Cryptocurrency mining ventures

The following article by Ryan J. Morgan and Melissa Munson of Steptoe & Johnson PLLC appears in the June 2022 issue of The PIOGA Press.

While cryptocurrency has been around for over a decade, a significant number of companies that produce cryptocurrency have recently focused on companies producing natural gas as potential business targets. Crypto-mining companies are largely seeking a dependable and cheap source of energy to power their cryptocurrency mining operations. As a result, oil and gas producers seek to learn more about the crypto-mining business in order to evaluate how their companies should best approach this new opportunity.

Cryptocurrency is a term that describes digital assets with money-like characteristics. CoinMarketCap, a price-tracking website, identifies approximately 17,000 cryptocurrencies with a combined market cap of $1.8 trillion. The top half-dozen crypto currencies make up more than 80 percent of that market. Bitcoin currently is the highest-valued cryptocurrency, trading over the past year in the range of $29,807 to $67,566 and averaging $47,273 per coin in 2021. There are two ways to acquire cryptocurrencies: (i) existing tokens of cryptocurrency can be purchased through a currency exchange, and (ii) new tokens of cryptocurrency can be received as a reward for participating in the transaction validation process. The second method requires a source of electricity to power the computers that contribute processing power to the network.

There are several different ways transactions can be structured involving the use of natural gas to generate electricity at or near the well pad for use in cryptocurrency mining. In recent years, we have seen an interest in crypto-mining utilizing both stranded natural gas (which includes both associated natural gas that is being vented or flared from oil wells, and natural gas wells for which there is no existing infrastructure or insufficient takeaway capacity) as well as opportunistic natural gas (i.e., gas for which the economics of a crypto-mining venture are potentially more attractive than the available or perceived/predicted returns for selling gas into the market). Crypto miners deploy data centers in modular containers in close proximity to oil or gas wells, make arrangements with the producer to secure the natural gas, convert that gas to electricity using generators and power onsite operations.

The scope of the operator’s desired ownership or involvement in the overall venture must be determined for purposes of negotiating and drafting the appropriate documentation. Generally, the venture will involve the following: (i) production of natural gas; (ii) delivery of natural gas to localized generators; (iii) production of electricity; (iv) delivery of electricity to localized crypto-mining equipment; and (v) operation of mining equipment/facilities and resulting generation of cryptocurrency. The operator needs to evaluate the components of this process and determine those over which it wants operational control and those in which it wants to have an ownership interest, keeping in mind that the answers may be different. Operators can be involved in such ventures in varying capacities, including (i) as a seller of natural gas, (ii) as a provider of electricity, (iii) as a joint venture partner or project co-owner, or (iv) as an owner of the entire venture. Whichever manner the operator chooses to structure its transaction, one item of particular importance in the negotiation is the method of compensation and whether to receive some compensation based on, or maybe even in the form of, the cryptocurrency generated by the project.

There are a number of legal issues to consider when structuring the transactional documents for a project involving natural gas sourced from a producing well and the localized production of electricity to power crypto-mining computers. Operators need to carefully review any applicable agreements to ensure they have all of the rights needed from the property owner(s) for the proposed business venture. Operators also will need to evaluate whether any other existing contractual agreements contain obligations implicated by the planned project, such as acreage dedication, area of mutual interest, joint development and joint operating agreements. Several important deal terms need to be evaluated and drafted appropriately, including the term of the project; the identification and valuation of assets being contributed to the venture; the source of capital; a clear outline of the steps, timing and budget for the performance of the venture; whether there is an opportunity for future development and expansion and, if so, each party’s obligation to participate; how the venture will be managed; how operating expenses will be allocated; how each party will be compensated; and how parties to the venture can ultimately exit their investment.

Additional considerations include regulatory oversight at the local, state and federal levels, as well as challenges by non-governmental organizations and third parties. As the operator and crypto-mining company discuss the potential venture, they should be mindful of whether the structure of their planned activity will expose one or more parties to undesirable regulation and the anticipated challenges to the venture from outside groups that object to the planned project specifically or as a project involving hydrocarbons generally.

Crypto-mining projects provide an interesting opportunity for many operators and in particular for those whose wells are producing natural gas that has no takeaway capacity or market. As with any venture that involves relatively new technologies and evolving legal regimes, it is important to understand the risks and to negotiate the structure of the transaction to meet the company’s objectives while anticipating and mitigating the negative consequences of future changes affecting the deal’s fundamental assumptions.

These materials are public information and have been prepared solely for educational purposes. These materials reflect only the personal views of the authors and are not individualized legal advice. It is understood that each case is fact-specific, and that the appropriate solution in any case will vary. Therefore, these materials may or may not be relevant to any particular situation. Thus, the authors and Steptoe & Johnson PLLC cannot be bound either philosophically or as representatives of their various present and future clients to the comments expressed in these materials. The presentation of these materials does not establish any form of attorney-client relationship with the authors or Steptoe & Johnson PLLC. While every attempt was made to ensure that these materials are accurate, errors or omissions may be contained therein, for which any liability is disclaimed.