After oil and gas prices took sharp declines in the latter part of 2014, the following years forced production companies to rethink how their business operated. With tight capital budgets, razor thin profit margins (for the lucky few), and no sign of improving oil and gas economics, organizational efficiency became imperative.
How were oil and gas companies to streamline their operations and somehow generate a return for their shareholders? At some point, even the best hedges from $100 oil days were going to expire. For most, the low hanging fruit in cost savings was the usual: layoffs, slashed corporate budgets, and reduced (sometimes altogether) dividends.
But lurking behind these seemingly straightforward strategies were individuals involved in more creative and sophisticated ways to streamline the modern oil and gas company. Change in any setting has ripple effects that sometimes aren’t felt until several years later. While most people find change unsettling, there are others that see a situation in flux and see an opportunity to try new things, and disrupt archaic traditions; Canada’s oil and gas sector being a perfect example.
Technology is ever evolving. The product lifecycle is short. Just when you think a certain technological concept has zero relevance to the industry that you may find yourself in, the next thing you know it is front and centre in your everyday working life. But then of course, as soon as you become accustomed to this brave new world, some other new fangled technological kid on the block comes around and blows everything apart once again.
Blockchain. Distributed Ledgers. Smart Contracts. For the past few years, these mysterious terms and others have crept increasingly into the media landscape to the point of buzzword territory. But always it seems, these terms are confined to the silos of technology for the sake of technology. At what point, one may wonder, will these things matter to me? To my seemingly staid industry? For the sake of oil and gas, traditionally an industry slow to adopt groundbreaking new technologies, that moment may be just around the corner. With that, enter Calgary based software technology company GuildOne Inc. (GuildOne).
GuildOne is pioneering the application of smart contracts, distributed ledgers, and blockchain technology to the oil and gas industry. But before each is explained, let it be known that the overarching reason and objective for GuildOne’s applications is to help production companies achieve efficiency. In other words, save time and money. Simple as that.
GuildOne recently executed an oil royalty contract settlement and payment transaction through the use of their Royalty Ledger. The significance of this industry first feat is that Royalty Ledger is, in effect, a smart contract. What’s a smart contract? A software program that can execute the terms of a contract. Yes, that’s right, software has crept into the world of automated contract execution.
Royalty Ledger utilizes R3’s Corda blockchain platform to facilitate an oil royalty calculation, settlement and payment transaction. What is a distributed ledger? Essentially, it is a database enabling secure digital transactions without the need for a trusted third party. And blockchain technology can in a way be thought of as a brand name for a Distributed Ledger framework. Think Kleenex for the tissue industry. Blockchain was made famous by cryptocurrencies (a whole other beast) like Bitcoin and Ethereum. A distributed ledger is the bedrock technology that enables the use of smart contracts. The key aspect of distributed ledgers is that once a transaction between parties has been made (one that can only be made with the consent of each stakeholder), the record cannot be tampered with. It is set in stone. Another key aspect is that each transaction can be traced back to the original transaction that established the arrangement between each stakeholder in the first place. Imagine receiving a twenty-dollar bill and on its backside the entire transactional history of the bill is recorded. That is in a sense what a distributed ledger would enable.
For the oil and gas industry, the terms of a royalty contract are agreed on by each party at the outset. That is how things have been done for decades. But complicating contracts is the prevalence of joint venture partners, buy-outs, farm-ins, the occasional freehold landowner (in a majority leasehold mineral right Canada), and the list goes on. When it comes time to pay a royalty out, everyone’s royalty math can be different.
Staffed in the silos of Corporate Calgary are armies of production accountants, analysts, and decision makers that do largely nothing but figure out who gets paid what share of the revenue received from hydrocarbons sold to market. Royalty payouts for the most part are made on a monthly basis. When disputes rear their all too common ugly head, another two or three months of time and money are spent sorting out what went wrong and why.
Royalty Ledger aims to create an ecosystem whereby disputes are mitigated. If successful, once the royalty payment is made between parties (through the software enabled execution of the terms of the contract), that will be the end of it. Time and money saved. Administrative headache gone.
James Graham, GuildOne’s Managing Director, announced the Royalty Ledger proof of concept as part of his keynote address at the Blockchain IoT and Machine Learning in Oil and Gas Conference, which was held in Calgary, Alberta. Royalty Ledger, developed in partnership with NAL Resources Management Limited (the royalty payor), PrairieSky Royalty Ltd. (the receiver of the royalty), and ATB Financial (the financial institution sending and receiving the actual royalty money) is expected to be the first software program, world wide, to execute a smart contract in the oil and gas royalty sector.
So how would the mechanics of this transaction work? The following is straightforward example.
NAL Resources Management Limited (NAL) manages producing wells. Every month the company needs to pay a portion of the revenue received from selling hydrocarbons on the market to royalty owners. PraireSky Royalty Ltd. (PrairieSky) happens to be the largest independently-owned fee simple mineral title royalty holder in Canada. They need to get paid their interest in the royalties they own that are derived from producing oil wells managed by companies like NAL. In between the two companies, is a traditional bank. The bank, ATB Financial (ATB) in this case, stores each company’s deposits. GuildOne serves as the host for the Royalty Ledger software program. Before any royalties are paid out, the terms of the royalty contract need to be agreed upon by NAL and PrairieSky. Once they do that, the terms are codified in smart contract software (Royalty Ledger).
Once that time of the month comes for NAL to pay, the software will automatically ping ATB to send an electronic funds transfer to PrairieSky. And that is it. If there are disputes, either PrairieSky or NAL can see how and why the calculations where made in the software, and then refer back to the terms of the contract to see if there is indeed a breach. Simple.
But why does this all matter? Again, back to efficiency. Royalty Ledger at its core is designed such that accuracy, trust and accountability and can be found in the byzantine landscape that is upstream oil and gas royalty payments. As anyone worth their salt in the Alberta (and for that matter Canadian) energy sector will say, disputes between stakeholders are par for the course when it comes to accurately calculating who is owed what. Alberta’s royalty framework is anything but straightforward. There are many moving parts.
“As an industry, we are suffering through a commodity cycle of low prices,” says NAL’s Chief Financial Officer Keith Steeves. “We have additional competition associated with renewables and an increasing lobby for us to produce products in an environmentally friendly way. This means more regulations and more costs. For us to remain in business as a producer and to become a top producer we must become the low-cost producer and Royalty Ledger helps us do exactly that.”
Mr. Steeves anticipates Royalty Ledger along with automation and digitization of volumetric gathering and marketing information has the potential to save NAL between thirty and eighty percent of the effort it typically takes to get from start to finish when paying out monthly royalties. Royalty Ledger is a critical component to this initiative.
Now it is important to note that Royalty Ledger is still in the proof of concept phase of development. The product has yet to go to market. But GuildOne’s proof of concept importantly shows that yes, the framework and technology do work. And that yes there will be efficiencies gained. Whether oil and gas companies choose to adopt the technology, however, is a different question. For as many have seen in past boom and bust commodity cycles, once oil and gas prices improve, achieving efficiency doesn’t really seem all too important as it once did. For as they say, even turkeys can fly in a hurricane. And although Canada’s energy sector is a long way from being out of the woods, WTI appears to once again be on the verge of surpassing $70. Don’t those $30 oil days seem quaint?