My Account
Sustainable Investing

Natural Gas: Climate Foe or Part of a ‘Just Transition’ to Clean Energy?

What Investors Need to Know

10/06/2022

Key Takeaways

There are valid arguments for and against increased reliance on natural gas to fight climate change.

Framing the issue in terms of how best to transition to a clean energy future provides a useful perspective.

We see opportunities to support a just transition to that better future through thoughtful investing in the natural gas industry.

Sustainable investing involves many debates about which business activities can be considered “green.” Some clearly qualify, such as those engaged in providing renewable energy. Others, such as mining and burning coal, clearly don’t. But some fall into a gray (or “light green”) area, and investors are understandably confused when environmental, social and governance (ESG) experts differ as to whether a company or industry should be considered a climate friend or foe.

In this article, we’ll explore the arguments for and against using natural gas as part of a sustainable energy mix and American Century Investments’ view on investing in natural gas as part of a just transition to a clean energy economy. Perhaps surprisingly, natural gas proponents include not just energy and pipeline companies that generate revenue from extracting and transporting it. Many deeply committed to achieving a greener energy future see natural gas as a way to get there.

In July 2020, the European Union, which is on the vanguard of defining “green,” adopted the EU Taxonomy. This first-of-its-kind regulation defines what can be labeled as a green investment in the EU and covers most sectors. But it delayed classifying natural gas and nuclear power while various groups lobbied intensively as to whether these energy sources help or hurt the fight against climate change.

What is the EU Taxonomy?

This classification system aims to specify the economic activities that can be marketed as environmentally sustainable to investors in EU countries. It includes criteria that an economic activity must meet to earn a “green” label. One of its goals is preventing greenwashing (i.e., false or exaggerated claims that an investment is environmentally friendly).

To further complicate an already complex issue, in May 2022, the European Commission announced a 210-billion-euro ($220-billion) plan to end the EU’s dependence on Russian oil and gas over the next five years and speed its transition to green energy. While the plan calls for investments in traditional renewable energy and environmentally friendly retrofits, it also proposes spending 10 billion euros ($10 billion) on a dozen gas and liquefied natural gas projects.¹ One month later, the EU Parliament voted to classify natural gas and nuclear power as sustainable investments. Despite some opposition, it is unlikely to be overruled.²

At American Century, we believe most investors would favor replacing every natural gas-fired power plant with renewable energy immediately if possible. But, of course, it isn’t. Therefore, we invest in companies across the energy spectrum, including natural gas producers and the various companies that provide infrastructure and transportation for these energy sources.

While the EU Taxonomy helps inform our view, we are developing our own framework to evaluate the sustainability-related risks and opportunities presented by natural gas.

Arguments in Favor of Natural Gas in the Energy Mix

The primary arguments in favor of using natural gas include:

  • It is less polluting than coal and oil.

  • It is widely available, although transporting it overseas can be a challenge.

  • It can cover needs when renewable, but less reliable sources aren’t available.

Burning natural gas generates less carbon dioxide (CO2) than coal or oil to produce a given amount of energy.

Most natural gas is used to generate power and provide heat — for industrial use and in our homes and commercial buildings. Only about 0.1% is used as fuel for transportation.³ One million British thermal units-equivalent of natural gas generates 42% less CO2 than burning coal and 27% less than burning fuel oil.⁴

While renewable energy is preferable, when it isn’t available, shortfalls are addressed with conventional sources, and natural gas-fired plants can provide consistent, reliable energy with flexible on/off cycles.⁵'⁶ Natural gas has a 92% efficiency rate from the wellhead to the end-user, compared to power generated by coal, which operates at only a 32% efficiency rate. Natural gas is still more efficient than oil’s 83% efficiency rate (although modern systems can reach up to 95%).⁷'⁸

Figure 1 | Natural Gas Emits Less Than Half the CO₂ of Other Fossil Fuels When Generating Electricity

(CO₂ Emissions per Kilowatt-hour in 2020)

This bar chart shows that burning natural gas to generate electricity emits less than half the carbon dioxide per kilowatt-hour than coal and petroleum fuels.

Source: U.S. Energy Administration. Electricity generation is net electricity generation. Includes electricity-only power plants. Combined heat and power plants are excluded because some of their CO2 emissions are from fuel consumption for heating purposes.

Thus, natural gas can be seen as a transitional fuel to keep power plants humming while the world ramps up its renewable energy supplies. The EU commissioner for financial services said the EU taxonomy categorized natural gas and nuclear power as green because it “recognizes the need for these energy sources in transition.”⁹

Many countries already have the infrastructure to store and use natural gas.

That means it can be used now without significant capital investment. Natural gas can be cooled and converted into liquified natural gas (LNG) that can be transported long distances. However, that requires additional infrastructure (part of the reason Europe struggles to replace Russian supplies).

Importantly, natural gas allows the U.S. to be nearly energy independent. Virtually all natural gas used in the U.S. is produced domestically, reducing the risk of geopolitically induced shortages like much of the world is experiencing due to Russia’s invasion of Ukraine.¹⁰

We have a long way to go to meet the world’s energy needs with renewable sources alone.

When the wind isn’t blowing, wind farms can’t generate power. Solar panels are dormant at night and during rain. While batteries can store solar and wind power, their capacity is limited and diminishes over time. Experts say we need to expand existing storage 100 times by 2040 to reach climate change goals using solar and wind energy.¹¹

Batteries also require mining metals, such as nickel and cobalt, which create other ESG risks for companies and investors, including energy and water use and environmental damage. The Democratic Republic of Congo, the source of roughly 70% of the world’s cobalt mining, has a shameful track record of relying on child labor in its mines.¹²

Notably, many of the world’s largest CO2generators are also the countries with the greatest access to natural gas. In the U.S., oil and coal supply 45.8% of our energy needs, compared to 32% for natural gas.¹³ Crude oil and related products produce 35% of Europe’s energy versus 24% for natural gas.¹⁴

Replacing oil and coal with natural gas in the energy mix in these regions could significantly reduce the world’s carbon footprint, providing more room in the “carbon budget” to allow developing nations to build clean energy infrastructure and increase energy security. Natural gas can also help to meet the energy needs of large populations in Asia, Africa and South America that traditionally depend on “dirtier” sources such as coal or oil, offering a strong rationale for ESG-integrated funds to hold positions in natural gas producers and pipelines.

Arguments Against Labeling Natural Gas as “Green”

Many oppose the move to label natural gas as a green investment, with good reason.

  • Extracting and transporting natural gas results in the leakage of methane. Methane emissions are a significant source of global warming.

  • Extracting natural gas can require significant water resources and may involve deforestation.

  • Extracting and transporting natural gas are associated with health hazards and deadly accidents.

  • Expanding the use of natural gas would prolong dependence on non-renewable energy.

Methane is a greenhouse gas nightmare.

Methane is responsible for about 25% of global warming and traps 25 times more heat than carbon dioxide.¹⁵'¹⁶ While methane leaks from natural gas wells and pipelines are not the only culprits (oil, landfills and livestock are non-trivial sources), every methane leak is a problem.

Natural gas advocates correctly argue that it burns cleaner than coal or oil, but that contention underestimates the impact of methane emissions and leaks. An Environmental Defense Fund study found that 3.7% of natural gas produced in the Permian Basin, located in the southwestern U.S., leaked into the atmosphere — much more than the 1.4% estimated by the U.S. Environmental Protection Agency (EPA).¹⁷ Natural gas may not be a bridge to a renewable future if extracting it leaks a significant amount of one of the strongest heat-trapping gases.

Extracting natural gas through hydraulic fracturing (“fracking”) uses a lot of water.

Fracking requires 1.5 to 9.7 million gallons of water for a single well.¹⁸ Most natural gas extracted in the U.S. today relies on fracking, which injects water, sand and chemicals at high pressures into shale and other rock formations to release the gas trapped inside.¹⁹'²⁰ While this is still less than the amount of water used to cool coal-fired power plants, it can significantly strain the water resources of communities where fracking occurs.

Fracking can also impact local drinking water supplies. An EPA study found that of 151 spills in 11 states between 2006 and 2012, 10% added fracking fluid and additives into creeks, streams and other bodies of water that people use.²¹ Some water used for fracking becomes so highly contaminated that it’s disposed of deep underground and removed from the freshwater cycle.²²

Extracting and transporting natural gas can cause deadly accidents and explosions.

In the U.S. alone, gas compressor stations, processing facilities and pipelines were responsible for explosions in five of the past 10 years. Workers were killed or severely injured in many of these incidents.²³ Leaks from natural gas pipelines and wells can pollute the air and water, causing serious health problems for local communities.

Prolonged exposure to natural gas leaks can increase the incidence of asthma, bronchitis, lung cancer and heart disease.²⁴ This not only violates principles of the U.N. Global Compact but also exposes energy companies to costly lawsuits and headline and reputational risk. Over 2,600 gas pipeline leaks in the U.S. have caused more than $4 billion in damages (including the cost of emergency services), killed 122 people, and released 26.6 billion cubic feet of fuel as methane or carbon dioxide.²⁵

Almost every country could move toward greater energy independence by using more renewables.

We believe expanding renewables would be a better use of capital and resources than extending the world’s reliance on fossil fuels. As previously noted, the U.S. has sufficient natural gas reserves to be energy independent, but not every country can say the same. Countries, such as India and China, without large-scale natural gas reserves, are attempting to move directly from dependence on coal to renewables by building large-scale solar, wind and other clean energy projects. This may allow them to leapfrog natural gas as a transitional fuel, shielding them from volatile oil and gas prices.

Although substantial infrastructure to support natural gas is in place, scaling it up near term to replace coal and oil will require more resources and capital. Those who oppose using natural gas argue that capital would be better spent building more carbon-free energy solutions, such as solar panels, wind turbines, and batteries for storage, along with carbon capture technologies.

High demand due to the extreme weather caused by climate change and supply challenges caused by Russia’s invasion of Ukraine have caused natural gas prices to spike. The rising price of natural gas and the declining price of renewables mean it may be cheaper to invest in renewable capacity than to build or expand natural gas plants and related infrastructure, especially since doing so would extend the world’s reliance on fossil fuels.²⁶

The Just Transition to Clean Energy

At American Century, we believe strongly in facilitating a just transition to a more sustainable global economy. We define this as a concerted effort to ensure that the important benefits of moving to a green economy are widely shared and that those who may suffer economically from the changes this transition entails are supported – including countries, regions, industries, communities, workers and consumers.

Advocates of natural gas note that an abrupt transition from fossil fuels would cause widespread economic disruption, including job losses and increased poverty.

A just transition recognizes that renewable energy jobs likely offer better long-term employment opportunities than those in the coal, oil and gas industries. A study by Clean Jobs, Better Jobs found that the “median hourly wages for clean energy jobs overall are about 25% higher than the national median wage.”

Jobs in solar and wind pay roughly $24.85 an hour, which compares favorably with hourly wages of about $24.37 an hour in the coal, natural gas and petroleum industries.²⁷ A just transition would include efforts to train people to work in renewables.

Those who argue against expanding the use of natural gas say that doing so would extend dependence on fossil fuels and that any capital invested in natural gas-related infrastructure would be better spent on developing and scaling renewables. A basic premise of supporting natural gas as a transitional fuel is that it is a temporary fix.

In our view, most economies will need to rely on natural gas to some extent as we continue the push toward clean energy. Our emphasis is on transitioning, not maintaining the status quo.

Homes, businesses, schools, hospitals, and virtually all services we use every day depend on affordable, reliable power. Natural gas, as a transitional fuel, can support economic growth and protect the most vulnerable in society by providing consistent and reliable energy.

In contrast, fuel shortages can lead to civil unrest, as recently witnessed in Sri Lanka. The goal is to keep the lights on while fighting to prevent climate change from irreparably harming the quality of life on earth. While natural gas may not be ideal, we think it may be the best available stepping stone in a just transition to a better solution.

A Clear-Eyed View of a Clean Energy Future

Natural gas is a textbook example of why defining a “green” investment can be difficult. Striving for perfection shouldn’t be the enemy of the next best alternative. We see natural gas as a transitional fuel somewhere in the middle of a spectrum of energy sources, with oil and coal at one end and clean, renewable energy at the other.

As a fossil fuel, natural gas has negative environmental consequences. But replacing coal or oil with natural gas in a responsible way can help to meaningfully reduce greenhouse emissions and slow the pace of global warming.

Our research-driven approach to integrating ESG issues in the investment process helps us to reduce the risk of greenwashing and identify sound reasons for holding select natural gas companies in our portfolios. As responsible stewards of capital, we believe the rising demand for natural gas calls for a clear-eyed view of the “light green” investment opportunity this transitional fuel represents.

Authors
Sharvari Johari
Sharvari Johari

Senior Sustainable Research Analyst

Explore More Insights

Read our latest articles and market perspectives.

1

“EU unveils $220bn plan to ditch Russian energy,” Al Jazeera, May 18, 2022.

2

Kate Abnett, “EU parliament backs labeling gas and nuclear investments as green,” Reuters, July 6, 2022.

3

American Petroleum Institute, “Natural gas is alternative energy,” accessed August 19, 2022.

4

U.S. Energy Information Administration, “Natural gas explained,” December 8, 2021.

5

Austrian Power Grid AG, accessed August 14, 2022.

6

C. Gürsan and V. de Gooyert, “The systemic impact of a transitional fuel: Does natural gas help or hinder the energy transition?” Renewable and Sustainable Energy Reviews 138 (March 2021): 110552.

7

IGS Energy, “What Makes Natural Gas the Cleanest Fossil Fuel?” accessed August 15, 2022.

8

Petro Home Services, “Heating oil vs natural gas: choose the best fuel source for your home heating needs,” accessed August 14, 2022.

9

Jennifer Rankin, “EU includes gas and nuclear in guidebook for ‘green’ investments,” The Guardian, February 2, 2022.

10

National Academies of Sciences, Engineering and Medicine, “What You Need to Know About Energy: Natural Gas,” accessed August 14, 2022.

11

Matthew Hutson, “The Renewable Energy Revolution Will Need Renewable Storage,” The New Yorker, April 18, 2022.

12

Michele Fabiola Lawson, “The DRC Mining Industry: Child Labor and Formalization of Small-Scale Mining,” Wilson Center, September 1, 2021.

13

American Geosciences Institute, “What are the major sources and users of energy in the United States,” accessed August 14, 2022.

14

Eurostat, “Where does our energy come from?” accessed August 13, 2022.

15

Nicholas Kusnetz, “Is Natural Gas Really Helping the U.S. Cut Emissions?” Inside Climate News, January 30, 2020.

16

U.S. Environmental Protection Agency, “Overview of Greenhouse Gases,” May 16, 2022.

17

Benjamin Storrow, “Methane Leaks Erase Some of the Climate Benefits of Natural Gas,” Scientific American, May 5, 2020.

18

Melissa Denchak, “Fracking 101,” Natural Resources Defense Council, April 19, 2019.

19

American Petroleum Institute, “Hydraulic Fracturing,” accessed August 15, 2022.

20

National Geographic, “Fracking Water: It’s Just So Hard to Clean,” October 4, 2013.

21

U.S. Environmental Protection Agency, “Hydraulic Fracturing for Oil and Gas: Impacts from the Hydraulic Fracturing Water Cycle on Drinking Water in the United States (Final Report),” 2016.

22

Denchak, “Fracking 101.”

23

Brian Palmer, “Natural Gas 101,” Natural Resources Defense Council, November 15, 2021.

24

Union of Concerned Scientists, “Environmental Impacts of Natural Gas,” June 19, 2014.

25

Valerie Volcovici, “New research reveals U.S. gas pipeline leaks have not improved,” Reuters, June 23, 2022.

26

Carol Clouse, “Is Natural Gas Sustainable,” Impactivate, August 27, 2020.

27

Jim Magill, “Oil, Gas vs. Clean Energy: Which Will Have Best Jobs in the Future?” Forbes, October 26, 2020.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

Many of American Century's investment strategies incorporate the consideration of environmental, social, and/or governance (ESG) factors into their investment processes in addition to traditional financial analysis. However, when doing so, the portfolio managers may not consider ESG factors with respect to every investment decision and, even when such factors are considered, they may conclude that other attributes of an investment outweigh ESG considerations when making decisions for the portfolio. The consideration of ESG factors may limit the investment opportunities available to a portfolio, and the portfolio may perform differently than those that do not incorporate ESG considerations. ESG data used by the portfolio managers often lacks standardization, consistency, and transparency, and for certain companies such data may not be available, complete, or accurate.

ESG Definitions:

  • ESG Integrated: An investment strategy that integrates ESG factors aims to make investment decisions through the analysis of ESG factors alongside other financial variables in an effort to deliver superior, long-term, risk-adjusted returns. Therefore, ESG factors may limit the investment opportunities available, and the portfolio may perform differently than those that do not incorporate ESG factors. Portfolio managers have ultimate discretion in how ESG issues may impact a portfolio's holdings, and depending on their analysis, investment decisions may not be affected by ESG factors.

  • ESG Focused: An investment strategy that focuses on ESG factors seeks to invest, under normal market conditions, in securities that meet certain ESG criteria or standards in an effort to promote sustainable characteristics, in addition to seeking superior, long-term, risk-adjusted returns. This investment focus may limit the investment opportunities available to a portfolio. Therefore, the portfolio may underperform or perform differently than other portfolios that do not have an ESG investment focus. ESG-focused investment strategies include but are not limited to impact, best-in-class, positive screening, exclusionary, and thematic approaches.