Chapter 7: Capital-Intensive Pathways: Process Substitution, Stranded Assets, and the Heavy-Industry Transition

The No. 1 blast furnace at Tangshan Iron and Steel works runs continuously for fifteen to twenty years between relines. The reline costs roughly 400 million yuan and takes two to three months. A furnace relined in 2020 will still be operating in 2040, past the midpoint of China's 2060 carbon-neutrality horizon. That single fact captures the central problem of capital-intensive green upgrading: the physical equipment that defines the industry's cost structure also defines the speed at which it can change. You cannot iterate a blast furnace the way you iterate a solar cell design.

Steel, cement, chemicals, and nonferrous metals face a problem of process substitution under extreme asset specificity. The challenge is making the economics of replacing a functioning asset work before physics or policy retires it. Several low-carbon processes exist at various stages of technical readiness. The obstacle is cost, infrastructure, and the coordination of firms, financiers, and governments.

7.1 Process Substitution and Technological Lock-in

7.1.1 The Physics and Economics of Heavy Industry

Steelmaking requires the chemical reduction of iron ore, which means removing oxygen from iron oxide. The dominant route—blast furnace-basic oxygen furnace (BF-BOF)—uses coke made from metallurgical coal as both fuel and reducing agent. A modern blast furnace consumes roughly 350 kilograms of coke per tonne of hot metal, down from more than 600 kilograms in the 1970s. The energy intensity of the BF-BOF route sits close to the thermodynamic minimum for coal-based reduction. Incremental efficiency improvements have largely been exhausted. The remaining emissions are embedded in the chemistry.

Cement presents a similar picture. Roughly 60 percent of cement-sector CO2 emissions come from the calcination of limestone, not from fuel combustion. Calcium carbonate decomposes into calcium oxide and carbon dioxide; you cannot make clinker without releasing CO2 from the raw material. The options are to capture the CO2 after release, to use a different calcium source, or to reduce the clinker content of cement by substituting supplementary cementitious materials such as fly ash or slag. The first is a capital-intensive retrofit. The second is not commercially viable at scale. The third is widely practiced and has limits.

Ammonia production via the Haber-Bosch process consumes hydrogen, currently derived almost entirely from natural gas or coal. Green ammonia would use hydrogen from electrolysis powered by renewable electricity. The process chemistry is identical; only the hydrogen source changes. Ammonia is a relatively tractable case for process substitution, provided the electricity is cheap and electrolyzer costs come down. Methanol and olefins are harder because they involve carbon as a feedstock, not just as a fuel. The alternatives—biomass, captured CO2, recycled plastics—are either limited in supply or more expensive.

Production costs in these industries are dominated by capital and energy, not labor. A blast furnace costs billions of yuan and runs for decades. A cement kiln is similarly long-lived. The fixed-cost share of total production cost in steel is typically 20 to 30 percent; in cement it can be higher. A firm that has just invested in a new blast furnace has strong incentives to run it to the end of its economic life. The emissions profile of the industry is locked in for the duration of the current capital stock. Global steel capacity is roughly 2.3 billion tonnes. Replacing even 10 percent of it with a new process technology would require building the equivalent of the entire steel industry of the European Union from scratch.

7.1.2 The Menu of Process Substitution Options

Hydrogen-based direct reduced iron (H-DRI) coupled with electric arc furnace (EAF) steelmaking is the most discussed option. Hydrogen reduces iron ore to sponge iron at temperatures below the melting point, and the sponge iron is melted in an EAF powered by electricity. If the hydrogen is green and the electricity is clean, the process can approach zero emissions. Direct reduction has been used for decades in gas-rich countries; the use of hydrogen as the reductant at commercial scale is new. The Hybrit pilot plant in Sweden began operating in 2020 and delivered its first hydrogen-reduced steel in 2021. The economics depend on the price of green hydrogen, currently several times the price of natural gas in most markets. The International Energy Agency's 2020 iron and steel technology roadmap estimated that H-DRI steel would cost 20 to 40 percent more than conventional steel at a carbon price of zero, reaching parity at roughly $60 to $100 per tonne of CO2 depending on energy prices.

Carbon capture and storage (CCS) applied to existing blast furnaces or to new direct-reduction plants is the second option. CCS retrofits capture CO2 from the flue gas or process stream and transport it to a storage site. The technology is proven in natural gas processing and fertilizer production but has not been deployed at scale in steel. Capture equipment, compression, transport, and storage can add 30 to 50 percent to production costs. Capturing and compressing CO2 consumes 15 to 25 percent of the plant's energy output. CCS can be retrofitted to existing assets, which addresses the lock-in problem directly. It requires infrastructure—pipelines, storage sites—that does not exist in most industrial regions.

Electrification of process heat is the third option. Many industrial processes use fossil fuels to generate heat below 500 degrees Celsius. Electric boilers, heat pumps, and resistance heaters can replace these in some applications. The economics depend on the ratio of electricity to fuel prices, which varies widely by country and industrial tariff structure. In China, where industrial electricity prices are often cross-subsidized, electrification can be attractive for low-temperature heat but is rarely economic for high-temperature processes such as steelmaking or cement calcination.

Material substitution is the fourth option. In cement, this means replacing clinker with fly ash, slag, limestone, or calcined clay. The Chinese cement industry has reduced its clinker factor from about 0.75 in 2000 to about 0.65 today. Further reductions are possible but limited by the availability of suitable supplementary materials and by construction standards that specify minimum clinker content for structural applications. In steel, material substitution means using more scrap in EAF production, already the dominant route in many countries but constrained in China by limited scrap availability and by the quality requirements of certain steel products.

Each option faces high capital costs, long payback periods, uncertain policy, and the absence of supporting infrastructure. A steel plant that switches to hydrogen needs a hydrogen supply chain; a cement plant that installs CCS needs a CO2 transport and storage network. These are collective goods that no single firm can provide. Markets alone do not solve this coordination problem.

7.1.3 Technological Lock-in and the Clockspeed Problem

Paul David and W. Brian Arthur described in the 1980s how early technology choices can persist even when superior alternatives exist, because of increasing returns to adoption, network effects, and sunk costs. Heavy industry is a textbook case. The BF-BOF route became dominant in the twentieth century because it scaled efficiently, because coal was cheap, and because the supporting infrastructure—ports, railways, coke ovens, skilled labor—coalesced around it.

Charles Fine's work on industry clockspeed offers a way to think about the consequences. Fine argued that industries differ in the rate at which their product and process technologies turn over, and that these rates shape competitive dynamics. Semiconductors and consumer electronics can iterate rapidly. Aircraft, heavy chemicals, and steel turn over on decadal timescales. The green transition in slow-clockspeed industries is a matter of managing the transition of a small number of very large assets.

The clockspeed problem has three dimensions. The equipment lasts a long time. The capital is sunk, and firms have strong incentives to recover their investment before replacing it. The skills, supply chains, and regulations that surround the technology are also long-lived. A steelworker trained on a blast furnace cannot easily transfer to a direct-reduction plant; a coal supply chain cannot easily pivot to hydrogen. These institutional complements reinforce the physical and economic lock-in.

In fast-clockspeed industries, the capability to upgrade is largely about learning by doing: firms try things, learn from failures, and iterate. In slow-clockspeed industries, the capability is about anticipation and coordination: firms must make bets on technologies that will not pay off for a decade or more, in coordination with suppliers, customers, and governments. The governance capability that matters is the ability to move in the right direction when movement is expensive and infrequent.

7.1.4 Why Process Substitution Is Harder Than Product Substitution

In solar manufacturing, a firm that develops a more efficient cell can scale it rapidly: the equipment is modular, the production line can be replicated, and the product is sold into a global market. The learning curve is steep because production volume is high and the feedback loop is short. In steel, a firm that develops a new process must build a plant, which takes years and costs billions, and the plant then operates for decades. The learning curve is shallow because the number of installations is small and the feedback loop is long.

This difference has implications for the geography of green upgrading. Product-based industries can cluster in locations with the right skills and supply chains, and the cluster can grow quickly. Process-based industries are tied to the locations of their existing assets—mines, ports, industrial zones—and cannot easily relocate. A solar firm can move to a new industrial park; a steel plant cannot. The green transition in heavy industry is place-based in a way that the transition in light manufacturing is not.

China's heavy industry is concentrated in a few provinces: Hebei for steel, Anhui and Guangdong for cement, Shandong and Jiangsu for chemicals. These provinces have built their economies around these industries, and the transition will reshape them. The governance challenge is technological and regional at once: how to manage the decline of incumbent assets and the growth of new ones in places where the two are intertwined.

7.1.5 The Role of Retrofits and Hybrid Pathways

Many process substitutions can be implemented as retrofits or hybrids, which reduce the capital cost and shorten the payback period. In steel, a blast furnace can be fitted with top-gas recycling, which captures and reuses the off-gas, reducing coke consumption by 10 to 20 percent. This is not zero-carbon, but it is a step. In cement, a kiln can be fitted with oxygen enrichment or with partial carbon capture, which reduces emissions without replacing the entire plant.

Hybrid pathways fit the clockspeed of the industry. A firm can implement a retrofit in a scheduled maintenance window, capture the savings, and defer the larger decision. The risk is that hybrids become a substitute for deeper change: a firm that has invested in a retrofit has less incentive to invest in a full replacement. This is lock-in by increments. The governance challenge is to design policy that rewards retrofits while keeping the long-term target in view.

The Chinese government has combined efficiency standards with a gradual tightening of carbon constraints. The dual carbon goals announced in 2020 set a 2030 peak and a 2060 neutrality target, which gives firms a long horizon but also a clear direction. The 14th Five-Year Plan (2021-2025) included targets for reducing energy intensity and carbon intensity, and the steel industry was required to cap its emissions by 2025. These policies create a framework within which retrofits and replacements can be sequenced.

7.1.6 Evidence on the Costs of Process Substitution

Fischedick and colleagues, in a 2014 study in the Journal of Cleaner Production, compared the techno-economics of innovative steel production technologies and found that hydrogen-based routes were technically feasible but economically uncompetitive without a carbon price. The EU's TRANSrisk project, which ran from 2015 to 2018, modeled the economy-wide effects of deep decarbonization in the European iron and steel industry and found that costs depended heavily on the availability of low-cost electricity and the pace of infrastructure build-out.

At a carbon price of $50 per tonne, the cost gap between conventional and near-zero steel is roughly 15 to 25 percent. At $100 per tonne, the gap narrows to 5 to 15 percent. At $150 per tonne, near-zero steel becomes competitive in many markets. These are order-of-magnitude estimates; the actual gap depends on local energy prices, the cost of capital, and the specific technology.

For cement, the cost gap is larger. Process emissions are harder to abate, and the alternatives are more expensive. A 2018 study by the European Cement Research Academy estimated that carbon capture at a cement plant would cost €60 to €100 per tonne of CO2 avoided, which translates into a 50 to 80 percent increase in the cost of cement at a carbon price of zero. The gap narrows at higher carbon prices, but the cement industry is more exposed to trade competition than steel because cement is a low-value, high-weight product that is expensive to ship. Passing through costs is harder.

A firm weighing a billion-yuan investment in a new process needs the current cost gap, the likely trajectory of carbon prices, energy prices, and technology costs over the next twenty years. This is a forecast problem of considerable difficulty, and it explains why so few firms have committed to full-scale process substitution without policy support.

7.1.7 The Learning Curve in Process Technologies

In product manufacturing, learning comes from cumulative production: the more units you make, the cheaper each unit becomes. In process industries, learning comes from cumulative capacity: the more plants you build, the cheaper each plant becomes. The mechanisms are similar—standardization, supply chain development, workforce skills—but the pace is slower because the number of plants is smaller.

In solar, subsidies that increase production volume drive down costs quickly. In steel, subsidies that increase the number of demonstration plants drive down costs slowly, because each plant is a major project. The learning curve is shallower, which means that the transition requires more patience and more sustained support. The first movers bear a disproportionate share of the cost, which creates a free-rider problem: firms that wait can benefit from the learning of others without paying for it.

The solution is some form of collective action, either through public funding of demonstration projects or through industry consortia that share the costs and the knowledge. The European Union's Horizon 2020 program funded several such projects, including Hybrit in Sweden and Carbon2Chem in Germany. China's approach has been more centralized: the government has designated green steel demonstration projects and provided funding through state-owned enterprises and policy banks. The effectiveness of these approaches depends on how well they generate and diffuse knowledge.

7.1.8 The Boundaries of Process Substitution

Not all emissions from heavy industry can be eliminated through process substitution. Some are embedded in the chemistry, as in cement. Some are fugitive, as in oil and gas. Some are from the supply chain, as in the mining of iron ore or the production of alloys.

Process substitution primarily addresses scope 1 emissions, which come from the production process itself. Decarbonizing scope 2 requires clean electricity, which is a grid problem. Decarbonizing scope 3 requires changes throughout the value chain, which is a coordination problem. Even a fully substituted heavy industry would not be zero-carbon unless the electricity grid and the supply chains are also decarbonized. The transition in heavy industry is inseparable from the transition in the power sector and in logistics, which are governed by different policies and different actors.

7.2 Stranded Assets and Investment Risk

7.2.1 Defining Stranded Assets

The Carbon Tracker Initiative popularized the term "stranded assets" in a 2011 report on fossil fuel reserves. Assets whose value depends on the continued use of carbon-intensive processes may lose value abruptly if carbon constraints tighten. A coal-fired power plant expected to run for forty years may be forced to close after twenty, leaving its owners with an unrecovered investment. A blast furnace expected to run for twenty years may face a carbon price that makes it uncompetitive after ten.

The concept has been applied mainly to fossil fuel reserves and to power generation. It is equally relevant to heavy industry. A steel plant, a cement kiln, a chemical complex—all are long-lived assets whose value depends on the cost of carbon. If the cost rises faster than expected, the assets lose value, either through write-downs or through reduced profitability and higher cost of capital.

A firm that faces the risk of stranded assets has an incentive to delay the transition, to lobby against carbon pricing, and to extract as much value as possible from the existing asset before it becomes obsolete. This is rational from the firm's perspective. It is costly from society's perspective because it slows the transition and increases the eventual disruption.

7.2.2 The Scale of the Problem in China

The steel industry alone has roughly 1 billion tonnes of capacity, with a replacement value of several trillion yuan. The cement industry has about 2 billion tonnes of capacity. The chemical industry is larger and more diverse. The total value of carbon-intensive assets in China is difficult to estimate precisely, but it is in the tens of trillions of yuan.

The risk of stranding depends on the pace of policy tightening. A gradual path to 2060, with a carbon price that rises slowly and predictably, keeps the risk manageable: assets can be retired at the end of their natural lives, and new investment can be directed toward low-carbon technologies. An abrupt path—carbon prices rising sharply or regulations tightened suddenly—raises the risk. The 2021 launch of the national emissions trading system, which initially covered only the power sector, was a step toward a carbon price, but the price has been low and volatile. The extension of the ETS to heavy industry, planned for the mid-2020s, will increase the risk.

The Chinese government is aware of this. The concept of "just transition" has entered official discourse, and the 14th Five-Year Plan includes provisions for supporting regions and workers affected by the transition. The challenge is to design policies that reduce emissions without triggering a financial crisis in the affected sectors.

7.2.3 Stranded Assets and Investment Decisions

The risk of stranded assets affects investment decisions through the cost of capital. A firm perceived as exposed to carbon risk faces higher borrowing costs, because lenders demand a premium for the risk of default. Banks and investors have begun to screen their portfolios for carbon exposure, and the cost of capital for coal-fired power plants has risen sharply.

Insurance and liability provide a second channel. Firms exposed to climate-related risks may face higher insurance premiums or may be unable to obtain insurance at all. This is more relevant for physical risks—flooding, drought—than for transition risks, but the two are connected.

Strategic decisions provide a third channel. A firm that expects its existing assets to be stranded has an incentive to invest in new assets, but it also has an incentive to delay the investment as long as possible, to extract value from the old assets. The result can be a "wait and see" equilibrium in which no one invests, and the transition stalls.

Kenneth Arrow's work on investment under uncertainty shows that uncertainty raises the option value of waiting: a firm that delays an irreversible investment preserves the option to invest later, and this option has value. Uncertainty about carbon policy can delay investment even when the expected return is positive. The solution is to reduce uncertainty, either by committing to a credible policy path or by providing insurance against policy risk.

7.2.4 The Counterargument: Stranded Assets Are a Feature, Not a Bug

Some economists argue that the risk of stranded assets is a signal to be heeded rather than a problem to be solved. If an asset is at risk of being stranded, it means that the market expects carbon constraints to tighten. The risk is a way of pricing carbon into investment decisions. Trying to protect firms from stranded assets would slow the transition and increase the eventual cost.

The risk of stranding is a discipline that encourages firms to invest in low-carbon technologies and to retire high-carbon assets. But the argument has limits. The risk is not always priced correctly. If investors underestimate the pace of policy change, they may overinvest in carbon-intensive assets, and the eventual correction will be more disruptive. The risk falls disproportionately on certain regions and workers, who may not have the resources to adapt. The risk can be self-reinforcing: if firms expect their assets to be stranded, they may cut maintenance and investment, which reduces the value of the assets and increases the likelihood of stranding.

The governance challenge is to manage the risk without eliminating it. This means providing a predictable policy path, supporting affected regions and workers, and ensuring that the financial system can absorb the losses without a crisis. It does not mean protecting incumbents from the consequences of their investments.

7.2.5 Measuring Stranded Asset Risk

The "carbon bubble" approach compares the emissions embedded in fossil fuel reserves with the emissions budget consistent with a climate target. If the reserves exceed the budget, some of them must be stranded. This approach has been applied mainly to fossil fuels, but it can be extended to heavy industry by comparing the emissions embedded in existing assets with the sectoral budget.

The "asset-level" approach models the profitability of individual assets under different carbon price scenarios. A plant is considered at risk if its cash flow turns negative under a plausible scenario. This approach requires detailed data on costs, revenues, and emissions, which is available for some sectors but not others.

The "market-based" approach uses financial market data to infer the risk. If investors are pricing carbon risk, the valuation of carbon-intensive firms should be lower than that of comparable low-carbon firms. Studies have found some evidence of this, but the effect is small and noisy.

Each approach has limitations. The carbon bubble approach is sensitive to assumptions about the climate target and the pace of decarbonization. The asset-level approach is data-intensive and depends on the modeling assumptions. The market-based approach is indirect and may reflect other factors. Estimates of stranded asset risk vary widely, which is itself a source of uncertainty.

7.2.6 Case: The European Experience with Stranded Assets in Steel

In the 2010s, the EU's emissions trading system created a carbon price that raised costs for steel producers. The industry responded by lobbying for free allowances and for border adjustments to protect against imports from countries without carbon prices. The free allowances were generous enough that the effective carbon cost was low, but the risk of future tightening was real.

ArcelorMittal, the largest European producer, has committed to building hydrogen-based plants in Germany, Spain, and France, with support from government subsidies. ThyssenKrupp has announced a similar plan in Germany. These investments are partly a response to the risk of stranded assets: the firms recognize that their existing blast furnaces will eventually face a carbon price that makes them uncompetitive, and they are investing now to avoid being caught.

The European experience also shows the importance of policy support. The subsidies for hydrogen-based steel, provided through the EU's Innovation Fund and national programs, reduce the cost gap and lower the risk for first movers. The EU's carbon border adjustment mechanism, scheduled to take effect in 2026, will extend the carbon price to imports, which reduces the risk of carbon leakage and makes the transition more attractive for domestic producers.

China's situation is different in important respects. The carbon price is lower, the policy path is less certain, and the state's role in investment decisions is larger. The underlying logic is similar: firms that expect carbon constraints to tighten have an incentive to invest in low-carbon technologies, provided the policy support is sufficient to make the investment viable.

7.2.7 The Social Dimension of Stranded Assets

A steel plant that closes affects its owners, its workers, its suppliers, and the community that depends on it. Many Chinese heavy-industry cities are resource-based cities that were built around a single industry. The transition will require diversifying these economies and supporting the workers who lose their jobs.

The Chinese steel industry employs roughly 3 million people directly and several million more indirectly. The cement industry employs about 1 million. The chemical industry employs more. New processes will create new jobs, but the transition will be disruptive, and the disruption will be concentrated in specific regions.

The governance response has been to promote just transition policies that support affected workers and regions. The 14th Five-Year Plan includes provisions for retraining, social safety nets, and regional diversification. The effectiveness of these policies will depend on the details: how much funding is provided, how quickly it is disbursed, and whether the new jobs are in the same regions as the old ones.

7.2.8 Stranded Assets and the Cost of Capital

Firms perceived as exposed to carbon risk face higher borrowing costs, which raises the cost of new investment. If the cost of capital for green projects is higher than for conventional projects, the transition will be slower.

The evidence is mixed. A 2019 study by the Bank of England found that carbon-intensive firms in the UK corporate bond market paid a modest premium, on the order of 5 to 10 basis points, though the effect varied by sector. A 2021 analysis by the OECD of corporate bond spreads across 15 countries found a carbon premium of similar magnitude for firms in high-emitting sectors, but the effect was not statistically significant in all specifications. In China, where the state owns many of the largest heavy-industry firms and where policy banks provide much of the financing, the cost of capital is influenced more by policy than by market perceptions. The state can direct financing toward green projects, which can accelerate the transition, but it also reduces the market discipline that would otherwise encourage firms to transition.

The financial system shapes the incentives that firms face, and it can either accelerate or slow the transition depending on how it prices carbon risk. Chapter 8 examines the role of green finance in more detail.

7.3 Policy and Governance for Heavy-Industry Transition

7.3.1 The Policy Mix

The transition of heavy industry requires a policy mix that addresses multiple market failures simultaneously. The carbon externality requires a carbon price or equivalent regulation. The learning externality requires support for demonstration projects and technology diffusion. The coordination failure requires public investment in infrastructure such as hydrogen networks and CO2 storage. The distributional failure requires support for affected workers and regions.

A carbon price alone will not solve the coordination problem; a subsidy alone will not solve the externality problem. The policy mix must be designed so that the instruments reinforce each other.

The European Union's approach illustrates the mix. The ETS provides a carbon price. The Innovation Fund provides subsidies for demonstration projects. The Connecting Europe Facility provides funding for infrastructure. The Just Transition Fund provides support for affected regions. The Carbon Border Adjustment Mechanism extends the carbon price to imports. The combination addresses the multiple failures at once.

China's approach is different in form but similar in logic. The national ETS provides a carbon price, initially at a low level. The government provides subsidies and low-cost financing for green projects through state-owned enterprises and policy banks. The government also coordinates infrastructure investment, such as the build-out of hydrogen production and the development of carbon capture and storage hubs. Just transition policies are included in the Five-Year Plans and in regional development programs.

A carbon price that is too low will not change behavior. A subsidy that is too generous will be fiscally costly and may create dependency. A coordination mechanism that is too centralized may be slow and inflexible. The governance challenge is to calibrate the mix to the specific conditions of each industry and region.

7.3.2 Carbon Pricing and Its Limits

Carbon pricing equalizes the marginal cost of abatement across sources, which minimizes the total cost of achieving a given reduction. It also provides a continuous incentive to innovate, because firms that reduce emissions save money.

In practice, carbon pricing has limits in heavy industry. The price needed to drive process substitution is high—on the order of $50 to $100 per tonne of CO2—and a price at that level is politically difficult to sustain. The demand for heavy-industry products is relatively inelastic, so a carbon price is passed through to consumers, which raises prices and can trigger political backlash. Heavy industry is trade-exposed, so a unilateral carbon price can cause carbon leakage as production shifts to countries without a price.

These limits explain why carbon pricing is usually combined with other instruments. Free allocation of allowances, border adjustments, and subsidies for green production all serve to reduce the cost of the transition for domestic firms while maintaining the incentive to reduce emissions. Free allocation that is too generous undermines the carbon price; border adjustments that are too strict can trigger trade disputes.

China's ETS has so far been lenient. The price has been in the range of 40 to 60 yuan per tonne (roughly $6 to $9), far below the level needed to drive process substitution. The system has been gradually tightened, and the extension to heavy industry will increase the price, but the pace is uncertain. The government has relied more on administrative measures—energy intensity targets, capacity caps, and pollution controls—than on carbon pricing to drive the transition. This approach has reduced emissions from some sectors, but it is less efficient than a carbon price and can create unintended distortions.

7.3.3 Public Procurement and Lead Markets

Public procurement can create lead markets for green products, which helps to overcome the chicken-and-egg problem of new technologies. If the government commits to buying green steel or green cement for public infrastructure projects, it provides a guaranteed demand that reduces the risk for producers. The higher cost of green products can be justified as a public investment in the transition.

The Netherlands launched its Green Deal approach in 2019, with a program to use green steel in public construction; the Dutch government's Rijkswaterstaat infrastructure agency committed to procuring low-carbon steel for major waterworks projects beginning in 2022. Germany's Federal Ministry for the Environment funded a green steel lead market initiative in 2021, with procurement commitments for public buildings. The EU's public procurement rules allow for environmental criteria in tenders, which creates a legal basis for preferring green products.

China's public procurement system is large, and government spending on infrastructure is a significant share of GDP. The government has announced pilot programs for green construction materials, and some provinces have begun to include carbon criteria in public tenders. China builds roughly 1 billion square meters of new floor space each year, and the steel and cement embodied in that construction is a major source of emissions.

The challenge is to ensure that the procurement criteria are credible and that the green products are actually green. If the criteria are too lax, they will not drive change; if they are too strict, they will exclude domestic producers and slow the transition. The governance capability required is the ability to set standards that are ambitious but achievable, and to verify compliance.

7.3.4 Industrial Policy and the Role of State-Owned Enterprises

Heavy industry in China is dominated by state-owned enterprises. Baowu Steel, Ansteel, China National Building Material (CNBM), and Sinopec are among the largest producers in the world. The SOE structure has advantages and disadvantages for the transition.

SOEs can be directed by the state to invest in strategic technologies, even if the short-term returns are low. The government can use its ownership stake to set targets, appoint managers, and allocate capital. This is a form of coordination that is difficult to achieve in a purely market-based system.

SOEs may face soft budget constraints, which reduce the pressure to be efficient. If an SOE makes a bad investment, the state may bail it out, which creates moral hazard. The result can be overinvestment in the wrong technologies or delayed retirement of obsolete assets.

The Chinese government has tried to address these problems through reforms that increase the autonomy of SOEs while holding them accountable for performance. The three-year action plan for SOE reform (2020-2022) aimed to improve corporate governance, increase market discipline, and reduce overcapacity. The direction is clear: the state wants SOEs to be more efficient and more innovative, while retaining the ability to direct them toward strategic goals.

For the green transition, the SOE structure can be an asset if it is used to coordinate investment and to share the risks of new technologies. The government can designate SOEs as the lead investors in demonstration projects, and it can use them to build the infrastructure that the transition requires. The risk is that the SOEs become dependent on subsidies and fail to develop the capabilities needed to compete in a low-carbon world.

7.3.5 Border Adjustments and International Coordination

Heavy industry is trade-exposed, which means that unilateral carbon policies can cause carbon leakage. If China raises its carbon price, some production may shift to countries with lower prices, which reduces emissions reduction in China but does not reduce global emissions. The result is a loss of competitiveness for Chinese firms without a corresponding environmental benefit.

The EU's Carbon Border Adjustment Mechanism is an attempt to address this problem. It imposes a carbon price on imports of steel, cement, aluminum, fertilizer, and electricity, based on the emissions embedded in the production process. The mechanism is designed to level the playing field between domestic and foreign producers, and to encourage other countries to adopt carbon pricing. The first reporting period began in October 2023; the financial obligation phase begins in 2026.

China has opposed CBAM as a protectionist measure, but it has also begun to develop its own carbon market and to consider border adjustments. The challenge is to design a mechanism that is compatible with WTO rules and that does not trigger retaliation. The governance capability required is the ability to negotiate international rules that are fair and effective, which no single country can accomplish alone.

Heavy industry is globally integrated. A transition confined to one country will be less effective and more costly than a transition coordinated across countries. The institutions that govern international trade and climate policy—the WTO, the UNFCCC, the G20—are the arenas where this coordination must happen.

7.3.6 The Just Transition as a Governance Capability

The phrase "just transition" entered climate policy discourse through the labor movement, and it has since been adopted by governments and international organizations. The core idea is that the shift to a low-carbon economy should not impose disproportionate costs on workers and communities that depend on carbon-intensive industries. In heavy-industry regions, this is not an abstract concern. A steel city that loses its main employer loses jobs, tax revenue, retail demand, and the social fabric that holds the community together.

Tangshan in Hebei produces more steel than most countries. Zibo in Shandong is a chemicals hub. Both have built their economies around a single industrial complex. The transition will require these cities to diversify, which is a decades-long process. The governance capability required runs past worker retraining: it includes the ability to attract new industries, to redevelop industrial land, and to maintain public services during the transition.

The policy instruments available are familiar from regional development economics: retraining programs, early retirement schemes, unemployment insurance, and investment incentives for new industries. The sequencing matters. If retraining is offered before new jobs exist, workers will leave the region. If investment incentives are offered before the old industry declines, they will be crowded out. The timing must be calibrated to the pace of the transition, which is itself uncertain.

China's approach has been to fold just transition into the broader framework of regional coordination. The paired assistance model, in which prosperous coastal provinces provide support to less developed inland regions, has been adapted to the transition. The 14th Five-Year Plan includes provisions for transformation and upgrading of resource-based cities, with funding for industrial diversification and worker retraining. The effectiveness of these provisions will depend on the details, which are still being worked out.

There is a deeper question about what "just" means in this context. Does it mean compensating workers for lost jobs, or does it mean ensuring that they have a voice in the decisions that affect them? The first is a matter of redistribution; the second is a matter of procedure. The literature on just transition has emphasized both, but the procedural dimension is often neglected in practice. Workers and communities are rarely consulted about the pace and direction of the transition, even though they bear the costs. Building institutions for meaningful consultation is a governance capability that China, like most countries, has not yet fully developed.

7.3.7 Standards, Certification, and the Measurement Problem

A steel plant's emissions depend on the composition of its inputs, the efficiency of its processes, and the accounting conventions used to allocate emissions across products. Two plants that produce the same steel can have very different emissions profiles, and the difference may not be visible to buyers.

The products are commodities, sold on the basis of price and specification, not on the basis of emissions. A buyer of steel cannot easily tell whether the steel was made with coal or with hydrogen. This information asymmetry undermines the market for green products.

Standards and certification systems are an attempt to solve this problem. The ResponsibleSteel initiative, launched in 2019, provides a certification scheme for steel producers that meet environmental and social criteria. The Cement Sustainability Initiative, now part of the Global Cement and Concrete Association, has developed a protocol for measuring and reporting CO2 emissions. These initiatives are voluntary, but they create a basis for comparison that buyers can use.

China has developed its own standards. The China Iron and Steel Association has issued guidelines for calculating emissions from steel production, and the government has launched a pilot program for green product certification. The challenge is to ensure that the standards are rigorous and that they are enforced. A certification system that is too lax will not distinguish green from brown; one that is too strict will exclude most producers and slow adoption.

Who sets the standards? Who verifies compliance? Who bears the cost of certification? These questions determine whether the standards are credible and whether they are adopted. The answers vary by country and by industry, and they shape the terms of competition in global markets.

7.3.8 The Role of Finance and the Banking Sector

A steel plant that switches to hydrogen needs billions of yuan in investment; a cement plant that installs carbon capture needs hundreds of millions. The banking sector is the main source of this finance in China, where capital markets are less developed than in the United States or Europe.

Chinese banks have been directed by the government to support green projects, and green lending has grown rapidly. The balance of green loans in China reached roughly 20 trillion yuan by 2022, according to the People's Bank of China, making it one of the largest green lending markets in the world. The definition of "green" is broad, and some loans that are labeled green may not be genuinely low-carbon.

The risk is greenwashing, in which firms obtain green finance for projects that are only marginally better than the status quo. The governance response has been to tighten the definitions and to require third-party verification. The China Banking and Insurance Regulatory Commission issued guidelines in 2021 that require banks to assess the environmental risks of their loans and to disclose the carbon intensity of their portfolios. The effectiveness of these guidelines will depend on enforcement, which is uneven.

The banking sector also faces a risk from stranded assets. If a bank has lent heavily to a steel company that becomes uncompetitive, the loan may becomenon-performing. A wave of such loans could strain the banking system. The government has tried to manage this risk by encouraging banks to restructure loans to carbon-intensive firms rather than to cut them off abruptly, which would trigger defaults and job losses. The approach is pragmatic, but it delays the recognition of losses and may prolong the transition.

7.3.9 Case: The Transition of the Cement Industry in Anhui

Anhui province, in eastern China, is home to Conch Cement, the largest cement producer in the world. The company operates dozens of kilns across the province and beyond, and its approach illustrates the mix of strategies that a capital-intensive firm can use.

Conch has invested in waste heat recovery systems that capture the heat from the kiln and use it to generate electricity. These systems can meet 30 to 40 percent of a plant's electricity needs, reducing both costs and emissions. The technology is mature and widely deployed in China; the remaining potential is limited.

Cement kilns can burn alternative fuels, such as biomass, waste tires, and municipal solid waste, in place of coal. Conch has co-processing facilities at several plants that use municipal waste as fuel, which reduces coal consumption and also provides a waste management service. The potential is limited by the availability of waste and by the quality requirements of the kiln.

Conch has increased its use of fly ash, slag, and limestone in cement blends, reducing the clinker factor. The potential is limited by the availability of these materials and by the strength requirements of the final product.

Conch has built a pilot carbon capture facility at one of its plants, with a capacity of 50,000 tonnes of CO2 per year. The captured CO2 is used in the production of chemicals, which provides a revenue stream that offsets some of the cost. The scale is small relative to the plant's emissions, but the pilot is intended to build experience and to test the economics. In 2022 the company announced a larger facility in Wuhu, targeting 500,000 tonnes per year, with commissioning planned for the mid-2020s.

The Anhui case shows that the transition of a capital-intensive industry is incremental. No single technology solves the problem; the firm combines multiple strategies, each of which contributes a modest reduction. The cumulative effect can be substantial, but it falls short of zero. The remaining emissions require deeper changes—carbon capture at scale, or a switch to a different process—that are not yet economic.

7.3.10 The Limits of Firm-Level Action

Conch can improve its own efficiency, but it cannot create the infrastructure for carbon capture and storage, or the market for green cement, or the policy framework that would make deeper reductions economic. These are collective goods that require government action.

A steel firm can invest in a hydrogen-based plant, but it cannot build the hydrogen pipeline, or the renewable electricity supply, or the carbon price that would make the plant competitive. The transition depends on public investment and on policy coordination that goes beyond what any single firm can do.

This is the central insight of the capital-intensive pathway. The governance capability that matters is not the capability of individual firms to innovate, but the capability of the system as a whole to coordinate investment, infrastructure, and policy. The firms that succeed will be those that can navigate this system, forming alliances with governments, suppliers, and financiers, and positioning themselves to benefit from the public goods that the system provides.

7.3.11 International Comparison: Germany, Japan, and South Korea

Germany has the most ambitious policy framework. The Energiewende, launched in 2010, set targets for renewable electricity and for emissions reduction, and the government has provided substantial funding for industrial decarbonization. The National Hydrogen Strategy, adopted in June 2020, committed €9 billion to hydrogen production and infrastructure, and a 2023 revision raised the figure to over €20 billion. The steel industry has responded with plans to convert to hydrogen-based production, supported by subsidies. ThyssenKrupp's tkH2Steel project, funded in part by the EU Innovation Fund, aims to commission a direct-reduction plant at Duisburg by 2026. The German approach emphasizes technology leadership and export opportunities: the goal is to reduce emissions and to develop the technologies that other countries will need.

Japan's approach is more focused on energy security and on maintaining industrial competitiveness. The Green Growth Strategy, adopted in December 2020, set targets for hydrogen, offshore wind, and carbon recycling, and the government has funded demonstration projects. Nippon Steel and JFE have invested in hydrogen-based reduction and in carbon capture. The Japanese approach emphasizes incremental improvement and the use of existing infrastructure, rather than radical replacement.

South Korea's approach is similar to Japan's, with a focus on hydrogen and on carbon capture. The Korean New Deal, announced in July 2020, committed funding for green infrastructure and for industrial transition. POSCO has invested in hydrogen-based reduction and in carbon capture. The Korean approach emphasizes export competitiveness and the development of new industries.

China's approach differs from all three in the scale of its state involvement and in the centrality of its 2060 target. The Chinese government has not published a detailed industrial decarbonization roadmap, but it has set targets for energy intensity and carbon intensity, and it has used SOEs and policy banks to direct investment. The approach is more centralized and less transparent than the European model, but it has the advantage of scale and of the ability to coordinate across sectors.

There is no single pathway to the transition. The choice of pathway depends on the country's industrial structure, its energy endowment, and its political institutions. The common element is the recognition that the transition requires a combination of carbon pricing, public investment, and industrial policy, and that no single instrument is sufficient.

7.3.12 The Temporal Dimension: Sequencing and Credibility

A carbon price that is introduced before the alternatives are available will raise costs without reducing emissions. A subsidy that is introduced before the infrastructure is in place will fund white elephants. A border adjustment that is introduced before the domestic carbon price is established will be vulnerable to legal challenge.

The principle that should guide sequencing is credibility. Firms need to know that the policy will be sustained, that the carbon price will rise over time, and that the support for alternatives will continue. Without credibility, firms will delay investment, which is exactly what the transition cannot afford.

The European Union has addressed this problem through legislation that sets binding targets and through institutions that are insulated from short-term political pressure. The ETS is governed by a market stability reserve that adjusts the supply of allowances in response to demand, which stabilizes the price. The Innovation Fund is governed by a committee that allocates funding according to published criteria. These institutions make the policy credible.

China's institutions are different. The ETS is governed by the Ministry of Ecology and Environment, which has limited capacity and is subject to political direction. The Five-Year Plans set targets, but the implementation is delegated to provinces, which may have different priorities. The result is that the policy path is less predictable than in Europe, which raises the risk for investors.

The Chinese government has recognized this problem and has taken steps to address it. The "1+N" policy framework, announced in 2021, sets out a comprehensive plan for achieving the dual carbon goals, with specific targets for each sector. The framework is intended to provide a clear signal to investors, and it has been followed by sectoral plans for steel, cement, and chemicals. The credibility of these plans will depend on their implementation, which is still in the early stages.

7.3.13 Governance Capability as the Missing Variable

The technologies exist, or are close to existing. The barriers are economic, institutional, and political. The governance capability required has several components. The first is the capability to set credible long-term targets and to sustain them across political cycles. The second is the capability to coordinate investment across firms, sectors, and regions. The third is the capability to manage the distributional consequences of the transition, supporting affected workers and communities. The fourth is the capability to measure and verify emissions, so that the market for green products can function. The fifth is the capability to engage with international institutions, so that the transition is coordinated across countries.

These capabilities are not evenly distributed. Some countries have strong institutions and abundant resources; others do not. China's capabilities are distinctive: it has a strong state that can coordinate investment and set targets, but it has weaker institutions for measurement, verification, and public participation. The transition will test these capabilities, and it will likely reshape them.

The firms that succeed in the transition will be those that can navigate this governance landscape. They will need to build relationships with governments, to participate in standard-setting, to access green finance, and to manage the social consequences of their investments. These are political and organizational capabilities, and the firms that develop them will have an advantage that goes beyond technology.

7.4 Conclusion: The Slow Path and Its Consequences

The capital-intensive pathway is the slowest of the three pathways examined in this book. It is constrained by the physics of production processes, by the long lives of capital equipment, and by the coordination problems that arise when many firms and governments must act together. The transition will take decades, and it will be uneven across sectors and regions.

The slowness has consequences. Emissions from heavy industry will continue for longer than emissions from other sectors, which increases the cumulative burden on the climate. The risk of stranded assets will persist, which creates uncertainty for investors and for communities. The governance challenges will be more demanding, because the transition must be sustained over a longer period.

The slowness also gives firms and governments time to learn, to build infrastructure, and to develop the institutions that the transition requires. The learning curve for process technologies is shallow, but it is not flat. Each demonstration project adds to the stock of knowledge, and each policy experiment adds to the stock of experience.

The next chapter turns to industrial clusters, which are the arenas where much of this learning takes place. Clusters concentrate the firms, the suppliers, the workers, and the institutions that the transition requires, and they create the conditions for collective action. The governance of clusters is therefore a central part of the governance of the transition. The analysis there will show how the capabilities described in this chapter are built, and how they can be strengthened.