Tempering risk: Steelmakers count costs of fossil fuel price volatility

For the second time in four years, global energy prices are spiking following supply upheavals emanating from military conflict. As the Iran conflict continues, the extent and duration of disruptions, particularly through the Strait of Hormuz, remain unknown and will depend on political decisions and diplomatic discussions, as well as the time to restore damaged infrastructure. Regardless of these uncertainties, fossil fuel prices will inevitably undergo another bout of price volatility.

At the same time, driven by emissions concerns, steelmaking has been undergoing a shift toward direct reduced iron (DRI) with capacity forecast to grow by 60 million tonnes per annum (MTPA) by 2030. Around a third of global DRI production is based in the Middle East, placing it directly at risk of disruption (though potentially insulated from fossil fuel prices through subsidies). Further afield, planned investments will likely attract additional scrutiny as natural gas prices rise (as was the case with the last price spike, which saw ArcelorMittal cancel plans for a DRI conversion in Germany). If all forecasted new DRI capacity is fired with natural gas, this would increase the sector’s total use by about 25% compared with 2022, potentially increasing exposure to volatile prices. 

Gas supply disruptions are already impacting smaller steel producers in India as the government prioritises supply for households. Larger Indian producers are also struggling to maintain output amid shortages of liquefied natural gas (LNG), while coal prices are rising in response to freight increases. 

While DRI is most often made using natural gas, production can be powered with coal or electricity (via electrolysis to produce hydrogen). In India, kiln-based DRI has long been produced with coal, but more recently shaft furnaces in China have been fuelled with coke oven gas (a by-product of coal processing for blast furnaces). Price volatility for both natural gas and metallurgical coal has been increasing since 2018, meaning DRI (and blast furnace) operators with any fossil inputs will be exposed to increasingly unpredictable energy prices. 

Figure 1: Price volatility for natural gas and metallurgical coal, 2000–2024

Increasing natural gas price variations have been most pronounced, starting with the impact to Russian supply following the 2022 invasion of Ukraine. The latest increases (European gas prices increased about 20% following the closure of a major LNG facility in Qatar) are only set to continue this trend. 

Metallurgical coal has also seen an increase in volatility starting with supply disruptions to Australian producers from cyclones in 2017, followed by changes in China’s trade policies (including a ban on coal imports from Australia in 2020, lifted in early 2023). Prices again jumped in early 2026 after flooding disrupted output from Queensland. The intensity of these rainfall and flooding events is expected to increase, further exacerbating price volatility. A significant portion of delivered metallurgical coal prices also come from freight costs, which are also set to suffer from instability from oil market disruptions through Asia. 

Steelmaking companies, as large consumers of energy, have long employed strategies like vertical integration to help manage energy price volatility. For example, in 2024 JSW acquired an interest in Illawarra metallurgical coal operations, while at the same time entering a market-linked contract from the same site. This approach provides a natural hedge against future price changes. Similarly, in 2016 Nucor acquired an interest from Encana for operating gas wells in Colorado to reduce exposure to volatile prices. However, these vertical integration strategies can put a strain on the steelmakers’ balance sheets – Nucor’s deal required an upfront US$700 million investment. 

Financial hedges (such as futures and options) offer another less capital-intensive way to reduce the impact of energy price swings while avoiding the operational, environmental and regulatory risks associated with direct ownership of fossil fuel producing assets. Exchanges with relatively large and liquid markets (for up to about two years into the future) provide hedging options for natural gas in several geographies including the US, EU and Asia. These hedging strategies still entail costs (e.g. risk premiums for options) for steelmakers that increase as the volatility of underlying fossil fuel prices increases.

More than 70% of the steel sector’s energy still comes from metallurgical coal, for which exchanges have emerged to provide hedging services. However, traded volumes remain small (about 14 million tonnes in 2025, compared with a total global production of more than 1,000MTPA). As a result, steelmakers have used other tools to help manage metallurgical coal price volatility. 

Prior to 2020, many steel pricing contracts were based on a formula that included the input metallurgical coal (and iron ore) price, allowing steelmakers to pass on energy price rises and protect margins. However, during the COVID19 pandemic, supply chain disruptions led to a gap between input prices and steel, which led many steelmakers to abandon formulas and instead use steel indices. This now leaves steelmakers exposed to energy prices rises if the steel indices do not also increase, which is a possibility given concerns about overcapacity depressing prices. 

In response to a rapid fossil fuel supply disruption, governments often have few options but to engage in demand management. This often entails prioritising which economic sectors can receive scarce supplies of fossil fuels. Industrial customers (particularly of natural gas) are usually the first to scale back operations to ease price pressures. For example, spiking gas prices in 2022 saw a wave of fertiliser production facilities curtailed across Europe. Any reduction in production for a DRI facility would have a significant impact, with the revenue loss of a one-month curtailment costing roughly as much as a 30% rise in gas prices over a year. 

Switching to renewable electricity provides steelmakers with another avenue to avoid fossil fuel price volatility (and associated costs). However, in many locations, the wholesale electricity price is set by the marginal cost operator –  often a gas peaking plant. As a result, wholesale electricity prices are often strongly correlated with natural gas prices, meaning steelmakers cannot simply connect to the grid and benefit from more stable prices. 

Figure 2: Price correlation between electricity and imported gas 

Eventually, higher renewables penetration reduces the fraction of time in which gas sets the price (as shown recently in Spain). This is why South Korea aims to speed up renewables deployment and China is continuing to develop green hydrogen in response to the current crisis. 

Steelmakers, as potential large consumers of electricity, can move more quickly than the grid by entering power purchase agreements directly with renewable energy developers. This approach takes advantage of renewables’ cost profile (high upfront capital with zero ongoing fuel costs) to establish long-term fixed prices for electricity. Provided steelmakers can secure these agreements with developers at reasonable prices, this can provide long-term energy price stability while maintaining competitiveness. Already, several steelmakers are pursuing this strategy, including ArcelorMittal, Stegra, thyssenkrupp, Nucor and BlueScope.

The ongoing and increasing uncertainty in fossil fuel prices has a cost for steelmakers, who will need to consider these impacts on planned investments. This higher volatility may further increase the attractiveness of renewable energy procurement, helping steelmakers to both reduce emissions and stabilise input costs.