization, to treat the technology question as the whole question. It is not. The technologies exist, in most cases, at demonstration or early-commercial scale. The binding constraints are economic and organizational: who bears the cost of the first-of-a-kind plants, how the risk of technology failure is shared, how the infrastructure is financed, and how firms build the internal capability to make and execute these decisions. Those are governance questions, and they are the subject of the next two sections.

7.1.7 Carbon Markets and Asset Stranding

7.1.8 What an ETS Does and What It Does Not

An emissions trading system, in its textbook form, caps total emissions and allocates allowances among covered entities; firms that emit less than their allocation can sell the surplus, and firms that emit more must buy. The carbon price that emerges is the marginal cost of abatement across the covered sector, and it provides a continuous signal that rewards abatement and penalizes emissions. The elegance of the instrument is that it achieves a given emissions reduction at the lowest aggregate cost, provided the market functions and the cap is credible.

That proviso is doing a great deal of work, and the gap between the textbook and the practice is where the governance story lives.

A cap that declines slowly and predictably gives firms time to plan capital investments; a cap that declines sharply and unexpectedly strands assets overnight. The European Union's ETS, after a decade of weak prices and surplus allowances, reformed its market stability reserve and raised its trajectory; the price rose from under 10 euros per ton in 2018 to above 80 euros by 2023, with excursions higher. That trajectory change was the single most important event in European heavy-industry decarbonization, because it converted a theoretical signal into a capital-allocation fact. China's national ETS, launched in 2021, covers the power sector first and has so far operated with relatively low prices and generous allocation; its extension to steel, cement and aluminum—announced and underway—will be the test of whether it can perform the same function.

Allocation methodology is the second design lever. Free allocation based on historical emissions (grandfathering) protects incumbent firms from the immediate cost of the cap but weakens the incentive to abate and creates a windfall for firms that have already reduced emissions. Benchmarking—allocating based on the best-performing installations in each sector—preserves the incentive to improve but penalizes laggards, which is the point. The choice between the two is a distributional choice, and it determines which firms bear the transition cost. The EU's shift toward benchmarking, and its plan to phase out free allocation for sectors covered by the carbon border adjustment mechanism, is a move toward making the polluter pay; China's initial allocation has been more generous, reflecting concerns about industrial competitiveness and the youth of the covered assets.

Then there is the treatment of process emissions and trade exposure. Sectors that trade internationally and face competitors not subject to a carbon price are exposed to carbon leakage: production migrates to jurisdictions with weaker policy, and global emissions do not fall. The EU's response has been the carbon border adjustment mechanism (CBAM), which imposes a carbon cost on imports of steel, cement, aluminum, fertilizers, hydrogen and electricity, phased in from 2023 with full effect from 2026. CBAM converts the carbon price from a domestic cost into a border condition, and it changes the strategic calculus for Chinese exporters: a ton of steel sold into Europe now carries an implicit carbon price regardless of where it was made. For capital-intensive Chinese firms, CBAM is the mechanism through which the European carbon price enters their investment decisions, even if they never trade an EU allowance.

7.1.9 The Price Is Not the Whole Signal

It is tempting to treat the carbon price as the sufficient statistic for the transition. The price rises, firms abate, the technology diffuses, the transition happens. This account is not wrong, but it is incomplete, and the incompleteness matters for capital-intensive sectors.

Carbon prices are volatile. The EU allowance price has ranged from under 5 euros to over 100 euros within a decade, and its forward curve is uncertain. A firm deciding whether to invest several billion dollars in a hydrogen DRI plant cannot rely on a spot price; it needs a view of the price over the asset's thirty-year life, and that view is necessarily uncertain. The result is that firms hedge, delay, or seek contractual guarantees—contracts for difference, carbon price floors, offtake agreements with downstream customers—that convert the uncertain price into a bankable revenue stream. The governance capability here is the ability to structure and negotiate these instruments, not merely to respond to a price.

Carbon prices are also incomplete. They cover some sectors and not others, some jurisdictions and not others, some emissions and not others. A steel firm in a covered jurisdiction competing with an uncovered competitor faces a cost disadvantage that the price does not correct; the border adjustment is meant to fix this, but its coverage is partial and its implementation is contested. The firm's strategic response is to locate production where the price is lowest, which is the leakage problem, or to differentiate its product on carbon content, which is the value-chain climbing opportunity. Both responses are governance choices, and the second is the one that builds capability.

And carbon prices interact with other policies. A carbon price plus a renewable portfolio standard plus an energy efficiency mandate plus a hydrogen subsidy produces a composite incentive that is not the same as the carbon price alone. Firms that read the composite correctly—that understand which investments are rewarded by which instrument—capture more value than firms that respond only to the headline price. The transition is driven by policy packages, not by a single price, and the capability to navigate the package is a competitive asset.

7.1.10 Stranded Assets: Definition and Mechanics

A stranded asset is an asset that has suffered a premature or unanticipated write-down in value because of a change in the regulatory, technological or market environment. The term was popularized by the Carbon Tracker Initiative in the context of fossil fuel reserves, but its application to heavy industry is more immediate and, in some ways, more consequential, because the assets are already built and operating.

The mechanics are straightforward once the carbon price is taken seriously. Consider a blast furnace with a remaining technical life of twenty years and an annual emissions profile of 2 million tons of carbon dioxide. At a carbon price of 50 euros per ton, the annual compliance cost is 100 million euros. At 100 euros, it is 200 million euros. Discounted over twenty years, the present value of that cost stream is a substantial fraction of the asset's book value, and if the asset cannot pass the cost through to customers—because competitors in other jurisdictions do not face it, or because the product is a commodity—the value impairment is real. The asset is stranded not because it stopped working but because the economics of operating it changed.

The estimation of stranded assets is an exercise in scenario analysis, and the scenarios differ in their assumptions about carbon prices, technology costs, policy stringency and demand. The range of estimates is wide, and it is worth being honest about the uncertainty. What is not uncertain is the direction: the carbon price is trending upward in the jurisdictions that matter for Chinese exports, and the technologies that would avoid the cost are becoming cheaper. The question is the pace, and the pace determines whether firms have time to adapt or are forced to write down.

For Chinese heavy industry, the stranded-asset exposure has three distinct sources, and they should be kept separate.

Direct carbon pricing is the first. As China's national ETS extends to steel, cement and aluminum, the covered firms will face a compliance cost that they did not face before. The initial allocation is likely to be generous, and the price is likely to be lower than in Europe, which softens the immediate impact. But the trajectory matters more than the level, and firms that plan on the basis of the current price rather than the expected trajectory will underinvest in abatement.

Border adjustment is the second. CBAM imposes the European carbon price on the embedded emissions of Chinese exports to Europe, which means that even firms that face no domestic carbon price face a European one when they export. The exposure is concentrated in steel, aluminum and cement, and it is larger for firms with higher emissions intensity. The strategic response—differentiate on carbon content, certify low-carbon production, relocate production into the EU or into jurisdictions with equivalent carbon pricing—is a value-chain decision, not merely a compliance one.

Demand-side transition is the third, and the least visible. Downstream customers—automakers, construction firms, electronics brands—are themselves committing to net-zero supply chains, and they are beginning to specify carbon content in their procurement. A steel supplier that cannot document low-carbon production will lose the contract regardless of price. This source of stranding operates through procurement rather than regulation, but it is arguably more powerful, because it transmits the carbon constraint through the value chain without waiting for a border adjustment.

7.1.11 The Investment Problem

The stranded-asset framework is usually applied to existing assets, but its more important application is to new investment. A firm that builds a conventional blast furnace today is creating a stranded asset tomorrow, and the decision to build it is a decision about the future carbon price. The investment problem is therefore the central governance problem in capital-intensive sectors, and it has a specific structure.

Irreversibility comes first. Heavy-industrial assets cannot be repurposed easily; a blast furnace is not a data center. Once the capital is committed, the option to wait is lost, and the firm is locked into a technology for decades. This makes the timing of investment critical: investing too early means bearing the cost of a technology that may be superseded; investing too late means facing the carbon price with an asset that cannot avoid it. The optimal timing depends on the expected path of technology costs and carbon prices, and on the firm's ability to stage the investment.

Lumpiness is the second feature. The investments are large relative to the firm's balance sheet, and they cannot be scaled incrementally. A hydrogen DRI plant is a multi-billion-dollar commitment; a CCS retrofit is a significant fraction of a plant's value. The financing structure therefore matters as much as the technology choice: who bears the risk, how the revenue is contracted, what guarantees are available. The governance capability includes the ability to structure finance, not merely to select technology.

Coordination is the third. Many of the investments require infrastructure that no single firm can provide—hydrogen supply, CO2 transport and storage, shared capture facilities. The firm's decision depends on whether the infrastructure will be built, and the infrastructure's economics depend on whether enough firms will commit. This is a coordination game, and it is resolved by institutions: industrial clusters, public-private partnerships, government-backed infrastructure investment. Firms that participate in these institutions shape the outcome; firms that wait are price-takers.

Learning is the fourth. First-of-a-kind plants cost more than nth-of-a-kind plants, and the cost decline comes from building them. A firm that builds the first plant bears a cost that its competitors avoid, unless the learning is shared or the first mover is compensated. This is the classic argument for public support of demonstration projects, and it explains why the EU's Innovation Fund and China's green hydrogen pilots exist. The governance question is how to distribute the learning cost fairly, and whether the firm that bears it captures enough of the benefit to justify the investment.

7.1.12 What the Evidence Says

The empirical literature on carbon markets and investment is large and growing, and a few findings are robust enough to guide the analysis.

Carbon prices affect investment decisions when they are high enough and expected to persist. The EU ETS's price rise after 2018 coincided with a wave of announcements of decarbonization projects in European heavy industry—HYBRIT, tkH2Steel, the various cement CCS projects—that had been discussed for years but not financed. The price was not the only factor, but it was the factor that converted discussion into commitment. Dechezleprêtre and Sato's review of the literature finds that carbon pricing has induced measurable innovation and investment, with effects concentrated in sectors where abatement options exist and prices are high.

Free allocation weakens the incentive. Firms that receive allowances for free have less reason to abate, and the empirical evidence on the EU ETS's early phases—when allowances were abundant and prices low—shows limited abatement beyond what other policies would have achieved. The reform of the market stability reserve and the shift toward benchmarking changed this, and the evidence on the post-2018 period is more encouraging.

Carbon pricing alone is insufficient for capital-intensive sectors. The investments are too large, the technologies too immature, and the coordination problems too severe for a price signal to do all the work. The jurisdictions that have made the most progress—the EU, the UK, Japan—combine carbon pricing with subsidies, infrastructure investment, and standards. The price is necessary but not sufficient, and the governance capability is the ability to combine the instruments.

Border adjustment changes the strategic calculus. The CBAM's announcement has already changed the behavior of exporters, who are beginning to measure and certify the carbon content of their products in anticipation of the mechanism. The behavioral effect precedes the implementation, which is a general feature of border measures: the announcement is the policy.

7.1.13 Governance Capability for Capital-Intensive Upgrading

7.1.14 From Compliance to Capital Allocation

Compliance is meeting the ETS obligation, filing the CBAM report, documenting the carbon content of the product. Capability is the organizational capacity to make capital allocation decisions under carbon constraint, and to do so in a way that positions the firm on the right side of the transition.

What does that capacity consist of? I want to be concrete, because the phrase "governance capability" can become a catch-all that explains nothing.

Measurement and verification infrastructure come first. A firm cannot manage what it cannot measure, and the measurement of emissions in heavy industry is technically demanding: process emissions require mass-balance calculations, energy emissions require fuel analysis, and the boundary of the calculation—which emissions are counted, at what stage of the value chain—determines the result. The EU's CBAM requires verification by accredited bodies, and the Chinese ETS is building a parallel system. Firms that invest in measurement infrastructure early can respond to reporting requirements quickly and can use the data to identify abatement opportunities. Firms that treat measurement as a reporting burden discover, too late, that they cannot document the carbon content that their customers demand.

Scenario planning and option valuation are the second component. The investment decisions are made under uncertainty, and the capability to structure that uncertainty—to build scenarios for carbon prices, technology costs and policy trajectories, and to value the options embedded in different investment paths—is what distinguishes firms that invest wisely from firms that invest on intuition. This is a technical capability, but it is also an organizational one: it requires the finance, strategy, operations and sustainability functions to work from a shared set of assumptions, which is harder than it sounds.

Stakeholder and institutional engagement come third. The transition in capital-intensive sectors is negotiated with governments, regulators, industry associations, infrastructure providers, financiers and local communities. The firm's ability to shape the terms of that negotiation—to secure a share of the subsidy, to influence the allocation methodology, to participate in the cluster infrastructure—is a competitive asset. This is not lobbying in the pejorative sense, though it can become that; it is the ordinary work of representing a firm's interests in the institutions that set the rules.

Portfolio management completes the set. A diversified industrial firm with assets in multiple sectors and regions must decide where to invest, where to divest, and where to hold. The carbon constraint changes the relative attractiveness of different assets, and the capability to reallocate capital across the portfolio—to exit a stranded asset before it is fully stranded, to enter a growing low-carbon segment before it is crowded—is the core of the climb.

These four components are not a checklist. They are a description of what firms that have navigated the transition successfully actually do, and the firms that fail tend to fail on one or more of them. The Chinese firms that have moved furthest—Baowu in steel, Anhui Conch in cement, Wanhua in chemicals—have built some version of all four, and their progress is visible in their capital allocation, not just their sustainability reports.

7.1.15 The Value Chain Climbing Mechanism

How does green governance capability translate into value chain climbing in capital-intensive sectors? The mechanism is different from the technology-intensive case, and it is worth spelling out.

In technology-intensive sectors, the climb happens through product innovation: a better battery, a more efficient solar cell, a greener electronics component commands a premium and moves the firm up the value chain. In capital-intensive sectors, the product is often a commodity—steel is steel, cement is cement—and the climb happens through the terms on which the commodity is supplied. The low-carbon producer can meet the carbon specifications of downstream customers, can document the embedded emissions that the customer needs for its own reporting, can offer long-term supply contracts with carbon-price pass-through, and can participate in the customer's scope-3 reduction strategy. These are not product features in the conventional sense, but they are differentiated offerings, and they command a premium or secure a contract that the commodity producer cannot.

Consider what a downstream automaker needs from its steel supplier in a net-zero supply chain. It needs steel with a documented carbon footprint, ideally verified by a third party. It needs assurance that the footprint will decline over time in line with the automaker's own targets. It needs a contract that allocates the carbon cost, so that the automaker can plan its own costs. It may need the supplier to use recycled content or green hydrogen, and it may need the supplier to locate production near the automaker's plants. A steelmaker that can meet these needs is not selling a commodity; it is selling a certified low-carbon input with a service component. Such firms secure contracts that commodity producers lose.

The premium is real but modest—green steel currently sells at a premium of perhaps 20 to 30 percent over conventional steel in the European market, and the premium is supported by willing buyers rather than by the full carbon cost. As the carbon price rises and as more customers commit to net-zero procurement, the premium should rise and the market should widen. The firms that position early capture the early premium and, more importantly, the learning that comes from serving the demanding customers.

7.1.16 The Chinese Position

Where does Chinese capital-intensive industry stand in this transition? The answer is uneven, and the unevenness is informative.

China is the world's largest producer of steel, cement, aluminum and most chemicals, and its plants are, on average, younger than those in Europe or Japan. The youth of the capital stock is a double-edged fact: it means the assets are more efficient than the older European stock, but it also means they have more remaining life and therefore more stranded-asset exposure if the carbon price rises. The Chinese steel industry's emissions intensity is close to the global average, better than India's and worse than the EU's best, and the gap is explained by the dominance of the BF-BOF route and the limited penetration of scrap-based EAF.

The policy environment is moving. China's national ETS was launched in 2021 with the power sector, and its extension to steel, cement and aluminum has been announced and is being implemented. The "dual carbon" goals—peak before 2030, neutrality before 2060—set the trajectory, and the 1+N policy framework elaborates it. The government has supported hydrogen pilots, CCS demonstration, and the upgrading of industrial clusters. The pace is deliberate, and the allocation is generous, but the direction is clear.

The firms are moving at different speeds. The largest state-owned enterprises—Baowu, Ansteel, China National Building Material—have published decarbonization roadmaps and are investing in pilots. The private leaders—Shagang, Jianlong, Conch—are also moving, often faster than the state-owned giants because their cost structures are leaner. The small and medium firms, which make up a significant share of capacity in cement and chemicals, are lagging, and they are the most exposed to the carbon price because they lack the balance sheet to invest in abatement.

The international dimension is increasingly important. Chinese firms are exposed to CBAM through their exports to Europe, and they are beginning to certify the carbon content of their products in response. They are also investing in low-carbon production abroad—hydrogen DRI in Southeast Asia, green ammonia in the Middle East—which is a form of value chain climbing that relocates the emissions-intensive steps to jurisdictions with cheaper renewable energy. This "green relocation" is a strategic response to the carbon constraint, and it is likely to grow.

7.1.17 The Limits of the Capability Argument

I want to be careful not to overstate the capability argument. There are limits to what firm-level governance can achieve in capital-intensive sectors, and the limits are structural.

The cost of the transition is the first limit. The investments required to decarbonize Chinese heavy industry are enormous—on the order of trillions of yuan over the next three decades, by most estimates—and no firm can finance them alone. The transition depends on public investment in infrastructure, on the cost of capital, and on the availability of subsidies and concessional finance. A firm with excellent governance capability but no access to affordable capital will not make the investments, and the capability will not translate into climbing.

Coordination is the second. The infrastructure—hydrogen, CCS, shared facilities—requires collective action, and collective action requires institutions that firms do not control. The cluster governance arrangements that Chapter 9 examines are the mechanism, and their effectiveness varies across regions. A firm in a well-governed cluster can make investments that a firm in a poorly governed cluster cannot, regardless of its internal capability.

The policy trajectory is the third. The transition's pace is set by policy, and policy is set by politics. A firm can shape policy at the margin, but it cannot control it, and a sudden change in the carbon price or the subsidy regime can invalidate the most careful investment plan. The governance capability includes the ability to hedge against policy risk, but hedging is costly and imperfect.

These limits do not negate the capability argument; they bound it. The firms that climb are those that build capability and operate within supportive institutions. The firms that are stranded are those that lack capability or face hostile institutions, and often both. The policy implication—that capability-building should be supported alongside infrastructure and pricing—is the subject of Chapter 10.

7.1.18 A Note on Measurement and Standards

The chapter has referred repeatedly to measurement and certification, and it is worth pausing on why they matter so much in capital-intensive sectors. The reason is that the carbon content of a ton of steel or cement is not a single number; it depends on the boundary of the calculation, the allocation of emissions across co-products, the treatment of recycled content, and the verification methodology. Two producers can report different carbon footprints for the same product without either being dishonest, and the difference can determine whether the product meets a customer's specification or a border adjustment's threshold.

The standards that resolve these differences are being built, and they are contested. The EU's CBAM methodology, the ISO 14067 standard for product carbon footprints, the Chinese ETS's measurement and reporting guidelines, and the various industry-specific schemes (worldsteel's CO2 methodology, the Global Cement and Concrete Association's guidelines) are converging but not yet converged. The firm's governance capability includes the ability to navigate this standards landscape—to measure according to the relevant methodology, to verify with accredited bodies, and to anticipate the direction of standards development. Firms that treat standards as a technicality discover that they cannot sell into the markets that matter; firms that engage with standards development shape the rules in their favor.

In capital-intensive sectors, the standard is the product specification, and the ability to meet the standard is the capability to sell. The measurement infrastructure that a firm builds for ETS compliance is the same infrastructure that serves CBAM reporting and customer procurement, and the firms that recognized this early built once and used the data many times.

7.1.19 The Aluminum Case: A Bridge Between Chapters

Aluminum deserves a short treatment of its own because it sits at the intersection of the capital-intensive logic of this chapter and the export-competitiveness concerns of Chapter 8. Primary aluminum is produced by electrolysis, which consumes enormous quantities of electricity—roughly 13 to 15 megawatt-hours per ton—and the emissions profile of a ton of aluminum is therefore dominated by the carbon intensity of the power supply. A smelter fed by hydroelectricity emits perhaps 2 to 4 tons of carbon dioxide per ton of aluminum; a smelter fed by coal-fired power emits 16 to 20 tons. The same metal, the same specification, the same uses—and a carbon footprint that differs by a factor of five.

This makes aluminum the clearest case in which the carbon constraint rewards geography and power sourcing rather than process innovation. China's aluminum smelters are concentrated in Xinjiang, Inner Mongolia and Yunnan, and the first two are coal-heavy while the third is hydro-rich. The industry's decarbonization pathway is therefore partly a matter of relocatingsmelting capacity to Yunnan and other hydro-rich provinces, and partly a matter of contracting for green power. Both are capital decisions, and both are constrained by the transmission infrastructure that determines whether green power can reach the smelter. The firms that secured hydro contracts and relocated capacity early are now selling low-carbon aluminum at a premium to European and Japanese customers; the firms that did not are facing CBAM exposure on their exports and a domestic ETS that will soon price their coal-based power.

The aluminum case also illustrates the interaction between carbon markets and trade policy. CBAM covers aluminum, and its methodology counts the embedded emissions of the power supply. A Chinese smelter exporting to Europe must document the carbon intensity of its electricity, which requires contracts and verification that most smelters did not previously maintain. The firms that built this documentation early are finding that it serves them in domestic procurement as well, because Chinese automakers and electronics brands are beginning to specify low-carbon aluminum in their own supply chains. The capability, once built, travels across markets.

Yunnan's own limits are worth noting. The province's hydro output falls sharply in the dry season, and smelters that relocated on the promise of cheap green power have discovered that the power is seasonal. Some have signed interruptible contracts that require them to curtail production in dry months; others have paired hydro with wind and solar, which adds cost and complexity. The lesson is that geography alone does not deliver low-carbon aluminum. It delivers a lower-carbon baseline, and the firm still has to manage the seasonal and contractual details that determine whether the documented footprint holds up under verification.

7.1.20 What Stranding Looks Like in Practice

The abstract language of stranded assets can obscure what it means for a firm, a workforce and a region. It is worth being concrete about the sequence.

It begins with a cost that cannot be passed through. The carbon price rises, the compliance cost increases, and the firm's customers—who are themselves under carbon constraint—refuse to absorb the increase. The margin compresses. The firm defers maintenance and delays the investment that would reduce emissions. The asset's performance deteriorates relative to competitors that have invested.

It continues with a valuation adjustment. The firm's auditors, applying impairment tests, recognize that the asset's expected cash flows are lower than previously assumed, and the book value is written down. The write-down may be announced as a one-time charge, or it may be absorbed quietly through depreciation schedules. Either way, the balance sheet weakens, and the firm's access to capital tightens.

It concludes with a decision about closure or sale. If the asset cannot be made competitive, it is closed, and the closure has consequences for the workforce and the local economy that go beyond the firm. If it can be sold, it is sold at a discount to a buyer who either has a lower cost of capital, a different view of the carbon price, or a plan to repurpose the site. The sale transfers the problem rather than solving it, and the buyer often discovers that the asset is more stranded than expected.

This sequence is not inevitable, and the firms that avoid it are those that invest ahead of the carbon price rather than behind it. But the sequence is common enough that it should be anticipated, and the policy question—how to manage the transition for the workers and regions affected—is one that Chapter 9 takes up in the context of cluster governance.

A concrete illustration comes from Tangshan, the steel city in Hebei that produces more steel than most countries. During the heavy pollution winters of the late 2010s, the city's mills were ordered to curtail output by 30 to 50 percent for months at a time. The curtailments were driven by air quality rather than carbon, but they previewed the mechanics of stranding: assets that could not run at design capacity, fixed costs spread over fewer tons, and a local government caught between employment and environmental targets. The mills that survived were the ones with the newest and largest furnaces, which could absorb the curtailment at lower unit cost. The older, smaller furnaces were idled and, in many cases, never restarted. Carbon pricing, when it arrives in force, will select along the same lines, and it will do so with less room for political negotiation than the air-quality campaigns allowed.

7.1.21 The Governance Capability Index, Applied

In Chapter 3, I proposed a way of thinking about green governance capability as a composite of measurement, strategy, execution and engagement. It is worth applying that framework to the capital-intensive sectors to see where Chinese firms stand.

On measurement, the large firms have built substantial infrastructure, driven by ETS compliance and export requirements. The smaller firms lag, and the gap is a source of competitive divergence. On strategy, the largest state-owned enterprises have published roadmaps and set targets, but the translation of targets into capital allocation is uneven; some firms have integrated carbon into their investment appraisal, and others have not. On execution, the record is mixed: pilot projects are proliferating, but the scale-up from pilot to commercial deployment is slow, constrained by infrastructure and cost. On engagement, the leading firms participate in standards development, industry associations and international initiatives, while the laggards remain passive.

The composite picture is of an industry in transition, with a leading group that is building capability and a trailing group that is not. The divergence is the story, and it is the story that the value chain climbing framework predicts: the firms that build capability capture the growing low-carbon market, and the firms that do not are left with assets that the market is learning to discount.

One detail from the index work is worth flagging. When we scored firms on measurement, the strongest predictor of a high score was not firm size or ownership type but whether the firm had a dedicated energy management function that reported to the general manager rather than to the environmental compliance department. Firms where carbon data lived inside the EHS office tended to treat measurement as a reporting obligation; firms where it lived in operations or finance tended to use it for decisions. The organizational location of the data mattered more than the sophistication of the meters.

7.1.22 The International Comparison

It is useful to place the Chinese position in international context, because the comparison clarifies what is distinctive and what is common.

The European Union has moved furthest on carbon pricing and border adjustment, and its heavy-industry firms are the furthest along in planning the transition. The EU's problem is cost: its carbon price is high, its energy costs are high, and its firms face the risk of losing competitiveness to jurisdictions with weaker policy. The CBAM is the response, and its effectiveness will determine whether European heavy industry decarbonizes in place or relocates.

Japan has taken a different approach, combining a carbon levy with a transition bond and a focus on hydrogen and ammonia co-firing. Its firms are technologically advanced but face the same cost and coordination problems as their European counterparts. South Korea has adopted a Korean ETS with relatively high prices and is beginning to see investment in hydrogen and CCS.

The United States, after the Inflation Reduction Act, has become the most generous jurisdiction for low-carbon investment, with subsidies that rival or exceed the EU's carbon price in their effect on project economics. Its approach is subsidy-led rather than price-led, and it has attracted investment from European and Asian firms, including Chinese firms in some segments.

China's approach combines a gradually strengthening ETS with industrial policy, state-owned enterprise targets and cluster-level initiatives. Its distinctive feature is the scale of its industrial base and the youth of its capital stock, which means the transition is both more consequential globally and more difficult domestically. The Chinese firms that navigate it will be the ones that build the governance capability this chapter has described, and their success or failure will shape the global market for low-carbon materials.

The comparison also exposes a difference in how the jurisdictions treat the first-of-a-kind problem. Europe subsidizes demonstration through the Innovation Fund and the Hydrogen Bank, and it accepts that the first plants will be expensive. The United States pays for them through tax credits that are uncapped and transferable, which has pulled projects across the Atlantic. China funds pilots through state-owned enterprise budgets and local government matching, which keeps costs low but spreads the learning across many small projects rather than concentrating it in a few large ones. Each approach has a logic; the Chinese one trades depth for breadth, and it remains to be seen whether breadth produces the cost declines that depth has produced in Europe.

7.1.23 The Chapter's Argument, Restated

Capital-intensive industries are the hard case for green value chain climbing because their emissions are embedded in process chemistry, their assets are long-lived and lumpy, and their products are often commodities. The transition requires capital allocation decisions of enormous scale under deep uncertainty, and the firms that make those decisions well are the ones that build green governance capability: measurement infrastructure, scenario planning, portfolio management and institutional engagement. The carbon market is the signal that makes the transition visible, but the signal alone is insufficient; the capability to act on it is what separates the climbers from the stranded.

The value chain climbing mechanism in these sectors runs through the terms of supply rather than the product itself. The low-carbon steelmaker or cement producer sells a certified input with a documented carbon footprint, a declining trajectory and a contract that allocates the carbon cost. That offering commands a premium and secures the customer relationship, and it is available only to firms that have built the measurement, production and contracting capabilities.

The Chinese position is uneven but moving. The largest firms are building capability and investing in pilots; the smallest are lagging and exposed. The policy environment is supportive but gradual, and the international environment—CBAM, customer procurement, investor pressure—is accelerating the transition faster than the domestic carbon price alone would. The firms that recognize this and invest ahead of the domestic price will be the ones that climb.

7.1.24 What Comes Next

The next chapter takes up the dual carbon goals and the export competitiveness of traditional advantageous industries, and the analysis here sets up its central question. If capital-intensive sectors face a carbon constraint that raises their costs and changes their terms of trade, what happens to the labor-intensive and technology-intensive sectors that depend on them? The furniture industry of Chapter 5 uses steel in its tools and chemicals in its coatings; the battery industry of Chapter 6 uses aluminum in its casings and chemicals in its cathodes. The carbon cost of the upstream sectors propagates downstream, and the export competitiveness of the downstream sectors depends on how the upstream transition is managed.

The chapter also sets up the cluster governance analysis of Chapter 9. The infrastructure that capital-intensive decarbonization requires—hydrogen, CCS, shared facilities—is built at the cluster level, and the effectiveness of cluster governance determines whether firms can access it. The regions that build the infrastructure will retain their heavy industry; the regions that do not will see it relocate or decline. That is the regional differentiation that Chapter 9 examines.

And it sets up the policy analysis of Chapter 10. The instruments that support capital-intensive decarbonization—carbon pricing, border adjustment, subsidies, infrastructure investment, standards—are the same instruments that support value chain climbing more broadly, and their design determines whether the transition is efficient and equitable. The policy architecture is the subject of the final chapter, and the capital-intensive sectors are its most demanding test.

The blast furnace in Hebei is still running. Its manager has a decision to make about the next reline, which is due in three years and will determine the furnace's emissions profile for the following two decades. He can reline for conventional operation, which is cheaper today and locks in the carbon cost. He can reline with injection capability for hydrogen or biomass, which costs more today and preserves the option to reduce emissions later. Or he can begin planning for the furnace's replacement with an EAF or a DRI plant, which is a much larger decision that depends on infrastructure that does not yet exist. The decision is a governance decision, and the capability to make it well is what this chapter has been about. The furnace does not stop while he decides.