Gas-to-crypto projects: Colorado case may shed light on lease terms

As oil and gas producers evaluate emergent opportunities with cryptocurrency mining, it is imperative to conduct a comprehensive risk analysis and ensure any programs are compliant with existing leases and contracts. A new lawsuit filed by a lessor in the District Court for Denver, Colorado claiming the lessee breached its lease obligations, in part through its cryptocurrency mining operations, shows the potential legal exposure producers may face as they take part in this developing segment of the industry.

Opportunities and considerations for gas-to-crypto projects

In the last few years, oil and gas producers and other energy companies have explored and implemented projects to take advantage of the synergy between energy-intensive cryptocurrency mining, on the one hand, and natural gas that is uneconomic or infeasible to transport to market, on the other, including “flared” gas. Gas that is otherwise burned or not produced is delivered to generate electricity for remote, relatively portable cryptocurrency mining “rigs” in the oilfield, which mine cryptocurrencies like Bitcoin.

In the cryptocurrency space, particularly for “proof of work” currencies like Bitcoin, there is tremendous demand for affordable energy. The electricity used for computing power and cooling equipment constitutes the vast majority of the cost of such operations. At the same time, there is pressure from multiple interest groups for “green” or environmentally conscious sources of power generation, especially as more legislators, regulators, and activist groups take aim at the energy demands of cryptocurrency mining. After the Chinese government instituted a nationwide ban on cryptocurrency mining in 2021, the domestic demand for energy and hash power has increased dramatically. For these reasons, cryptocurrency mining operators are constantly on the lookout for innovative and affordable sources of energy.

For oil and gas companies, gas supply arrangements with cryptocurrency mining operators may provide some mitigation of environmental effects related to operations and create additional potential revenue streams for otherwise uneconomic gas. Cryptocurrency mining rigs are relatively portable and can be constructed for nearly any locale and level of input. The rigs’ power needs can be supplied by gas-fired generators on-site, which connect to flared or uneconomic gas sold and delivered by producers with no need for significant takeaway capacity. The sales arrangement is not only a source of revenue but can also be a means to reduce emissions, depending on specific technical aspects of the agreement. Specifically, producers are likely to see a decrease in direct emissions because otherwise vented or flared gas is redirected for use as fuel for the mining operation. Emissions from this productive use are likely to generate a smaller carbon footprint overall, with direct emissions attributed to the miner and only secondary emissions attributed to the producer as a fuel supplier.

While these synergies provide exciting applications for cryptocurrency mining in the oilfield, oil and gas companies will want to carefully consider certain attendant risks when negotiating supply agreements, joint ventures, or other arrangements with cryptocurrency mining operators or undertaking the efforts themselves.

First, standard lease forms, as well as the bodies of laws and regulations governing the industry, may not adequately contemplate cryptocurrency mining projects. In other words, they may not account for selling or using flared or uneconomic gas to power cryptocurrency mining. And although the industry has historically been very adaptive to cutting-edge technologies, it takes time for best practices and market standards to emerge.

Second, there are litigation risks from the usual potential claimants: landowners, suppliers, other counterparties, and special interest groups. With respect to mineral ownership, cryptocurrency mining may give rise to potential royalty claims and, as shown below, may also lead to claims asserting breach of lease provisions. With respect to gas supply arrangements and other arrangements related to the operation of wells and mining rigs, there may be potential claims by or against suppliers of mining rigs or related services, such as breach of contract or warranty, as well as potential indemnity claims. There also may be counterparty risks inherent to cutting-edge markets and technologies. Finally, special interest groups, such as climate change activists, may present public relations or even regulatory and litigation issues to the extent they target the cryptocurrency industry and its miners.

A newly filed Colorado lawsuit shows one potential claim a lessee may face in connection with any arrangement they may have with cryptocurrency miners.

Hobe v. Bonanza/Civitas: New lawsuit shows risks

A suit filed in a Colorado state court last month, Hobe Minerals Limited Liability Company v. Bonanza Creek Energy Operating Company, LLC and Civitas Resources, Inc., puts at issue the effect of cryptocurrency mining operations powered by gas wells and the lease provisions for those wells. Its resolution may shed light on the sufficiency of operations to hold oil and gas leases, as well as the interaction between cryptocurrency mining operations and other lease provisions.

Hobe Minerals arises from a dispute relating to oil and gas leases Hobe entered with Bonanza (later operated by Civitas through its merger with Bonanza). Hobe owns minerals in the Denver-Julesburg Basin and Wattenberg Field in Weld County, Colorado. Hobe and Bonanza executed two leases, one in 2015 and one in 2016, which eventually were part of eight pooled units established by Bonanza. Bonanza eventually drilled and produced oil from eight wells on the properties, one in each pooled unit. According to Hobe, Bonanza flared all gas produced from the eight wells and thus did not pay any gas royalties. There was no gas gathering pipeline for the wells.

On July 31, 2023, Hobe filed a complaint in the District Court for the City and County of Denver, Colorado against Bonanza and Civitas, seeking, among other relief, a declaration that its leases had expired. Hobe alleges that after several years of oil production from these eight wells, Bonanza shut them in and began paying shut-in royalties. After Bonanza shut in two of the wells, the Colorado Energy and Carbon Management Commission (ECMC) prohibited Bonanza from flaring more gas from the units and Bonanza proceeded to shut in the remaining six wells. Hobe claims that Bonanza was capable of continuing to produce oil without producing any gas (which would have required either flaring or a pipeline) but it did not.

Bonanza later sought and obtained permits to use the gas in cryptocurrency mining operations. Once Bonanza obtained the permits, it resumed production from the wells intermittently. Specifically, Bonanza allegedly cycled trailers containing the mining rigs among the wells so that Bonanza could produce oil and gas from the wells and use the gas to fuel the mining rigs, which are owned by a third party. Allegedly, Bonanza paid the third party “seven figures” to conduct the cryptocurrency mining operations. Hobe claims that despite Bonanza apparently paying the mining company to take the gas, Bonanza also paid a “de minimis” royalty on the sale of gas to that third-party cryptocurrency mining company in what Hobe characterizes as “an attempt to hide its conduct and lack of production and sale of gas.”

Hobe claims that after Bonanza began the cryptocurrency mining program, oil production from the wells declined by 80% to 96% as compared to the production before the shut in and before the utilization of cryptocurrency mining to dispose of the gas. Hobe also claims that the mining was insufficient to hold the leases and so they expired.

In its lawsuit, Hobe seeks a declaration that the leases terminated due to a lack of sufficient operations and that the cryptocurrency mining operations did not continue the leases beyond the primary terms. Hobe also asserts claims for trespass, an accounting, conversion, unjust enrichment, and breach of contract.

While the allegations recited above reflect only the plaintiff’s version of events, at minimum, this litigation demonstrates that embarking on cryptocurrency mining operations without the agreement of all stakeholders can result in litigation or other legal risks that may often be addressed when drafting agreements or via amendments.

Key takeaways

1. There is an emerging opportunity for oil and gas companies to leverage otherwise uneconomic gas in arrangements with cryptocurrency mining operators to produce a new revenue stream, mitigate environmental impacts of otherwise “flared” gas, or both. But to do so requires strategic evaluation and proper planning to optimize arrangements with stakeholders and minimize legal risk.
2. Current industry form contracts and oil and gas common law and regulations may not yet account for opportunities and potential disputes arising from the intersection of the energy industry and the cryptocurrency industry.
3. The recently filed Hobe v. Bonanza lawsuit in Colorado may be a harbinger of further litigation as lessors evaluate potential claims relating to on-lease cryptocurrency mining.