Does the switch from coal to gas facilitate the transition to the low-carbon economy? The commonly accepted answer to this question is yes.
This is because the combustion of natural gas produces 40% fewer emissions than the combustion of coal. Nevertheless, there are two fallacies that are crucial to consider when assessing the decarbonisation strategy presented by oil and gas majors, wherein the percentage of gas in the portfolio is increased relative to other fuel types.
The first fallacy is about leakage rates. Methane, the main constituent of natural gas, is a colourless, odourless gas that is difficult to detect. According to the Intergovernmental Panel on Climate Change (IPCC) the global warming potential of methane is 84 times that of carbon dioxide over a 20-year time period. Taking into account feedback loops, such as increased biodegradation or the melting of permafrost, the warming potential increases to 86 times. It is worth noting, however, that a high degree of uncertainty surrounds these feedback cycles, and it could well be the case that they are far greater than the estimates make out to be.
This means that a relatively small amount of leakage can have dramatic climatic effects. In fact, leakage rates that surpass 3.2% of gas volume eradicate the climate benefits of using gas over coal. Due to the wide range of possible points within the value chain through which leakage may occur, this is highly concerning. The magnitude of this issue is contextualised by the International Energy Agency’s estimate that the implementation of abatement efforts in the oil and gas sector to manage methane emissions would be as beneficial for the climate as closing all Chinese coal-fired power plants.
The incentives for reducing leakage go beyond the impact on the climate and the embedded risks that this entails. Leakage represents loss of potential sellable product. This explains why such interest has been granted to the issue by the oil and gas sector. It has become a central investment theme for the Oil and Gas Climate Initiative.
The first step for companies to take is to measure and disclose leakage rates. This poses challenges due to the disparity of leaks and need for continuous measurement. Not enough data has been collected to make claims about the industry as a whole, however, estimates for the industry’s leakage rate range from 1.5%-9%. One company we engaged with in 2017 admitted to a leakage rate of 9%, which it has managed to reduce since to 2%.
While investors continue to pressure oil and gas companies through the Methane Working Group of the Principles for Responsible Investment and a multitude of shareholder resolutions, we are concerned that existing measurement techniques are insufficient. Research shows that 90% of leaks are accountable to human error, which causes brief, intense leakage events.
In addition, large discrepancies exist between bottom-up measurement by companies and top-down measurement by satellites, such as the one under construction by the Environmental Defense Fund. Measurements from satellites show methane emissions from the oil and gas sector to be 90% higher than those estimated by the US Environmental Protection Agency (EPA).
As the head of the EPA attempts to roll back regulation, it is up to investors to maintain pressure on the continued progress of the industry and help companies piece together the discrepancies between the two measurement techniques.
I will address the second fallacy in my subsequent blog.