Abstract This paper examines the detailed energy and exergy distribution of a 34 cc (cc) air-cooled, two-stroke engine configured to operate on different natural gas (NG) compositions, pure methane, and propane. The engine was developed for application in a small, decentralized combined heat and power (CHP) system. It included optimized intake and exhaust resonators designed from Helmholtz resonance theory to promote effective scavenging. Operation occurred at wide-open-throttle (WOT) at an engine speed of 5400 revolutions per minute (RPM) with low-pressure direct injection (LPDI). Electronic ignition timing was adjusted for maximum brake torque (MBT) while the air-fuel ratio (AFR) was adjusted by injection duration, such that both rich and lean combustion were examined. In addition, start of injection (SOI) was adjusted to balance maximum fuel trapping and combustion stability. Full energy and exergy distribution analyses were completed, as engine operating regimes changed. Exergy was divided into work (available), lost (recoverable), and destructed availabilities. It was found that fuel loss and heat transfer contributed the most to exergy losses, accounting for around 15% and 9% of fuel exergy, respectively. Propane with the highest density, showed the highest in-cylinder trapped energy, heat transfer and, peak utilization factor (UF) of 85.3%. Due to fuel presence in the exhaust, lower 1st law efficiency did not necessarily result into a lower 2nd law efficiency. Higher mixture stratification with propane operation increased carbon monoxide (CO) emissions and hydrogen (H2) content due to rich operation. CO oxidation could recover up to around 5% and 4% of injected fuel energy as heat for CHP system with propane and NG, respectively. Peak 2nd law efficiencies were around 60.5% while peak 1st law indicated efficiency was around 29%. This discrepancy was due to both exhaust hydrocarbon (HC from fuel slip and incomplete combustion) content, exhaust CO content, and heat loss availabilities.