Alliance Trust: why we like natural gas and our qualified position on fracking
Investment house Alliance Trust invests in non-fossil fuels, but makes an exception for natural gas, which it describes as a “beneficial transition fuel”. It adds that shale gas from fracking can also be positive to sustainable development. Mike Appleby, a sustainable and responsible investment analyst at the firm, explains why.
Hydrocarbons, such as oil, gas and coal, emit carbon dioxide when burnt and this is the main contributor to manmade climate change. For this reason we avoid companies with high exposure to carbon intensive fossil fuels such as coal and oil (in particular tar sands).
These three hydrocarbons have very different carbon intensities (emissions per unit of energy derived from their combustion). Estimates vary, but burning natural gas to produce energy results in significantly lower emissions – approximately 30% less carbon emissions than oil and about half the carbon emissions as coal.
Source: World Resources Institute: Taxing carbon to finance tax reform (Hanson C, Hendricks JR) March 2006. *Million metric tons of carbon per quadrillion Btu.
Natural gas: a transition fuel with genuine environmental benefits
We like natural gas as we believe it is an important transition fuel to substitute more carbon intensive fossil fuels. For example, it is estimated in the US that substituting the existing average coal-fired power station with a natural gas powered power station would result in a reduction in carbon dioxide emissions of over 60% at a similar cost.
We also like natural gas as a substitute transport fuel, especially replacing diesel in trucks as it results in an improved emissions profile and reduces CO2 emissions in this fast growing sector.
We prefer non-fossil fuel forms of energy and investing in these areas as well as energy efficiency which will be key to us moving towards a more sustainable energy system. We firmly believe that a “shale-gas revolution” (which we believe is unlikely in the UK) is not a substitute for a step change to increase investment in renewables and energy efficiency measures to reduce our reliance on fossil fuels.
Our position on oil and gas companies: we have very limited investments in this industry
We do not invest in the majority of the oil and gas sector mainly due to the emissions associated with using these products. We make an exception for companies that are predominantly focused on developing natural gas and measure this in terms of the proportion of the company’s reserves that are natural gas as opposed to oil or tar sands.
Companies with 70% of their reserves in gas are potential candidates for investment in the Sustainable Future funds, if they also have strong management and a good track record of operating in a high impact and difficult industry. These criteria exclude the vast majority of companies in the oil and gas sector.
Our position on fracking: qualified support – if done properly, but wary of pure-play fracking investments
Shale gas is held tightly in the rocks and requires some new drilling and extraction techniques involving hydro-fracturing (aka fracking) which essentially pumps large amounts of water (with sands and chemicals) to break up the rock and allow the gas to escape and be extracted.
This is controversial due to the amounts of water it uses and its potential negative impact on the quality of drinking water, local objections to this as well as the disruption caused, potential local land tremors and also the amount of natural gas that escapes into the atmosphere (fugitive emissions) which can significantly increase emissions associated with this unconventional way of extracting natural gas. In turn, this undermines the ecological benefits of using natural gas as a substitute for other more carbon intensive fossil fuels.
We believe that, if done to the highest operational standards, and with the majority consent of the local people affected by the exploration activities, shale gas and its associated fracking is a net positive activity due the substitution of more polluting fossil fuels and to increase energy security. So, in theory, we won’t exclude a company just because it is involved with fracking on sustainability grounds – assuming they manage it carefully.
That said, from an investment perspective, there are reasons to be wary of companies with high exposure to shale gas as we believe the expected economics of these projects are over optimistic, mainly due to underestimated lifting costs, and decline rates – which results in expectations of investment returns being too high – not uneconomical but lower than hoped. We do not own any shale gas companies other than natural gas companies where there is limited involvement and we are purposefully wary of looking for exposure to the pure shale gas theme.
Recent exploration for shale gas in the UK: no material exposure and happy to keep it that way
We are less excited about prospects for shale gas in the UK than many and do not have any material exposure to UK shale gas exploration in the Sustainable Future funds. The main reason for our caution relates to local opposition and an over simplistic analogy of shale gas in the UK being a repeat of what has happened in the US.
While the UK government is trying to make local communities get more meaningful compensation rates for the inconvenience and potential risks of fracking – this is very different from the US where, generally, the mineral rights are owned by the occupier (not the government) and where the owner of the land is paid substantial royalty rates from exploration companies, greatly facilitating local consent.
Local opposition will likely remain high while it is perceived that locals have to put up with exploration close to them so that private companies can profit from shale gas.
We think that the UK has very limited fracking experience. It will take time before costs come down and they are able to conform to best operating practice to minimise the potential risks of water contamination and fugitive emissions. We also believe that the geology is unknown and decline rates (how quickly production falls over time) will need to be re-assessed before the economics of this shale gas exploration are better understood.
In the meantime, we are happy to avoid pure-play shale gas exposure in the UK (and note, there is limited listed investment opportunity exposed to this) as we see better investment opportunities elsewhere, mainly from non-fossil fuel power generation and companies providing products that enable us to use energy more efficiently, which saves us money as well as reducing emissions and improving our common environment.
Mike Appleby is SRI analyst at Alliance Trust Investments. This article originally appeared in the Alliance Trust SRI Hub, where you can also find a fully referenced version.
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