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Carbon Credits and Blockchain with CarbonPath

In this episode of Cowen’s Energy Transition Podcast Series, Sam Arnold, Co-founder, and COO of CarbonPath Group, joined Cowen’s Industrial Gas & Equipment and Energy Oilfield Services & Equipment Analyst, Marc Bianchi, and Next Generation Materials and Oil and Gas Exploration & Production Analyst, David Deckelbaum, to discuss CarbonPath’s carbon offset credit business. This offering incentivizes the oil industry to safely plug and abandon mature oil and gas wells and use blockchain technology to ensure credit authenticity.

Press play to listen to the podcast.

Transcript

Speaker 1:

Welcome to Cowen Insights, a space that brings leading thinkers together to share insights and ideas shaping the world around us. Join us as we converse with the top minds who are influencing our global sectors.

Marc Bianchi:

Okay. Hey everybody, Marc Bianchi here from the Cowen energy team, we’ve got another installment of our Energy Transition Podcast series currently with a focus on carbon capture. I’m joined by my colleague, David Deckelbaum and Sam Arnold from Carbon Path. Sam’s going to talk to us about their new business that’s involved in plugging and abandoning existing oil wells with the goal of creating carbon credits and hopefully helping the environment. So Sam, thanks so much for joining us. Maybe you could give us a little background on who you are and how you got to be in this position. Tell us a bit about Carbon Path and we’ll go into some Q&A.

Sam Arnold:

Sure. Yeah. Thanks Marc. Appreciate the time and being on here today. Good to be back in the energy fold a little bit, taken a couple year hiatus. As far as my background, I started off as an engineer with Exxon, did that for a number of years, spent some time on the sell side and then really the last, call it 12 to 15 years, in a portfolio management role on the buy side, primarily covering energy related stocks. Decided that probably wasn’t a long term career objective for me, decided to see what else was out there in the world. And I always felt like… I was at U of I in the late nineties, that’s University of Illinois. Mark Anderson was actually developing Netscape based upon Mosaic, which was the world’s first browser developed at U of I, and I actually worked in the computer lab and I felt like I missed that entire trend by going into oil and gas.

                And so when I left, I had a whiteboard, and what are the big trends? What are the things that I don’t want to miss this time around, the mega trends that are going to be happening in the world? And a couple of those that really fascinated me that I did a lot of market research on were blockchain technology, as well as the carbon markets. And so as I got deeper in the carbon markets, I was just fascinated, it was akin to buying bonds in the eighties. You had to go through brokers or be big enough to go through a project developer. And the market just seemed ripe for disruption and it was operating on a 1980s technology platform in a 2020 environment.

                That was the genesis for Carbon Path. But in general, it’s trying to solve a simple problem. There’s a methane emission problem which contributes a significant portion of the overall greenhouse gas emissions in the US and it’s pretty easy to solve it because it’s coming from a bunch of wells that don’t really make money for anybody. It doesn’t take much to incentivize the company to permanently shut and abandon them. And it won’t have much impact on the consumer either because it only represents about 5% of US production. So I’ll pause there. I said a lot.

Marc Bianchi:

No, that’s great. I mean maybe you could talk about how you guys got started with the business, who came up with the idea, what was the timelines to get to where you are now and what’s the path over the next 12 to 24 months?

Sam Arnold:

Yep. So I normally take my boys on a guys trip every year and we went to Houston and happened to have lunch. Was, I guess, February of ’21, maybe, with Matt Steele, the former CEO of Bruin Oil and Gas. We were talking about, I was looking at maybe looking at tax credits for drilling oil and gas wells. But like I said, in the background, I’ve been doing a bunch of work on blockchain and the carbon markets and he discussed that you could probably actually pay operators to shut down the dirtiest, oldest wells and that would probably have a pretty measurable impact on the environment. I think he came up with it originally by looking at the overall market cap of the E&Ps in 2020 and saying, I think, Google, Amazon and Facebook had enough cash on their balance sheets that they could have just bought all the companies and said, “Okay, fine. If you don’t like oil and gas, buy them all and shut it down.”

                That was the joke, genesis of it. Because we talked about it more was like, “Hey, there’s something here.” So kept in touch. Obviously, as I was working on the project, got my compliance of former employers approval to work on it. And we started really raising money in earnest basically this spring and finished that funding, but really had been working on the idea over the last, call it a year now. We’re currently working on a pilot project, we’re developing our tech and we’re funded, we believe, for the next two years.

David Deckelbaum:

Sam, can you go into what does a pilot project entail right now? Because I think you gave an outline of a lot of the focus of obviously we can create a carbon credit or carbon offset by plugging an oil and gas well. You brought up blockchain before and we’ll get into that later, certainly on the revenue side, but what is Carbon Path consuming capital for? What are you spending money on? Because it appears as though the business model is to compel oil and gas companies to shut end wells. Perhaps you would pay a nominal amount to do that and then you would be selling the carbon credit generated to… In theory, maybe the Amazons of the world that you outlined before that could have outright bought these companies. So what is your pilot intending to demonstrate in the market?

Sam Arnold:

Right. So really if being able to put, basically do the process, start to finish and put everything on blockchain. So we’re building on the cello blockchain, which is one of the most environmentally friendly and there’s been others that are using that. Somewhat would be a quasi competitor would be Adam Neumann’s Flowcarbon that just raised $70 million to do something similar, but they’re trying to take and kind of jam existing credits from registries onto blockchain, where we’re building our credits and putting everything on chain from scratch.

                The question would be, what does that buy you? Why put it on blockchain? And for me, the beauty of blockchain is the transparency of transfer of ownership. And right now anytime you buy or sell something, it’s always held in the either government or a single document that somebody holds somewhere so it’s very difficult to ascertain value where something on a carbon credit has been sold once, twice, 10 times. And so for me, something like a carbon credit where you want to ensure that it’s only been bought once and then either retired or traded and it’s only been generated one time is a perfect use case for blockchain.

                And one of the biggest problems that I found when I was looking at the carbon market for credit is just the ability to prove that the work actually occurred. So a lot of these would say, okay, well this is a forestry project based in Uganda or something and cut down these trees. But now we’re not, it’s like, okay, well I can’t really go to Uganda and look at it and know this exact plat and all, this exact forestry. So it’s very hard to measure and verify, but by putting everything on blockchain, we can, and especially with oil gas, given as highly regulated as it is, you’re going to be able to put a state or federal permit on chain that says, yes, this well was actually plugged and abandoned.

                Yes, here’s the third party engineering work from say a Ryder Scott or Netherland and Sewell that said this is the reserves that we’re leaving them in the ground. So really, anybody will be able to go look at our credit and look at any specific carbon credit or carbon token that we’ve created and verify themselves, go through our calculations and verify that the work has been done and get great comfort that this was actually something really [inaudible 00:09:04] and was only bought or sold once and it only has a single point of ownership. Does that make sense to you? It’s all focused on building that technology.

David Deckelbaum:

Sure. Well, I think that’s probably something that gets casually missed as the world thinks about the carbon capture economy is that you’re identifying a problem, which is how do you verify that the work has been completed? How do you know if a direct air capture facility retired 800,000 tons of CO2? How do you know if a carbon sequestration project was successful in that? So it sounds like there’s a proprietary technology angle, particularly around blockchain, that almost is required as this sort of nascent market develops here that you think is something that, one, there’s a business case for what you’re doing in creating carbon credits. But there’s also like a scalable technology aspect to what you’re doing that would apply to verification. Is that fair?

Sam Arnold:

It is. Yeah. We think that other third party verifiers, the [inaudible 00:10:06], the gold standards, although we don’t think we’re competing head-to-head with them, they’re more focused on the forestry and aspect of the carbon market, but we think industry is the source of the majority of actual emissions, so we want to be more the industrial source for carbon credits.

David Deckelbaum:

Okay. Just one last one for me on this is just, can you at a high level maybe talk about the benefits of a cello based blockchain versus some of the others from an environmental perspective. Because obviously, there’s a critique in how energy consumptive blockchain can be. So how does cello differentiate there? Because that’s obviously been a common pitfall as we look at the crypto world that’s supported by blockchain that consumes more energy than several states consume.

Sam Arnold:

Yeah. That’s right. So, there’s really different types of mechanisms for understanding whether somebody owns something on blockchain, proof of work or proof of stake. So proof of work is basically a great race to solve a puzzle. And so you have these massive computers and computer farms that are running sometimes off natural gas from wells in the block or Texas or Saudi Arabia or wherever. And they’re huge energy sucks because you have millions of computers trying to put out trillions of hash rates per second, to be the first guy that solves the problem. And once you solve that problem, you get all the spoils from it. So it’s a winner take all and that’s highly intensive from an energy consumption standpoint.

                What proof of stake tries to do is say, “Hey, we’re just going to nominate, depending upon what protocol it is, say a couple hundred computers and you guys are going to solve the puzzle and whoever completes it, that’s fine, but everybody should complete it. You vote on it. If more than 50% come up with the same answer, perfect. Now it’s a block. And so you have very limited energy intensity with a proof of stake mechanism.

                But how do you verify that they’re not bad actors? Well, what you do is you have them stake and that’s the proof of stake. So put up their own capital that whatever currency it is, so whether it’s cello or if it’s any of the other ones that are out there, you basically have to put up, call it anywhere from $10,000 to a $100,000 to be able to stake. And if you do anything that you get called out for, if you get caught being a malicious actor, they basically penalize you by taking away that state cello. So you have a financial incentive to be a good player in the game and therefore you have only a very small subset of computers that are racing hard to solve these problems and trying to solve these hashes at any given time. Thus their energy consumption is significantly lower. Does that make sense?

David Deckelbaum:

Yeah, that makes sense. Thanks Sam.

Sam Arnold:

So there’s lots of proof of stake out there, but we think cello actually is just a better platform where people are really trying to migrate and become… Well, we like it because it’s trying to solve a problem in general, where they’re trying to be more of a crypto that can be utilized by people on their smartphones. And that really democratizes the use of crypto to basically second and third world, which I think is where it’s really needed because you take away government interference, you take away the ability to take a bribe or whatever it is. When you look at, I think what’s left a lot of countries behind versus say the United States or others, it’s really our system of laws and contracts and the ability to not get taken down at every step of the way. And so I think blockchain can really help level the playing field in that respect.

                I think it can really be a game changer for basically countries that have fallen behind. So I’m a huge believer in the cello blockchain in general, because of that promise, in addition to it being a very low energy intensive and thus more environmentally friendly blockchain technology. Does that all make sense?

David Deckelbaum:

Yeah. That makes sense.

Marc Bianchi:

That helps get certainty around authenticity and paper trail as it relates to these credits. But I think there’s a whole nother question that people have about measurement and whatever we’re claiming the credit is representing, is it really representing that much CO2 emission? Talk to us about what problems exist in the market today with that and what you guys are doing might be a little bit more precise measurement or might solve some of those uncertainties that are out there.

Sam Arnold:

One of the big questions you always have is additionality, where would this be undertaken without the credit? And so a lot of credits put on blockchain recently were older credits from another verifier that were used in conjunction with a lot of wind and solar projects. And so the question becomes, well, is that really additive? Those projects probably would’ve happened. Utilities were going to build those things irrespective of giving the credit. So it’s not really additive. So there there’s been a problem from older credit from that standpoint. We think ours is completely additive just because if you understand the way the oil and gas industry works, wells are very rarely actually plugged and abandoned. They’re just sold down the food chain to a lesser capable operator that usually has a lower cost structure and make that work where I don’t know if I’ve gone over this with you guys in the past, but there’s 4.3 million wells in the US, only 800,000 produce anything. And half of those produce less than a barrel a day.

                So, you have 400,000 wells that are basically just pumping one barrel a day and a lot of water and a lot of associated gas, and a lot of that’s leaking. And so we know that without our credit, these wells that are producing 15 barrels a day or less are going to keep producing for decades. So we think it’s completely additive.

                The second thing is how do you verify it? And I think that’s unique to each problem. So they’re trying to get technology with drones and stuff like that. So say if you’re, go back to our Ugandan forest, trying to fly over and measure that with some sort of frequency or satellite measurements. So technology’s coming to make that better. But you, as a credit buyer, you have no visibility into what exactly part of the forest you were saving. So if you’re a project developer and you’re Amazon and you’re working with them on a bilateral agreement to buy the credit, you may have pretty good insight into these are all the coordinates and this is exactly what we’re going to save. But as you, as a third party buyer and the after market or secondary market really don’t have any visibility into that.

                By us putting it on chain, everybody who’s a buyer or just an interested party, will be able to have the exact same information. So it really democratizes the ability for anybody to buy a credit and feel good about it. So I think within forestry based and nature based credits, being able to measure it and verify it is advancing with technology and will get better over the next 10 years, but only the biggest, largest buyers right now have really any insight into how that’s occurring. But for us, everybody will have the exact same insight because it’s pretty easy, especially if it’s a well been producing for five to 10 years. And David you’ll know this, getting the last 10 years of production’s pretty easy to verify, it’s already is gone down on its hyperbolic or exponential decline curve. And it’s pretty easy to guess what a well is going to do in years 11 and 12 versus 1 through 10.

David Deckelbaum:

I guess. Can you talk about the, now you highlighted before the population of wells that you’d be going after and I guess it sounds like you’ve already done the math on the arbitrage between being able to create the carbon credit by shutting in that well versus the revenue that well would produce given prevailing commodity prices. You came up with a genesis for this business model when commodity prices were quite a bit different a couple years ago and certainly last year. So when you think about the addressable market today, you think you can frame or how much of an arbitrage exists between the carbon credit that you can create off of shutting in a well versus even a well, that would produce a barrel a day, that’s still $120 today.

Sam Arnold:

Right.

David Deckelbaum:

How do you think about that arbitrage and how willing do you think that sort of captive source of what you’re using for feed stock is?

Sam Arnold:

Yeah. That’s a great question. And initially as prices started increasing, we were considerably concerned about that, but as we did the math and really looked at, it really depends upon the wells that are calling 15 barrels a day are much more sensitive to that price of oil. But when you start getting down to a couple barrels a day, it’s not that sensitive. So you maybe go from, you need $20 a ton to $40 a ton. So our pilot project, we’re selling at $30 and that makes enough money for the operator to be able to fund the plugin and abandonment, all the land reclamation for the landowner for the surface location, as well as take our fee and have a little bit left over that compensates them for what they would’ve been able to sell the well for.

                So our idea is really at the point of say a SMid cap getting ready to sell on an oil and gas clearing house to a small mom and pop, we want to prevent that transaction from occurring. Don’t sell it for $20,000 or $50,000 or $10,000 or even $3,000. Actually go ahead and plug and abandon it. You’re benefiting for a couple different reasons. One, you know that that liability’s never going to come back on you because you’re going to permanently get rid of that liability. And then two, you know that you’re doing the right thing for the environment because not all, but I’d say the majority of smaller operators don’t have the financial capability where if there’s leaking valves, there’s some sort of casing failure, they can’t repair that. They don’t have the financial means. So they’ll let it either just sit or they’ll continue to produce.

                And then those become methane leakers, pretty significant to the environment, as well as they can contaminate water up above. Because everybody was always mad about fracking and how that can contaminate the source, fresh water near the surface. And it can’t, if it’s a new well that’s a proper cement job and casing, but an older well, that’s been around for 10, 15 years that’s been intermittently shut in, has bacteria, can form H2 add. That’s one that can have communication with the surface and as well as groundwater supplies. So for me, even if you lost a little bit of money doing this, if you’re a SMid cap, it’s the right thing to do.

David Deckelbaum:

Can you talk about, I guess how you envision, maybe you can talk about the pilot, just soup to nuts, how do you get involved? Who do you call when you pick up that phone for the first time? How are you advising the individual operator? I mean, it sounds like the population that you’re going after would otherwise be public companies that more or less have these abandoned wells, not necessarily the mom and pops or families where it’s been on their thousands of acres of farmland that perhaps they know nothing about. I mean, is that the population that you’re going after, and then maybe you can just walk us through casually, how you guys get involved in the process and what expertise you’re lending along the line?

Sam Arnold:

Yeah. So we think our kind of sweet spot is about 200,000 wells that are producing between 15 barrels a day and one barrel a day. And those are the ones that are most likely to get sold at auction to a mom and pop. So we want to stop this SMid cap from selling to that mom and pop. So our target audience are the SMid caps and we’ve talked about this with the majority of them. And I think they’re all intrigued by that ability to have something else other than just sell it for a nominal amount and take the P&A liabilities off their books, but knowing that one day it could come back to them. For example, in the Gulf of Mexico, it can always come back to the previous operator and it can’t right now, but that could change in the future. So it is something I think that E&P should think about as a longer term risk from climate change. So for me, getting that permanently off the books by doing the work that should be done is paramount, and so that’s who we’re going after.

                We make the calls, people say, “Yeah, here’s a batch of wells.” And the nice thing is we can actually, and you know this David, we can do the desktop analysis and say, “Hey, Here’s the wells we think qualify, why don’t you do these?” So we can push. And in our website, investors are going to have the ability to say, “Hey, I want to see company X, Y, Z, how many wells do they have that could be useful in this process?” “Hey, why do you need oil and gas? You could generate $250 million of carbon credits if you shut down all these wells producing less than 15 barrels a day and took carbon credits. And here’s the actual API numbers. I mean, this is all public information. We can get that.

                So we’re going to be able to have that. So maybe if an EMTs not too keen on doing it, we can get the investing community to kind of push and say, “Hey, no, this is a good idea. This only represents a couple percent of your production, but it’s a pretty big NAV uplift if you sold them and taking that P&A liability really helps the NAV values. So we think that we’re going to work with the companies to identify wells, but then also investors can too. And then once those wells have been identified, the company, if it’s a field level manager, let’s say for Devon, then they can go get on our website. They can put in API numbers or they can just do a search and we can tell them, “Hey, this is, we think how many tons of CO2 of credits that you would generate. And this is about the amount that it’s worth.” And then if they want to open a case file and really do work, they have to have permissions to do so from their company, but then we’ll start our work on it, which is all the verification and calculations and starting to prep it and put it on chain.

                And then as the work is completed and we get that final permit, then we can mint the token and then if they want us to sell it for them or if they want to take them and put them in their wallet, if they’re sophisticated enough to do so, they can do that too. So we’re trying to work with them to get them the financing that they need. So really it would just be a working capital problem for the MPs to shut down the wells, but hopefully only by a few month lag.

David Deckelbaum:

Got it. So, yeah. So for the listening the API number, you’re giving basically a unique identifier that for every oil and gas well, but you’re almost using like a grassroots or almost an activist project to compel people of here’s the information that’s out there. Here’s the opportunity. Now let’s get the conversation started. So it sounds like there’s obviously a benefit of removing a liability, but you’re also giving someone an extra bullet in their sustainability report-

Sam Arnold:

That’s true.

David Deckelbaum:

… that they’ve created this value. And then I guess it’s for carbon pass revenue model, are you just taking a commission? Is it a flat fee for the service and how are you guys thinking about that as you scale?

Sam Arnold:

Yeah. We’re just taking a percentage commission of the credits generated. So we’re kind of alongside you basically where we’re taking the credits in kind, so we’re having to sell them and we will have either kind of the same if it was an IPO, the same protections for the company as well, where we can’t go just dump them on the market the next day so to protect the pricing of it. The good thing is I think one of the things we haven’t talked about is I think the market’s going to be very large and deep for these credits. It’s just being aware of market participants, most companies in the S&P 500 have now made climate pledges to go carbon neutral either by, call pick your number 2030, 2040, 2050, depending upon the entity, and I think that’s an attainable goal in the long term.

                I think in the short and medium term, companies as they’ve made this goal are starting to look at what they can do within their existing operations to lower their carbon footprint or finding that there’s limited scope to do so. So I think that’s going to be the bridge in the short term. And so we think the demand for credits is going to explode and we don’t think it can be met with nature based solutions. I think it’s fine for a lot of investors who’ve said, “Yeah, we want you to focus on climate,” and that’s the right thing to do and I believe that, but also the financial community isn’t going to tolerate 200%, 300% of free cash flow to go do so. It has to be done in a more measurable way that doesn’t impact these guy’s balance sheets or the company’s balance sheets. So I think as they do that, they’re going to need credits that are reasonably priced and actually have a real impact.

                The thing that I really liked about what we’re doing is it solves a huge problem, because one, it stops methane emission and it stops the additionality of new orphan wells because they’ll never get to that point. But once you’ve actually done that, you’re providing billions of tons of potential credits. They call it around a $30 price point, which is significantly cheaper than Biochar, or Direct, or Capture or anything that’s out there that isn’t really yet a proven technology. I mean, this is proven technology. Our costs are very specific and we know what they are and it’s not going to change over time. So if I would be able to provide a huge dispatch curve of credits at $30, I think you’d just keep the movement going, because if we ran out of credits and then people had to go carbon neutral by paying $300, $500 a ton, I think a lot of management teams would balk on their pledges and those would fizzle out.

                I think we’re really enabling companies to have that bridge to actually get to their carbon neutral goals. Because I don’t know, say a waste management, they have to change out their whole fleet. They’re not going to do it in two years or five years, but 30? Yeah, they can probably do that. And the grid can probably keep up with that. So shutting down 600,000 wells that aren’t really producing that much oil and gas but are the bulk of all methane emissions, it just makes so much sense that I don’t see why this shouldn’t be… To me, it’s the lowest hanging fruit of the climate change initiative. Everybody should be all hands on deck going after this.

Marc Bianchi:

The credit that’s generated on a 15 barrel a day well, what are the streams of CO2 or CO2 equivalent that are contributing to that? So you mentioned methane, are those 15 barrels also being counted as avoided barrels that’ll be combusted in the economy someday? Just talk to us about what builds up into that credit.

Sam Arnold:

Yeah. So this is what I think is slick of what we’ve done as far as… As I’ve seen other credits and viewed them, their methodologies to generate require a lot of capital investment upfront. And that’s hard for a lot of people to do. So you’ve seen some of these orphan wells where they want you to go try to put a tent around once you’ve found the well site and try to measure the methane. We think that’s great and it gives you a very scientifically exact number, but unfortunately nobody’s going to do it. And so our thought is this needs to be able to be done with desktop analysis before you get into the field and actually start spending the dollar. So the way we’ve constructed it is to be able to do that, to actually spur action, but do it in the lowest cost initially as possible.

                And so, what do I mean by that? Well, we know that in general, through studies with Environmental Defense Fund and others, that on average about 10% of methane gets emitted out of every oil and gas well that’s over 10 years old. And so that’s just occurring now. Some might be 20%, some might be 7%, some might be 3%, but in general, that’s the average. So if that’s called 20, 25 times more potent as a greenhouse gas than carbon, a 10% leakage times 20, if it’s a pure of gas well, that’s 200% of basically the Scope 3, meaning if you just assume that every molecule of gas wasn’t leaked as methane but was eventually burned as a Scope 3 emission, you would have one number. And then if you said, “Okay, well, part of that’s leaked out of the well, but it’s a much more potent greenhouse gas, that’s another.”

                So we’re really trying to solve the one where it’s leaking out of the well head, because that’s really bad, but we measure it using the conservative number, which is basically reserves left in the ground. And we take reserves because if you look at a reserve calculation that’s based upon pricing points and economic limits. And we wanted to take pricing now because we want to say, “Oh, was our credit so good at a $100 oil, now that’s dropped to $50.” So we wanted take that out of the equation. So we’re only looking at production either over the next 10 years or til it drops to a barrel a day. Now we know, even if it drops to a barrel a day, there’s 400,000 wells in the country that are producing less than a barrel a day, so it would continue to get produced. But by making that cut off a barrel a day, you’re taking price out of the equation.

                And then we did a time cut off of 10 years, even though as you know, some of these wells have been producing for a 100 years, just because we wanted to keep it more align with forestry and not give credit for too far out in the future. So we’re really either taking the smaller number of either 10 years or down to one barrel of production. And when you look at whatever the oil and gas that’s left in, and we’re taking samples, which will also be on chain so you’ll know the chemical makeup of the commodity, you can assume if it was all going to be burned, how much CO2 was going to be emitted into the atmosphere. And that’s what we base it off of. But we’re actually being, we think conservative because the majority of those wells, it would never actually get to a tailpipe of a gas plant or to somebody’s car. It would end up being leaked to the air’s methane and it would actually do a lot more environmental damage to what we’re calculating. So we’re solving the problem, but we’re doing it in a much more capital efficient manner and giving you a much more conservative answer. Does that make sense?

Marc Bianchi:

Yeah. No, that’s helpful. So you mentioned the global warming potential on methane 25 times. I mean, I think that’s 100 year GWP. You could argue if you use 20 years, it’s like 85X. I mean, is there a standard or is that just you guys taking a conservative approach like you did with the modeling around down to one barrel? Is there a subjectivity in what GWP you select?

Sam Arnold:

Yeah. We could have used 80, which would make us much more conservative, I guess, in our number, but we just picked 20%, 25%. We’re saying, “Hey, that’s over 100 years,” as you said. So we just thought that was the most conservative answer, but it still tells you, we’re probably only taking half the credits that we actually should from a greenhouse gas perspective. But if you took it times 80, then it’s obviously much more conservative.

David Deckelbaum:

Can I ask a potentially cynical question?

Sam Arnold:

Sure.

David Deckelbaum:

Since you started looking at this, especially since ESG became front and center for many of these oil and gas companies, and a lot of them have net zero targets out there, particularly the ones that are sequestering or capturing CO2, others are out there trying to solve, and this is just on the oil and gas exploration, production side, trying to solve for at least Scope 1 emissions. Have you seen an acceleration in plugging and abandoning wells that you would have otherwise gone at over the last couple of years from these companies that are theoretically… You identified a situation where if there’s a company X in the public realm that has a portfolio of 1,000 wells and 300 of them are these older vertical wells. At this point, I suppose that there’s some horizontal wells out there as well that are producing at these levels. But I would imagine the percentage of Scope 1 greenhouse gas intensity that’s coming out of that subset of wells that you’re targeting is a large portion of each company’s total Scope 1, at least of methane emissions out there.

                Because the rest would be inherently hooked up to gas infrastructure, gathering infrastructure, and many of these wells, they were drilled at times where there just wasn’t any infrastructure in place and they never built it there because there wasn’t a reason to. Have you seen these companies actually getting after those wells more earnestly over the last couple years, or do you think that population of wells has largely remained the same?

Sam Arnold:

I feel like there is some companies that are starting to do a little bit more P&A work, but it’s a pure cost to them. And I’m thinking specifically in the DJ, but in general, if there’s 10,000 wells drilled in the US every year, another 10,000 age into our methodology so the pie is kind of growing every year. So to me, the simplest answer for E&P is rather than spending that $50,000 or $100,000 historically is to sell it to another operator and wipe your hands clean of it.

David Deckelbaum:

That’s $50,000 to $100,000 today, spot cost of plugging a well, getting a switch up in their hip per well.

Sam Arnold:

Right. Or, so you could pay a $100,000 and say, “Hey, look at us, we’re good ESG stewards of the environment.” Or, you could sell it to a mom and pop for $20,000. Take in $20,000, not have to spend $100,000 and get the liabilities off your books. Like Shell, they were smart fellows for getting out to Shell Oil, but I mean, they just sold it to Conoco Phillips, nothing changed. I mean, those wells are still getting produced and drilled so it’s kind of a similar phenomenon. And to me that’s the easiest thing for an E&P to do and I don’t see that changing, especially as the pie grows and from wells aging into this as we drilled so many wells over the last 10 years with Shell. So it’s becoming a bigger and bigger problem.

                A lot of these companies, if they looked up, they’re plugging, abandonment liabilities, and hold them forward to today, those numbers would be extremely large. And so I think it is a looming potential problem for the E&Ps as well. And so the easiest answer is to just get rid of them to somebody else, but we’re providing the ability to at least offset some of that pain. So if you’re going to have to pay $100,000 to plug it and you could have taken $20,000 in, you’re really down $120,000. But maybe if you could get $80,000 back, maybe that’s more tolerable within your capital program.

David Deckelbaum:

Yep. And is there just a, without naming names, is it the SMid cap publics that you would be mostly going after? Are the majors taking care of this for themselves or is it really the E&P world is your oyster right now? Or, is there one market that makes the most sense?

Sam Arnold:

Yeah, I would say it’s really anybody. I mean, we’re working with some environmental groups that actually own land that has some abandoned wells on them. We’re looking at stuff with SMid caps, with larger caps. It’s all across the board. I think most people have this problem and there’s one in particular, there’s the study done by Environmental Defense Fund, which I’ve referenced before, but it broke down the number of operators on these wells and you’re talking in the thousands of different operators.

                And there’s also been some work done by another investment bank that’s actually looking at there’s these wells that were supposedly sold but once again, the transfer of custody that I talked about earlier, the blockchain helps with, the paperwork is lost in the courthouse or something somewhere where it’s still showing as these wells are, they’re still owned by the public company and the public company doesn’t have any record that they own them, but nobody does. And so there’s that risk that the governmental entities come back and say, “Hey, you need to fix these because you’re still the owner of record as far as we’re concerned.”

David Deckelbaum:

Is there an additional tangible financial benefit from Randland reclamation or rehabilitation? I mean, it’s something that I think you all have talked about, but we’ve seen, I guess, other tax credits, I guess in certain jurisdictions for reclaiming sites or environmentally rehabilitating these sites, is that something that would be applicable here as well?

Sam Arnold:

Yeah. I mean, it could be. We’re trying to keep it simple and just trying to have the credit take care of all of that, but there are what we call the side benefit from that where we’re going to work with various environmental crew to suggest, obviously in the leases, it’s up to the landowner and the surface landowner of what they want to do. So they may want that well pad, because they may want it for a parking lot for farm equipment or what have you. But there is the case to be made that, “Hey, you’re hooked up to the grid here.” Maybe it makes sense to put up a small wind farm or solar site or something because you actually are connected to the grid at this location. So there’s lots of things you can do with the surface that we’re going to suggest, but we’re not trying to take credit for it. And at the end of the day, it’s going to be the surface owner’s decision.

Marc Bianchi:

Cool. Kind of getting close to time here. As a way to wrap it up, Sam, you’re a professional investor for several years and now you’ve spent time looking at this market. If you were to put your professional investor hat on and take lessons learned from going through this process, anything that you would share about what investors should be asking companies about their carbon targets or their Scope, 1, 2, 3 emissions reductions and any high level thoughts on risks or opportunities for companies in oil and gas. Just curious if you’ve got any new perspective having gone through what you’ve gone through.

Sam Arnold:

Yeah. I would say if it’s broader companies that have made some sort of climate pledge, just the roadmap to actually getting there and what it’s going to take from a capital standpoint or a percentage of free cash flow, or is this just going to get captured in the DDNA charge as equipment gets older and they go through their regular cycle? So companies that seems to be taking various different paths to get there, some more aggressive than others. So I would certainly be curious about that as well as the bridge when they are buying credits or doing offsets, what their philosophy is on that. And if there’s any way that they have any transparency into those credits. Because I think right now it’s very difficult, how do you procure them? So they said that the Apples, the Googles, the Amazons of the world can have entire teams dedicated to procuring credits and working bilaterally with project developers and get 50 page project memorandums and have great depth and understanding of what they’re doing.

                But as you start going down the food chain to smaller and smaller companies, they’re not going to have that ability. So just how do they ensure that what they’re buying is real, those would be my things. For the one on gas specifically, just their plugging and availabilities, maybe what the assumed discount rate is for that. The timeline, there’s been some pretty, I guess, well publicized companies that have some pretty significant abandonment liabilities out there that have been discovered where they have a lot of wells so they’re just cycling on and off producing one barrel for one day a month, just so it doesn’t get into the abandoned wells and then forced to be shut in by regulatory authorities. So that could be a huge liability if that got pulled forward.

                And probably lastly, I would think that how do they feel about the long term risk if they are selling wells to a smaller operator? If there is some sort of disaster, say you sold your wells to somebody in the far net. There’s some sort of leak and it, I don’t know, let’s say has an accident somewhere because it’s in a pretty metropolitan area, could they be held liable for that? And lawyers are always going to go after the deeper pockets. And if it’s a smaller, less capitalized entity, could they have the target on their back? And how do they think about that? Because to me, I think as soon as they sign on the doted line that they sold it, their hands are wiped clean of it, which historically has been true. But as this problem grows worse with orphan wells and potential for any type of environmental liabilities going forward, could they be held responsible for that?

Marc Bianchi:

Yeah, no, that’s all great perspective and stuff that people probably should be putting on their question lists at conferences. Sam, this has been awesome. Thanks so much, Sam Arnold from Carbon Path. You can get him on the website there, carbonpathgroup.com and Sam, thanks so much. We really appreciate the time.

David Deckelbaum:

Thanks, Sam.

Marc Bianchi:

Yep. Thanks Marc. Thanks, David. Really appreciate the time. Good to see you guys.

David Deckelbaum:

Always, best of luck.

Speaker 1:

Thanks for joining us. Stay tuned for the next episode of Cowen Insights.


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