Methane Emissions and the Gas Ecosystem: Buyers, Sellers, and Banks
Ben Cahill, Nikos Tsafos, Ian Barlow, CSIS, December 17, 2021
Reducing methane emissions is one of the fastest ways to slow the pace of global warming. Since the oil and gas industry produces more than 20 percent of the world’s anthropogenic methane, cutting methane emissions from the sector will be critical. These efforts will focus on producing countries, where cost-effective fixes at well sites and transmission and storage facilities can deliver quick wins in the coming decade. But changing the way that natural gas is traded and consumed can also play a role, even if these innovations take more time.
To engage global gas players in this effort, it is important to identify policy and market levers that might alter their mandates and commercial drivers. Equally important is to look beyond Europe and the United States to regions where national oil companies (NOCs) and state utilities are common. These companies have different mandates and stakeholders, so new strategies and approaches may be required to encourage them to cut methane emissions.
There are several ways to incentivize global gas players to reduce emissions. First, rules such as the proposed methane performance standard for gas in the European Union could spur changes in producing countries that want to maintain access to export markets. Second, greater market demand for “differentiated” or cleaner gas could provide incentives for suppliers, encouraging them to monitor and reduce their emissions footprint from wellhead to delivery. Policies and regulations will have a larger impact than voluntary, market-driven changes, but it is important to consider how both could spread.
These trends could converge in the liquefied natural gas (LNG) sector, which accounted for around 17 percent of total natural gas emissions in 2020 (including supply and end-use). If policy signals from buyers spread through the global gas system, the LNG industry is the most likely vector, since it connects disparate policy environments and markets. Still, it could take years for the industry to significantly lower methane emissions.
Mapping out some of the most important actors in global gas—LNG sellers and buyers, regulators, financial institutions, and insurers—as well as their mandates can shed light on how these changes may occur. This exercise is especially important because many players such as state gas and power utilities and NOCs still lack clear methane-related targets.
This paper covers three broad topics and offers several conclusions on methane emissions and global gas. First, the paper analyzes how companies make commercial decisions on gas projects, including how buyers judge project risks and viability, as well as the most important elements of contract negotiations. It also considers how the methane intensity of gas supply might fit into the array of issues that buyers and sellers negotiate. Second, the paper outlines several important aspects of LNG project finance to show how projects are typically funded, as well as the types of public and private companies and financial backers that play a role. Details from selected LNG projects around the world provide a sense of the financial institutions that are active in this space. A third section offers a typology of major players in global gas, outlining their commercial scale, key projects, role in the domestic gas sector, and climate and methane commitments. Finally, the report offers conclusions and preliminary suggestions on how to engage this diverse array of actors on methane emissions, and what incentives might change their gas purchasing and investment decisions.
Due Diligence: How Companies Make Commercial Decisions on Gas1
Most LNG is still traded through long-term contracts. These contracts typically last for 15 to 20 years and are often renewed upon expiry. As a result, buyers and sellers conduct extensive due diligence before entering into a long-term agreement. Buyers considering where to source natural gas consider several risk factors. When all else is equal, a buyer might prefer gas that has lower methane intensity, but it is important to understand the backdrop against which these decisions are made. For buyers, these concerns fall into five major categories.
- Will the supply of gas be predictable and reliable? Supply reliability is the most important factor when signing a long-term purchase agreement; if the gas is not available, what is the point of a long-term deal? But evaluating reliability is a complex task. Partly the question comes down to geology: the size and quality of the resource base underpinning the transaction, the degree of certainty (all reserves estimates are probabilistic), and the technical factors that might affect production—for example, unique challenges that could lead to interruptions.
Reliability is also partly affected by broader geography. Some LNG crosses the Suez or Panama Canals, exposing delivery to bottlenecks. Some countries export all their gas through one location; others have multiple export channels. Natural disasters can also impact exports; an earthquake in Papua New Guinea shut down production for several months in 2018. The International Energy Agency has noted that over 50 percent of the world’s LNG plants in 2020 were “heavily exposed to risks from violent storm surges.” These are all risks that weigh heavily on buyers.
Politics also affects reliability. Several LNG exporters have experienced civil strife and outright war (such as Indonesia, Nigeria, Algeria, and Yemen), interrupting LNG exports or cutting them off entirely. Civil strife does not always affect production and exports, but in many cases it does. Understanding how civil strife might impact production requires a detailed understanding of the source country and its geography. Even in the absence of conflict, domestic politics can impact exports—for example, when a government prioritizes domestic consumption over exports.
- What is the commitment level and track record of the project sponsors? Any deal to buy gas is ultimately a bet on certain counterparties and a belief that those counterparties can deliver the gas on time without challenges that might lead to a contract renegotiation. As such, buyers spend a great deal of time weighing the credibility, track record, and commitment of the sellers. Buyers ask whether the project’s sponsors have done similar projects before, whether they have a good team in place, whether this project is a priority for them, and if they have the resources to push this project forward in addition to partnerships to help them address shortcoming
- Do the various project stakeholders support the project? Sponsors, of course, only control so much. Projects are built in a specific place and during a specific time. Buyers look closely at the various stakeholders: the host government, local communities, workers, non-governmental organizations, and so on. Alignment between these parties is key. Projects without host government support rarely succeed, and misalignment with local communities can lead to trouble down the line. Naturally, not every stakeholder will support the project. In that case, it is essential to have a clear, transparent, fair, and relatively quick regulatory, political, and judicial process to mediate disputes. In its absence, disagreements can fester and undercut project development, occasionally derailing projects completely.
- Is the broader ecosystem favorable to project development? Understanding the ecosystem in which a project will be constructed—including the regulatory structure, availability of labor, and suitability of the environment—is essential. Buyers ask questions such as: Can the state review, negotiate, and execute contracts? Is the environment safe? To what extent is new infrastructure needed, and how easy might it be to construct that infrastructure? Can local workers support the project, or will a project need to attract workers from elsewhere? If so, are there physical, political, or legal challenges to doing so?
- Will the project make money? Commercial viability is a relative term. What is commercially challenging one day might be attractive the next. But buyers try to understand whether the relative allocation of risks and rewards makes sense and whether the state is projected to make a sufficient return for its resources (in areas where the state owns the resources). In general, the buyer and the seller negotiate over contract parameters such as volume, price, duration, flexibility, commercial structure (who is responsible for shipping, for example), and penalties for non-performance. The result is a sales and purchase agreement that could easily top 100 pages. These factors are important for commercial negotiations and create a foundation on which all discussions take place.
This is not an exhaustive list, but it should underscore a key fact: long-term transactions depend on a careful balancing of several forces, and buyers weigh many factors before they decide what gas to buy and under what terms. Methane intensity could eventually become one of those terms, but it is likely to be part of this broader calculus.
Gas quality specifications are already a component of long-term contracts. Not all gas is the same when it comes out of the ground, and pipeline systems can accept different kinds of gas qualities. Although gas quality is often summarized based on its calorific value or Wobbe Index, the actual specifications set by pipeline operators vary considerably across the world. Negotiating over the specific kind of gas to be delivered is a long-standing practice in the industry. (It is also standard practice in oil, where gravity and sulfur content are key variables that affect the price for various types of crude oil.)
However, one important note is that gas quality has a clear bearing on price. Gas needs to be processed, and this can either add costs or create revenue. For example, if processing takes out ethane, propane, or butane, these are valuable products that can be sold. The same is true for oil, which comes in different quality crudes that can be processed by different refineries at different costs.
All these considerations in buyer decision making suggest several possible ways methane intensity can become a greater factor for buyers. At one extreme, methane intensity could become a standard variable over which buyers and sellers negotiate, such as calorific value or the Wobbe Index. In this world, buyers and sellers could set boundaries for acceptable products or negotiate along a spectrum, perhaps paying a premium for lower values of methane intensity. In such a scenario, it may be easier to include methane intensity in the price even in short-term or single-cargo transactions, as opposed to solely long-term contracts. At the other extreme, methane intensity could be one of the factors in the complex calculation over which buyers and sellers negotiate. In this case, its impact on price would be less visible but still important.
LNG Project Finance
To analyze how concerns over methane emissions may affect the global gas industry, it is important to consider how LNG projects are financed. A brief explanation and some illustrative examples will show the range of actors involved in bankrolling LNG projects, including commercial banks, state banks, export credit agencies (ECAs), and multilateral development banks. These institutions have various commercial and strategic reasons for supporting LNG projects, and they also have varied sensitivity to emissions and sustainability factors.
LNG projects are large, expensive ventures that often take five years to construct and provide a long-term payoff over 15 years or more. Like other infrastructure projects, they call for long-term investment that entails significant risk. Companies typically fund projects through a mix of equity—direct financing from project shareholders from their own balance sheets—and debt financing. Given the cost of large LNG projects, which can exceed $20 billion, a 70 percent debt to 30 percent equity split is common. LNG project finance often takes the form of limited recourse debt or borrowing by the project itself as opposed to the project sponsors, with the creditor able to seize only certain predefined assets in the event of a default. Aside from traditional loans, LNG project bonds are becoming a more common instrument to raise capital, with more than $10 billion in issuances in 2019 (pre-Covid).
Because these projects require so much debt, they attract a wide range of financial backers. Commercial banks provide most of the lending, but state institutions play a significant role. LNG projects provide long-term gas supplies that help bolster energy security, so governments—particularly in import-dependent Asian countries—have historically taken a strong interest in backing LNG projects. Japan, South Korea, China, and other countries support global liquefaction projects through direct equity investment, lending from state institutions, and trade insurance.
State development banks and ECAs are key players in LNG project finance, and multilateral development banks sometimes invest as well. ECAs such as the Japan Bank for International Cooperation (JBIC) and U.S. Export-Import Bank (EXIM) provide loans but also help reduce risk through loan guarantees, while insurers such as Nippon Export and Investment Insurance (NEXI) provide trade insurance cover and political risk insurance. These institutions help shield projects from political and commercial risk that might otherwise make borrowing prohibitive, and they play an important role in attracting other financial institutions. For example, eight ECAs as well as the African Development Bank provided direct loans and loan cover for Mozambique LNG—a project subject to significant political risk—which encouraged 19 commercial bank facilities to back the project. Yamal LNG also attracted substantial support from ECAs and state banks, although the project has a very different risk profile
Some elements of LNG project finance are worth noting. First, despite the significant downturn in oil and gas investment in recent years, large projects continue to attract finance. It is true that investment in sanctioned (fully approved) LNG projects has declined significantly over the past five years, particularly in 2020 when Covid-19 decimated industry investment. But 2019 marked the largest-ever investment in new liquefaction capacity, with projects constituting 70 million tons per year (mmtpa) reaching final investment decision (FID). It can be hard for project sponsors to lock up firm sales contracts, but those with strong commercial interest are not struggling to access capital.
Variables Shaping Methane Strategies
Beyond company type, a few factors help determine corporate strategies on methane emissions. First, companies have different stakeholders and investor pressures. All gas companies need to adjust their business strategies to prepare for the energy transition, but publicly traded companies are more exposed to environmental, social, and governance (ESG) pressure from investors with significant climate commitments. By contrast, majority state-owned companies in Asia, Latin America, Africa, and the Middle East are generally more insulated from this investor scrutiny.
There is a wide variation in ownership of NOCs and utilities; some are wholly owned by governments, while others are listed either domestically or internationally. In the case of fully state-owned companies, unless their sole shareholder makes reducing methane emissions a priority, the channels of external influence will be limited.
Another key factor is company mandates and roles. One of the principal tasks of NOCs and state gas companies in import-dependent states is to ensure energy security. Their mandate to deliver reliable and affordable energy guides decisions on how they produce and procure gas. The carbon footprint and methane emissions intensity of supply is rapidly becoming an important issue, but it will fit into this broader context. This should not imply that these companies will not make efforts to cut methane emissions, but rather that they will respond to state directives. Governments will ultimately provide guidance on how state companies should alter their gas purchasing decisions and equity investments and balance these goals against energy security mandates.
Last, their position in the domestic gas market is important. Some NOCs and utilities have monopoly power in the domestic market, while others face limited competition or fully deregulated markets. Many NOCs are domestic gas producers as well as importers. Major gas buyers may operate midstream, storage, and power generation assets. For companies with a larger domestic gas footprint and a range of assets, there may be more avenues to reduce methane emissions. For example, a state utility tasked with cutting methane emissions over the next decade (in line with the Global Methane Pledge) can opt to procure different fuels for power generation or fix leaks in storage and transmission. That utility may have an incentive to buy differentiated LNG cargoes, but other measures will have a bigger impact.
Improving the sustainability of the global gas industry depends on changes to both supplier and buyer behavior. Most of the action will take place on the supply side, and new regulations in Europe and the United States could have a significant climate impact. Demand-side changes can also send important signals that will affect seller behavior. For now, the emissions intensity of gas is not a critical factor in how companies buy gas or assess risks and commercial factors for their equity investments, but over time this could change. How will this process occur, and how could it be accelerated?
First, regulatory and policy changes can have a big impact on buyer behavior and incentives. In other words, companies will begin to care if governments and gas regulators make methane monitoring and abatement a priority. In turn, feedback from companies can influence policy design and new rules. For NOCs and utilities, advocates of “differentiated” or cleaner gas might have more success if they engage with regulatory agencies and policymakers rather than just the companies themselves. For a gas-importing country that has signed on to the Global Methane Pledge—say South Korea or Japan—it will soon be time for the government to think about the most effective ways to realize progress. Often that path will run through the energy sector and their state institutions.
Second, investors matter a great deal. Asset managers with extensive energy sector holdings are generally less exposed to state firms, but they hold shares in many NOCs and utilities. Are institutional investors engaging NOC management teams on methane? Is there more that could be done to signal that investors want companies to make this a more concrete priority in their sustainability plans? For LNG exporters and supermajors, institutional investors could both reward companies offering cargoes with certified emissions and encourage other companies to follow suit.
Third, it is important to engage with financial supporters of LNG projects. ECAs, state insurance firms, development banks, and others may not yet have methane intensity on their radar. But these institutions have outsized influence on the LNG industry. If they make it clear that emissions intensity of gas is an important part of their calculus in terms of which projects to support, that will incentivize project sponsors to provide more comprehensive and accurate data. Still, the drivers for these institutions are not likely to shift dramatically, given their incentives to support projects that enhance energy security.
Finally, competitive positioning in the LNG trade is dynamic, and commercial offers or innovations by companies can spread and affect industry standards. Gas sellers and traders are always searching for competitive advantages. If they spot an opportunity to help customers meet their sustainability goals, it is reasonable to assume they will seek credible emissions data and try to offer a differentiated product.