This paper presents a new compensating system, which consists of a shunt active filter and passive components for mitigating voltage and current disturbances arising from an Electric Arc Furnace (EAF). A novel control strategy is presented for the shunt active filter. An extended method based on instantaneous power theory in a rotating reference frame is developed for extraction of compensating signals. Since voltages at the point of common coupling contain low frequency interharmonics, conventional methods cannot be used for dc voltage regulation. Therefore, a new method is introduced for this purpose. The passive components limit the fast variations of load currents and mitigate voltage notching at the Point of Common Coupling (PCC). A three-phase electric arc furnace model is used to show power quality improvement through reactive power and harmonic compensation by a shunt active filter using the proposed control method. The system performance is investigated by simulation, which shows improvement in power quality indices such as flicker severity index.