How Advance Market Commitments and Contracts for Difference Can Help Create a Market for Green Industrial Products

The manufacturing of heavy industrial products is a major contributor to climate change, with cement production accounting for 8% of global carbon dioxide (CO2) emissions and steel production accounting for 11%. While reducing industrial emissions will be critical to meeting global climate goals, progress to date has been slower in this sector than in some others, like power and transportation. A key reason for this is the inherent chemical processes of manufacturing that release CO2 and have high temperature requirements.

The good news is that technological innovation to decarbonize heavy industry is ramping up. But implementing these solutions at scale will require the creation of a thriving market that can drive demand and spur investment in novel, green industrial products.

Learn more about how sustainable procurement standards and other tools and policies can help countries pay for their climate goals with our Paying for Paris Resource Hub.

Green procurement, where public and private entities commit to purchasing low-carbon products and materials, is often the policy of choice to create demand for green cement, steel and other industrial products. But while procurement commitments help grow the market for existing or nearly commercialized low-carbon materials, new approaches will be needed to scale the deployment of emerging technologies that can deliver deep emission reductions.

To meet this need, other market-based “demand-side” policy instruments like advance market commitments and contracts for difference are gaining traction as promising mechanisms that can help finance this transition.

• Advance market commitments (AMCs), also known as “advance purchase agreements,” are contractual agreements for the future purchase of products that are still under development. An AMC undertaken by governments or private sponsors can help guarantee a buyer for emerging low-carbon products when they are ready to be sold.
• Contracts for difference (CfDs) are contractual agreements that pay the difference between a pre-determined price of a product under development and the market price of that product when it’s ready for sale. These contracts, typically undertaken by government entities, create a price guarantee for manufacturers of a pre-commercial product. This helps in planning for investments, offsetting the costs of investing in new technologies and reducing price premiums for consumers.

By providing a commitment today to purchase low-carbon products when they come to market, AMCs and CfDs can help manufacturers line up financing needed to commercialize new technologies. They are ideal for products ready for scaled demonstration and deployment which have technological readiness levels above 6 (on a scale from 1-9).

How Can AMCs and CfDs Support Decarbonization in the Cement and Steel Sectors?

Typical green procurement policies target products already on the market or close to commercialization. Procurement policies for low-carbon cement and steel, where many technologies are still being developed, may also include benchmarks for the future purchase of green products with short- to medium-term timelines. However, procurement on its own is not able to provide targeted funding for technological innovation.

AMCs and CfDs focus on commitments to purchase or fund products developed with emerging technologies that are further from market. These policies may target specific technologies and can help fast-track the adoption of high-cost, low-carbon industrial solutions — such as carbon capture and storage and hydrogen-based direct reduced iron (H2-DRI) — by guaranteeing demand and price certainty. With such policy support, as well as scale and experience, the high cost of these emerging technologies is expected to decrease.

While green procurement is typically broad and targets all manufacturers in a sector, AMCs and CfDs are narrower in scope, with binding contracts between a sponsor and one or more manufacturers in the sector. For example, a sponsor could agree to an AMC with a steel manufacturer to purchase 10,000 tons of zero-carbon steel produced through H2-DRI, to be delivered by a certain date at a mutually acceptable price. Having a guaranteed purchaser of the zero-carbon steel would give the manufacturer greater confidence to invest in scaling up H2-DRI.

Another sponsor, such as a state entity, could draw up CfDs for concrete made with low-carbon cement from plants retrofitted with carbon capture technology. These CfDs would allow the manufacturers to offset the cost of their carbon capture investments.

Where Are AMCs and CfDs Already Being Considered or Used in the Industrial Sector?

Several governments and initiatives are currently implementing or considering AMCs and CfDs for the industrial sector. For example, First Movers Coalition (FMC) is a global public-private initiative focused on private procurement. Its members aim to decarbonize their supply chains though AMCs for low-carbon cement, concrete and steel for at least 10% of their purchases. At New York Climate Week in September 2023, FMC announced a new platform to match buyers and sellers for "near-zero" steel. The same week saw the launch of another AMC-like initiative led by RMI called the Sustainable Steel Buyers Platform, which brings companies together to purchase 2 million tons of green steel from North American producers.

On a national scale, Germany will implement a carbon contracts for difference (CCfDs) program for energy-intensive industries including cement and steel beginning in 2024. These CCfDs will complement the EU Emissions Trading System (ETS), paying the difference between the fluctuating ETS carbon price and a strike price that accounts for the required investment in low-carbon technologies. For example, if the carbon price is $30 per ton of CO2 (tCO2) and the strike price is $80/tCO2, then manufacturers are paid $50 for every ton of CO2 reduced.

In the U.S., the Department of Energy’s Office of Clean Energy Demonstrations is considering demand-side mechanisms such as AMCs and CfDs for clean energy technologies in sectors including cement, steel and hydrogen production. At the state level, a bill was introduced in California to issue AMCs for low-carbon cement and concrete in at least 10% of public purchases.

CfDs are also becoming popular for green hydrogen, which can play a significant role in decarbonizing heavy industries. To boost production of low-carbon hydrogen, the EU and the U.S. have proposed CfDs and France will be implementing CCfDs starting in 2024. In the U.S., such a CfD would be complementary to existing support measures, such as the IRA tax credit for clean hydrogen production.

Key AMC and CfD policies and initiatives being implemented, proposed or considered within the industrial sector

_{*Note: EU-ETS – European Union’s Emissions Trading System; DOE-OCED – US Department of Energy’s Office of Clean Energy Demonstrations.}

What Are Some Challenges of Adopting these Policies?

Implementing AMCs and CfDs in the industrial sector will mean overcoming several hurdles. These policies require parties to agree on a mutually acceptable present price for future goods, which can be contentious. In addition, it is not always certain that manufacturers will be able to deliver products that meet agreed-upon standards on time and within budget. This may make sponsors hesitant to rely on AMCs for essential goods and could dissuade risk-averse manufacturers from considering AMCs as a pathway for green investments.

Determining where in the cement and steel value chains these policies should apply is also a challenge. For cement/concrete, policymakers and sponsors must decide whether to design AMCs and CfDs for cement producers (who contribute up to 80% of emissions from the concrete value chain), concrete producers, or end-use businesses (such as building developers).

Steel, a material used in various sectors beyond just construction, will need its own set of considerations. Implementing AMCs and CfDs further down the value chain can increase demand for multiple products at once but may dilute their innovation-enhancing benefits in the development of emerging technologies.

Additionally, the high costs of adopting decarbonization technologies make implementing these policies difficult. To justify such large investments, a manufacturer may require a larger market commitment than sponsors of AMCs and CfDs are willing to take on. And, compared to conventional steel and cement products, AMCs for low-carbon materials involve buyers paying higher prices. For their part, CfDs transfer substantial financial burden from industrial manufacturers to governments for long periods of time.

These policies will also require the development and adoption of standards that define “green” or "low carbon" and methods for matching sponsors (buyers) to manufacturers (sellers). Both of these processes can create additional administrative burdens but are beneficial in the long run for future climate policies.

What’s Next for AMCs and CfDs in the Industrial Sector?

While questions remain on how these policies can be most effectively designed to support scale-up, AMCs and CfDs are rapidly gaining interest as levers to decarbonize the industrial sector.

Key steps policymakers can take to overcome challenges as they work to design and implement AMCs and CfDs should include:

• Conducting extensive consultations with industry stakeholders to understand factors such as technological readiness levels, key value chain actors, upfront costs and the technical and administrative support required.
• Adopting emissions reporting and benchmarking standards that are harmonized and accessible to manufacturers. The Environmental Protection Agency is developing such standards through its environmental product declaration program and carbon labeling program.
• Developing pilot programs for targeted technological pathways to test the efficacy of the policies.
• Launching platforms to efficiently match buyers and sellers of green products for AMCs (such as the FMC and RMI platforms for low-carbon steel mentioned above).
• Learning from the experiences of the AMCs, CfDs and CCfDs already implemented in other sectors and by other governments.

If designed effectively, AMCs and CfDs can help spur the uptake of innovative low-carbon solutions throughout the industrial sector and facilitate sophisticated climate policies going forward using standards, resources and tools developed for these policies.