29 Mar NFTs And The Oil And Gas Industry
A non fungible token or NFT for a digital work of art sold recently for several million in crypto currency, which raises the question of how NFTs might apply to oil and gas.
Why We Collect Things
I was dusting the mantle over the fireplace this week (because in the lockdown I’m using my time wisely). A year of general household malaise have allowed the dust to settle in a thick and depressing layer, and it was long past time to deal with it.
Our mantle is where we have a collection of stone carvings from our various travels, and as I picked up each one to give it a wipe-down, I felt a slight twinge of nostalgia for the time when we purchased these pieces. This one was from a trip to Iqaluit when we almost got lost on the ice floes, and that one is a rescue from the basement of an art gallery in Calgary, and that one was from a one-eyed jade carver from pre-handover Cat Street in Hong Kong.
Of all species, humans have a curious fascination for the unusual and the exotic, and many among us are great collectors of things. Collecting starts very early in life, with Barbie dolls, beach glass, stones, Lego, and Pokémon cards. Generations have their collections—I once collected postage stamps, and baseball cards, but my mother collected tea cups and cranberry-coloured glass. It should be no surprise that today’s generation, the digital generation, will collect digital things.
And sure enough, a recent news story caught my attention this week as a digital artist sold a montage of his digital works at auction for $69m in cryptocurrency, in the form of a non fungible token, or NFT.
Let’s break this apart, beginning with the term fungibility.
Real Fungible Assets
An asset that is fungible has a perfect substitute of the same value. A 20 dollar bill can be exchanged for another 20, or 2 tens, or 4 five dollar bills, or 20 ones, or 200 dimes, or any combination of bills and coins that adds up to $20. Gold, casino chips, and a company’s stock certificates, are examples of fungible assets.
As commodities, petroleum products like gasoline, are fungible. Your gasoline-powered car can accept fuel from any gasoline station, regardless of the brand of fuel or where it was made. Methane and propane are 100% fungible. The burner tip in your furnace doesn’t care whether the methane originated in Canada or in Australia. Every molecule is identical.
Crude oil is sort of fungible. Not all crudes are alike because crudes vary considerably in their chemical composition and specific gravity, so one barrel of crude cannot be readily substituted for another in all instances. Traders compensate for the lack of perfect substitution by grouping crudes into grades, and agreeing a price differential between various grades.
The oil industry is just one huge exercise in taking a non-fungible asset and making it thoroughly fungible and available to the widest possible market.
Fungible assets conveniently have quantifiable values that readily enable transacting. I can easily convert my $20 bill into rubles, gold, casino chips, or bitcoin.
Real Non Fungible Assets
Assets that are non-fungible have some unique characteristics that make them non-substitutable for other assets in the same asset class. The stone carvings on my mantle, art work in general, and buildings are non fungible assets. I have a house and Michael Jordan has a house, but they’re not even close in value.
Oil and gas wells are non fungible assets in the same asset class, but they are not substitutes.
Digital Fungible Assets
Fungibility extends to the virtual world too. Digital fungible assets include crypto currency (one bitcoin can be swapped for another bitcoin), and loyalty points. We probably don’t realise it, but we are all merchandising in fungible digital assets as collectors of AirMiles and PetroPoints.
Digital Non Fungible Assets
Which brings us to the curious asset class of digital non fungible assets, which can include trade marks, digital art, software code, videos and movies, ring tones, GIFs, memes, digital land in video games, digital weapons, digital makeup and virtual costumes. Did you ever imagine that these assets would have value?
In 2019, I visited the Rijksmuseum in Amsterdam and was surprised to discover that the Museum encouraged you to take photos of the art collection with your phone. My photo of a piece of their art is not a substitute for the original and the value of the original is not diminished because of the existence of the photo. In fact, the photo might encourage others to visit the Museum for themselves.
The twisty bit about non fungible digital assets is that they can be infinitely and perfectly copied (unlike my imperfect photo of famous works by Rembrandt), and until now, we have not had a mechanism to distinguish the copies from the original.
Non Fungible Tokens
That’s where the token comes in. The token is a certificate of ownership for a non fungible asset that is stored immutably on a blockchain ledger. The non fungible asset can be real (such as real estate), or digital. The token can then be bought and sold, like other assets, and through the power of smart contracts, new functionality can be delivered, such as limiting the number of copies to be made, or building an expiry date, or linking to other digital assets. The token lives on one of the many blockchain databases out there, meaning the asset owner may not need to stand up any proprietary infrastructure to bring an NFT into existence.
NFTs can play a disintermediation role. Via the blockchain database, the buyer and seller can connect with each other without the services of an intermediary (such as a gallery in the case of art).
It’s at this point that you probably say “I don’t get it”.
From a collector’s stand point, the part to “get” is whether you believe that the first instance of a non fungible digital asset can retain value for a collector, even though the digital asset can be infinitely and perfectly copied. The answer is probably yes, if there are collectors who, for whatever reason, believe it can.
From a business stand point, the part to “get” is whether you can imagine creative ways to monetise intellectual property beyond licensing a copy, selling the rights, or using the services of an agent.
Applying NFTs in Oil and Gas
For an industry devoted to turning non fungible assets to fungible ones at scale, it’s probably not obvious where there might be a role for NFTs. But like many technologies that come first to other industries, NFTs will eventually find a home in oil and gas. As usual, it will likely take a little longer for the industry to catch up.
Here’s a few examples that I think could be realised:
Engineering designs are instances of pure intellectual property. The designs exist only in software, as a collection of data, that working in tandem with the software, yield diagrams for making mechanical things. Examples include instructions for 3D printed objects, designs for refinery processes, or process models for carrying out some specific transformation. Engineers working in oil and gas are constantly inventing new ways to improve yields, reduce waste and energy, debottleneck processes, and all of these efforts result in fresh content.
The content could be recorded as an NFT and with smart contracts, the use of the content could be licensed in new creative ways (such as on a per unit basis, or subscription).
A novel business model supported by software is a non fungible digital asset. Using a token to hold the original design and code creates the possibility of fractional ownership of the token. This can unlock new mechanisms for the funding of novel business ideas and concepts. For example, a service company wants to create a cloud-enabled machine learning solution to minimise methane venting on gas wells, and tokenises the algorithm, enabling investors to own a share in the algorithm. Green financing may come to the industry.
If there’s one thing oil and gas has in abundance, and growing every day, is data. Data assets are non fungible and digital, and thus have tokenization possibilities. For example, much subsurface data is unused and unexploited because the industry lacks the resources to tackle it all at once, and devotes its limited precious resources to only the most promising plays. The balance, likely 80% or better, could be auctioned using NFTs for crowd sourced analytic purposes.
As usual, new technology, or in this case, a 12 year old technology with a relatively new use, has its own limitations and considerations. The regulatory environment needs to catch up with the digital natives. Smart contracts are neither smart nor are they legally contracts, and in many respects must still be tested in litigation. Non fungible digital assets create valuation and taxation questions, not to mention questions of ownership succession, inheritance and eventual disposal. How do you insure a non fungible digital asset? In which jurisdiction should you register a non fungible digital asset?
Watch this space.
As usual, it’s the digital natives in the creative space that found the way to monetise an infinitely copiable non fungible digital asset, but I expect the oil and gas industry to figure out how to use NFTs in the real world. Meanwhile, I’ll be dusting the mantle, admiring my collectible non fungible real assets and contemplating if this blog site could be structured as an NFT and sold for millions.
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