The recently presented Hobe Minerals Limited Liability Company v. Bonanza Creek Energy Operating Company, LLC, et al A lawsuit in a Colorado trial court questions whether intermittent cryptocurrency mining can maintain an oil and gas lease beyond its primary term. While lawsuits seeking to determine that oil and gas leases have ended are nothing new, the cryptocurrency mining angle in Hobe Minerals raises an interesting question and highlights the need for oil and gas owners to be aware of things like cryptocurrency mining and its impacts on an oil and gas lease.
Hobe Minerals is an oil and gas owner that leased thousands of acres to Bonanza, an oil and gas driller, in Weld County, Colorado, north of Denver. [Complaint ยถ 18]. The lawsuit alleges that Bonanza originally intended to include the Hobe Minerals lease in a sprawling development, with dozens of horizontal wells in eight units, but Bonanza only drilled eight wells, one in each unit. [Complaint ยถยถ 32-37]. After the drilling of these wells, Hobe Minerals recognized that oil was being produced and sold regularly, thus generating royalties; The associated produced gas was flared and no royalties were paid on the gas. [Complaint ยถ 38]. According to Hobe Minerals, Bonanza did not connect the wells to a gas gathering system. [Complaint ยถ 39].
After several years of flaring associated gas produced with oil, Colorado's regulatory agency apparently denied Bonanza the ability to continue flaring the gas. [Complaint p. 46]. As a result, Hobe Minerals says Bonanza stopped producing oil and gas from the wells. [Complaint ยถ 47]. Then, according to Hobe Minerals, Bonanza attempted to restart production on a rolling basis by paying a cryptocurrency mining company to move portable trailers containing cryptocurrency mining equipment to the well sites. [Complaint ยถยถ 50-51]. The cryptocurrency mining trailers would generate electricity for the mining operation by burning the gas produced in the wells. [Complaint ยถยถ 50-52]. Hobe Minerals claimed it had been paid de minimis royalties for this gas consumed in cryptocurrency mining, rather than the value you should have received if the gas was traded or sold. [Complaint ยถ 50-52]. Hobe Minerals also alleges that, as part of the cryptocurrency mining operations, the pits were only operational for a fraction of the time they had been before and produced substantially less. [Complaint ยถ 53].
Hobe Minerals sought various solutions to its lawsuit based on a number of theories. The treatment given by the court to the different theories proposed by Hobe Minerals alone deserves further study. But relevant to this discussion are arguments that the leases in question ended because they were operated intermittently and uneconomically. [Complaint, First Claim for Relief] and that Bonanza violated the implied commitments to prudently develop, produce, protect against drainage, operate and market the gas because other operators would have installed a gas collection system to sell the gas instead of flaring it or disposing of the gas in intermittent cryptocurrency mining activities. [Complaint, Third Claim for Relief].
Notably, Hobe Minerals did not claim that cryptocurrency mining was a problematic use of gas under the lease. In fact, Hobe Minerals suggests in its Third Relief Claim that other operators would have installed a gas gathering pipeline or used cryptocurrency mining equipment at each well site, to avoid opening and closing wells, which allegedly affected well pressure. Deposit. [Complaint ยถ 135].
He Hobe Minerals The case is in its early stages, but its partial focus on cryptocurrency mining raises an issue that is likely to become more widespread. Cryptocurrency mining uses enormous amounts of computing power to verify blockchain transactions on computer networks. Significant amounts of energy are needed to power "mining" computers and keep them cool. Since natural gas is burned to generate electricity, oil and gas well sites can be attractive sources of gas for cryptocurrency miners to power their cryptocurrency mining operations. Likewise, other large energy consumers, such as computer data centers, may find oil and gas well areas attractive for similar reasons.
Mining cryptocurrency at well sites presents several issues that oil and gas owners should be aware of. On the one hand, the existence of bona fide commercial sales at well sites to cryptocurrency miners could help establish a real price for the gas at the well, rather than relying on the logically suspect "net backing" calculation method for calculate the values โโat the wellhead. But oil and gas owners must confirm that appropriate royalties are paid. In early 2023, A federal government report indicated that drillers did not pay hundreds of millions of dollars in royalties to the federal government because, instead of being sold, the gas was used to generate electricity for computers involved in cryptocurrency mining.
If drillers are paying a cryptocurrency mining operation to get the gas, such as Hobe Minerals Alleges, valuing that gas for royalty purposes is not simple and the pricing values โโare not reliable. Additionally, if drillers sell substantially discounted gas to cryptocurrency mining pits, or pay cryptocurrency miners to take the gas, that affects the driller's lease operating expenses and warrants further investigation into whether the lease is producing in payable quantities.
The consumption of gas for cryptocurrency mining operations in the lease where the well is located raises other issues involving the validity of the lease. If a lease requires the payment of a royalty on gas traded and sold outside the leased premises, a driller may attempt to argue that the consumption of gas in the lease for cryptocurrency mining operations does not trigger a royalty obligation. But, in Pennsylvania, that should go against the statutory minimum royalty obligation.
The Pennsylvania Guaranteed Minimum Royalty Act identifies the minimum royalty requirement that a lease must contain to be valid. It is stated that:
A lease or other similar agreement that transfers the right to withdraw or recover oil, natural gas, or gas of any other designation from the lessor to the lessee will not be valid if the lease does not guarantee to the lessor at least one-eighth of the royalty of all oil . , natural gas or gas of other designations removed or recovered from the property in question.
58 PS ยง 33. So, to be valid, an oil and gas lease must guarantee at least a one-eighth royalty on all oil and gas extracted or recovered. In Kilmer v. Elexco Land Services, Inc.., 990 A.2d 1147 (Pa. 2010), the Pennsylvania Supreme Court interpreted the GMRA's โdisposal or recoveryโ requirement to be determined at the physical wellhead, where oil and gas are removed or recovered from the ground. . The natural gas used to generate electricity for cryptocurrency mining operations is, without a doubt, โextracted or recoveredโ from the ground. Therefore, a lease must ensure that the driller pays royalties on that gas for the lease to be valid. However, oil and gas owners should be aware of the types of oil and gas activities that occur under the lease to ensure they are paid correctly.
Cryptocurrency mining and other in-situ uses of oil and gas offer potential new business opportunities for drillers and can also benefit oil and gas owners. However, as the Hobe Minerals As the case indicates, oil and gas owners must be attentive to where and how gas is sold and whether operations are carried out in accordance with the lease agreement.
