Decarbonizing LNG

Putting a green premium on natural gas Eric Yep, Ivy Yin, Takeo Kumagai

Current premium on carbon-neutral LNG around $1.6 million per cargo
Carbon-neutral trades highly opaque and lack transparency
Buyers and sellers to reconfigure LNG deals as decarbonization accelerates

Bill Gates’ new book “How to avoid a climate disaster” drives home the point that lowering the “green premium” is key to solving the climate crisis. It defines the green premium as the price difference between a product that has carbon emissions and its zero emissions alternative, like a gas-guzzling internal combustion engine vehicle and its electric vehicle substitute. The bigger the green premium, the further we are from a zero-carbon future, Gates says.

In the LNG market, over fifteen carbon-neutral cargoes have been traded in the past year and a half alone, and at least one 5-year carbon-neutral LNG contract between a buyer and seller has been publicly announced. This carbon-neutral LNG carries a price premium that corresponds with the emissions footprint of the cargo and the prevailing price of carbon offsets.

This premium, which is the differential between regular LNG and carbon-neutral LNG, was assessed at around $0.484/MMBtu at the end of August for carbon-neutral LNG delivered to Japan, South Korea, or China from Australia, according to the new S&P Global Platts assessment launched this year.

This means that an average 175,000 cubic meter carbon-neutral LNG cargo could cost roughly $1.7 million more than a regular LNG cargo.

These prices bring transparency to a trade that has been incredibly opaque. Actual trades in the industry have been shrouded in secrecy, despite growing market interest, and everything from the carbon price assumptions to the number of offsets underpinning the LNG cargoes have not been publicly disclosed.

This opaqueness and lack of disclosure is harmful to the industry and obstructs genuine efforts to decarbonize natural gas, and hinders the role of gas as a bridging fuel in the energy transition. The secretive trades also raise all sorts of questions.

How much do we know about carbon-neutral LNG? How does one go about decarbonizing a shipload of LNG, which carries enough energy to heat more than 43,000 homes for an entire year? Who is paying the premium? Can this premium even be defined as a “green premium” if you factor in true alternatives like renewables?

The race to be socially responsible

In the life cycle of an LNG cargo, from the development of a gas field to final combustion in a power plant, roughly a third of the emissions are estimated to come from the production and transportation of the hydrocarbon molecule, although this can vary depending on the source of the gas.

Share of emissions in full life cycle of an LNG cargo (%)

The oil and gas industry, already under pressure to validate its social license in many parts of the world, is responsible for these upstream emissions.

Alongside shareholder pressure for greater climate-related disclosures, ongoing initiatives to curb these emissions include the World Bank’s “Zero Routine Flaring by 2030” program to halt the burning of gas from producing fields and the use of renewable energy on gas production sites by oil companies, instead of burning their own petroleum fuels.

We are not just looking at a race to decarbonize natural gas, but also “demethanize” natural gas. The “carbon-neutral” LNG cargo of the future will most likely be “methane-neutral” as well.

Gas producers have been warning of a coming global crackdown on methane emissions for years. As far back as April 2017 at Gastech Tokyo, Maarten Wetselaar, head of integrated gas at Shell, had said that gas’ long-term role in a low-carbon energy system was being “challenged on the issue of methane emissions” and the industry must ensure it has a handle on its “environmental footprint, including methane emissions.”

In the US, the race to decarbonize natural gas has already taken off, with operators, especially in the northeast, being pushed to certify 100% of their natural gas operations as socially responsible, not only to advertise to their investors but also to meet coming regulations that could potentially put a lot of unprepared companies underwater, said Emmanuel Corral, low carbon analyst at S&P Global Platts Analytics.

Corral said technologies to assist in the monitoring of methane emissions are being developed rapidly. These include Project Canary that has arrangements with upstream and midstream companies to monitor and certify emissions, including LNG suppliers, and the Sentinel-2 and Sentinel-5P satellites that detect project-specific methane emissions from space.

There is traction on the demand side to decarbonize gas too. China’s national oil companies have been experimenting with auctions of carbon-neutral LNG on domestic exchanges, and Singapore’s Pavilion Energy has been working to put in place a measurement system for the LNG it purchases.

Japanese gas importers, who have bought many of the carbon-neutral LNG cargoes, are in discussions with their downstream customers for supplying low-carbon gas in the longer term, and the government is working to formalize a mechanism that could allow the usage of carbon credits from carbon-neutral LNG to offset any future national emissions obligations.

Further discussions are needed to clarify Japan's carbon credits, including carbon-neutral LNG, Fumihiro Kajikawa, director of METI's environmental economy office, said at a press briefing in August. "We understand that carbon-neutral LNG is basically introduced on a voluntary basis," Kajikawa said.

"There could be various stages to look at this."

How we position [the carbon credits] under the act of promoting global warming countermeasures is something we have not made much progress in our discussions. This will likely be discussed in the process of clarifying the [carbon] credits.

Fumihiro Kajikawa, director of METI's environmental economy office

Questionable trades

Carbon-neutral LNG trades conducted so far however have been highly opaque and neither buyers nor sellers have fully disclosed the terms of the trade, due to concerns of being scrutinized for using low-quality carbon offsets or protecting underlying data calculations, or both.

LNG traders are worried the carbon-neutral LNG trade could be cornered by oil majors and upstream companies with proprietary access to emissions and field data.

Studies have shown that some types of upstream operations like shale or deepwater drilling could be more emissions-intensive than conventional gas fields, and countries where national oil companies control oil and gas production data are even less transparent.

Some of the publicly announced carbon-neutral LNG trades may have been transacted entirely for the purposes of “greenwashing” with no real underlying carbon credit component, according to some industry insiders.

In other transactions, carbon credits likely yielded profits in addition to the underlying LNG sale.

Oil majors with foresight had invested in carbon projects several decades ago at much lower costs, maybe at around $2-$3/ton of CO2, and those credits are now being monetized at market prices several times higher, William Pazos, chief executive and co-founder of carbon trading firm Air Carbon, said in a recent interview.

With no clear information on how recent carbon-neutral LNG cargoes have been transacted, buyers with no carbon trading expertise are not even certain they have title to the carbon credits needed to make claims on emissions reductions through established mechanisms.

He said there are some foundational elements about how any commodity, LNG or otherwise, can be claimed to be “carbon neutral,” but the absence of sufficient information in the public domain means that it is not possible to assess current trades against benchmarks.

The absence of a universally accepted approach to 'carbon neutrality' means that its meaning, applied in the context of a commodity, is open to interpretation by market participants.

Peter Zaman, partner at law firm Holman Fenwick Willan LLP

“My impression is that many of those necessary elements exist in some of the trades, but I doubt they all exist in many of the trades. In time, the market will gravitate toward a minimum acceptable standard,” Zaman said.

He said a mixed level of understanding invites opportunities for the LNG trader with greater familiarity to take advantage of those with less familiarity, and currently “many importers don't fully know what they really want or need for their own emissions reporting needs and therefore are mostly being led by the producer who, usually, has a more sophisticated understanding of the relevant issues.”

Decarbonization of LNG contracts

The lack of data around carbon-neutral LNG has thrown open a whole can of legal uncertainties for buyers, ranging from how to deal with carbon regulation by governments to the inclusion of climate-related disasters in force majeure clauses.

In the long run, everything between certification charges and more severe measures including entry bans for LNG cargoes is feasible and, especially for the structuring of long-term contracts, all these unknowns translate into difficulties in terms of risk allocation in a multi-jurisdictional setting.

Agnieszka Ason, Visiting Research Fellow at the Oxford Institute for Energy Studies and legal expert on LNG contracting.

The availability of carbon-neutral solutions has added a new dimension to the negotiation of LNG sale and purchase agreements (SPAs), she said, adding that while structuring a “carbon-conscious” LNG deal, parties will choose between emissions reduction and offsets with the ultimate choice hinging upon the cost.

Ason, who is working on the drafting of carbon-transparent LNG SPAs, said such contracts remain experimental and have not evolved to the level of injecting carbon-neutral solutions directly into contracts. “It could take some time and experience with shorter and smaller deals until we see the emergence of full-fledged (high-volume and long-term) carbon-neutral LNG SPAs,” she said.

“The problem with LNG SPAs is that they typically offer limited avenues for triggering contract adjustments. In particular they do not contain

practicable contract renegotiation clauses,” she said, adding that conventional price review clauses that are ‘the usual’ route for securing contract changes do not make any specific reference to decarbonization and may simply not be applicable.

This could potentially become problematic for gas importers in situations such as when carbon prices surge to unacceptable levels.

Ason said to mitigate such risks, buyers and sellers can agree to renegotiating LNG contracts “in response to new decarbonization requirements, with an efficient time frame for negotiations and recourse to formal dispute resolution mechanisms such as arbitration as the next step.”

She also said force majeure clauses could apply to climate change-induced floods and other natural disasters, testing and potentially expanding the understanding of “Acts of God” under some contracts. Force majeure is usually triggered in events that no party can control or events that are “Acts of God”.

There is also some scope for the use of force majeure clauses in relation to “acts of government” or “international standards” related to decarbonization that “impede the ability to deliver or take LNG or affect other aspects of performance under the contract,” Ason added.

GHG Emissions for natural gas/coal supply (kg CO2e/MWh)

Editor

Project Lead

Information Design and Layout

Wendy Wells

Surabhi Sahu

Junaid Rehman