By Kenneth B. Medlock, III, Steven R. Miles and Marcia Hook
In the energy industry, it has long been the conventional wisdom that natural gas will serve as a “bridge fuel” to a low-carbon future. Industry participants and some policymakers have touted the benefits of natural gas as a climate-friendly substitute for more carbon-intensive fuels, such as coal. This wisdom is being challenged, however, as the natural gas industry faces increasing pressure from investors, regulators, and customers to do more to help meet climate change objectives and Environmental, Social, and Governance (ESG) investing and financing goals. Already, more than 3,100 investors with $110 trillion in assets under management have signed on to the Principles for Responsible Investment, which supports its signatories in incorporating ESG factors into their investment and ownership decisions. Banks and other lenders are voluntarily joining industry-led groups such as the Partnership for Carbon Accounting Financials, which has 70 members with $9 trillion in assets under management. In response to this pressure, liquefied natural gas (LNG) producers have begun looking for ways to reduce or offset their carbon footprints. This has helped fuel the emergence of a new product within the LNG industry: Green LNG.
The Green LNG market is nascent and the “Green” in Green LNG refers to either reducing greenhouse gas (“GHG”) emissions or offsetting GHG emissions associated with some or all of the LNG value chain – from upstream gas production and pipeline transportation, through to liquefaction, ocean transport, regasification, and downstream use of the natural gas (see figure 1). Companies in the LNG value chain can reduce GHG emissions in a number of ways, including using biogas for feedstock, reducing emissions from upstream, pipeline, and liquefaction facilities, using renewable energy to power their liquefaction facilities, and using carbon capture, utilization, and storage (CCUS) technologies. LNG sellers can offset their GHG emissions by purchasing offsets to compensate for all or part of their GHG emissions or engaging directly in activities that offset GHG emissions (e.g., afforestation or reforestation, or investment in renewable energy).
Figure 1. The LNG Value Chain
A number of factors will drive an LNG seller’s decision whether to reduce or offset GHGs from some or all of the LNG value chain, including the degree of control the LNG seller has over the various parts of the value chain. Many U.S. LNG sellers do not own or control the gas supply upstream of the LNG liquefaction facility. As a result, such a seller cannot itself reduce GHG emissions from upstream operations. However, the seller may be able to contract with its upstream suppliers to measure, reduce, and verify GHG emissions. Another key consideration could be price. Certified Emissions Reductions (CERs) are credits generated through the Clean Development Mechanism of the Kyoto Protocol that represent CO2 reductions associated with specific projects. CERs trade at approximately €0.28 (about $0.33 as of Sept. 30, 2020) per tonne of carbon dioxide equivalent (CO2e) for each month remaining in 2020 (per Futures Daily Market Report for ECX CER Futures, Sept. 30, 2020). However, a major LNG industry trade group, the International Group of Liquefied Natural Gas Importers (GIIGNL), cites the cost as $10 per tonne of CO2e, and some oil and gas companies are quoting multiples of that price. Such a wide range of quoted prices is ultimately due to a lack of transparency regarding what an offset represents and how it is achieved; however, this may be resolved with growth in liquidity in emission reduction credit markets. To be entirely “carbon-neutral” through the entire LNG value chain, an LNG seller will likely need to both reduce and offset GHG, which highlights a need for robust offset markets. The question of which party pays the additional costs to produce Green LNG remains to be determined, with some developers expecting a price premium that reflects a differentiated, ESG-compliant product. In principle, offsets can be purchased at any point in the value chain – by developers, shippers, marketers or end-users – which adds flexibility to the nascent marketplace for growth in offset credit market fungibility.
Because the Green LNG market is still in its infancy, there have been a limited number of Green LNG transactions. But even within this small data set, sellers have taken widely different approaches in terms of which parts of the LNG value chain they are responsible for, how emissions are quantified, and whether the “Green LNG” product involves reducing emissions, offsetting them, or both. For example, one major seller reportedly sold five cargoes of “Carbon-Neutral LNG” in 2019 and 2020. For each cargo, the seller committed to engage in a transaction to ensure that the amount of carbon dioxide (CO2) equivalent to that associated with the full value chain had been removed from the atmosphere through a nature-based process or emissions saved through avoided deforestation. Another seller used UN-certified emissions reductions from investments in Indian renewable electricity projects to offset downstream emissions from use of LNG (but did not include the upstream or transport of the value chain). In contrast, another major LNG buyer issued a tender requesting that bidders provide an accurate and verifiable GHG footprint of production, transportation, and delivery of LNG (but not downstream use) and stated that bidders should aim to reduce GHG emissions in the well-to-discharge terminal supply chain. However, committing to such reductions was not one of the tender’s express assessment criteria, and there was no obligation that bidders offer offsets, simply an accounting of the CO2 footprint. Finally, one major supplier of natural gas and LNG to Europe is offering “carbon management services” to customers, including carbon trading and carbon offsetting, allowing the customer to decide whether to purchase fully or partially carbon-neutral natural gas. It is unclear what standards the seller is using and whether such reductions or offsets are verified.
Another subset of sellers has focused instead on reducing emissions from the LNG liquefaction process either through use of more efficient liquefaction technology or through capturing and storing carbon. For example, two LNG sellers offered buyers “reduced-carbon” LNG by reinjecting CO2 into the subsurface after it had been captured during processing of the feed gas prior to liquefaction. Some other LNG sellers have teamed up with equipment manufacturers to install more efficient liquefaction technology to reduce emissions at the LNG liquefaction facility.
These different approaches highlight some key questions relating to quantification of GHG emissions for LNG facilities that must be resolved if Green LNG is to grow into a recognized and tradeable commodity. These include, importantly, how far upstream and downstream should an LNG seller be held responsible in terms of emissions? GIIGNL estimates that approximately 75% of GHG emissions from LNG are generated by its consumption. Thus, the decision whether to offset downstream emissions, which are outside the control of many LNG sellers, can materially affect the costs associated with a Green LNG cargo. Another fundamental question is how parties should measure emissions along the full value chain as well as how offsets are quantified to the extent that emissions reduction credits are used. For instance, should they attempt to engage in actual measurement, or instead use widely-accepted standards? While establishing actual Measurement, Reporting and Verification (MRV) mechanisms throughout the LNG value chain and/or for offset mechanisms may be a resource-intensive exercise, using widely-accepted standards may grossly misrepresent the emissions throughout the value chain or the credits obtained through offsets.
As LNG sellers are considering how to answer these questions, it is important to remember that for ESG investors credibility is vital. Measurement and verification of emissions reductions along the LNG value chain or through various offset mechanisms will likely be heavily scrutinized. This will, in turn, drive a need for broadly accepted certification programs that can adapt to an evolving marketplace., Such need could weigh in favor of using offset programs administered or monitored by a governmental authority or well-established organization.
The LNG and natural gas industry will increasingly face pressure as investors, regulators, and customers focus on measures to reduce emissions. Green LNG offers an opportunity for the LNG industry to address these demands and remain competitive. In order for Green LNG to succeed as a tool for achieving ESG objectives, however, the LNG industry must quickly come together to resolve certain issues impeding the acceptance of Green LNG as a uniform and tradable commodity, including:
- Developing and adopting accepted MRV standards to quantify GHG emissions (and reductions) from each part of the LNG value chain
- Determining which part(s) of the value chain each participant should take responsibility for (e.g., whether LNG sellers are responsible for upstream and downstream emissions, or just emissions associated with liquefaction), at least until a fully liquid and transparent market exists enabling parties to purchase offset certificates for any or all parts of the value chain.
- Establishing a transparent system for verifying claimed carbon reductions, including potentially the use of accredited third-party auditors.
- Agreeing on the form and substance of uniform offset certificates that will convey with the cargo, and engaging policy-makers so LNG buyers may trade such offsets and use them for compliance as well as ESG purposes.
The discussions regarding these issues should involve all LNG industry players—sellers, buyers, and traders—as well as policymakers and representatives from the ESG investing and financing communities. Failure to address these issues may result in “green” principles being applied in an ambiguous and inconsistent manner, slowing both the growth of LNG and progress towards achieving global climate goals. Done properly, however, Green LNG can help ensure that natural gas maintains its role as a vital part of the energy mix, helping to achieve climate goals while potentially earning a place in ESG investment and financing portfolios.
Kenneth B. Medlock III, Ph.D., is the James A. Baker, III, and Susan G. Baker Fellow in Energy and Resource Economics at the Baker Institute and the senior director of the Center for Energy Studies.
Steven R. Miles is a nonresident fellow for the Center for Energy Studies. He also serves as senior counsel at Baker Botts LLP, where he headed the LNG team for much of his 35 years as a lawyer. In addition to LNG, his practice focused on natural gas, electric power and renewable energy.
Marcia Hook is a Senior Associate at Baker Botts LLP. She advises clients in transactional and regulatory matters relating to the energy industry.