The Exchanges

Q So as you've studied this ecosystem, looking for these little niche opportunities that look like great investments under the theme of something where you feel a lot of things are overcapitalized, where have you looked and found other opportunities?

A We think there's too much capital chasing renewables, and renewables are actually disrupting our grid system. They're causing intraday price volatility. They're causing electricity to be less reliable. That has actually, in a weird way, placed weight on the value of a dispatchable electron. The value of an electron that you can say, I want you on or off, because you can't really tell the wind to blow or tell the sun to shine. So in electrification, for example, we've been chasing weird problem. You'll start to get the theme that all of our problems tend to be a little weird, but the weird problem looks like there's upstream companies that are flaring natural gas. So why does this happen? A lot of times when an operator is drilling a well, that well is mainly for the oil economics. And if the gas is priced too cheaply, there's not enough money in the ecosystem to pay for a pipeline to get it out of there, or the pipeline's already filled. That causes this friction where operators flare natural gas and burn it off. That is a terrible thing. It's terrible for the environment. It's actually terrible for the upstream operators. It's terrible for the mineral owner. It's just one of these inefficiencies of life. So we have a firm, Conduit, that goes to these firms and says, hey, in lieu of you flaring methane, Which is very bad for the environment as well. Why don't we put that methan…

AI assessment note: “we have a firm, Conduit, that goes to these firms and says, hey”

Q What did you learn in your time in private equity that led you to form your own firm?

A It was a small firm, and I was in charge of the land component piece of the business. We owned about a million acres on shore, largely in the Marcella Shale, but some in the Eagleford down in South Texas as well. And I learned about myself that I really liked talking to landowners. I really liked trying to get deals done in this kind of nuts and bolts fashion. I also learned about myself. I don't like complicated financial engineering. I don't like inserting puts and calls and preferred equity and ring fencing debt securities because maybe I'm too dumb to understand it, but I think that it just ends up with misalignment and transactions where everybody thinks they're on the same page, but they end up really not on the same page. And I'm very thankful for that experience for my old firm. They gave me an enormous amount of responsibility very early. And I don't think I could have gotten that exposure at another firm, just in terms of really being in charge of very large investment programs very early on, all the way from the ground level to the CEO and making sure that they were put together correctly.

AI assessment note: “I learned about myself that I really liked talking to landowners.”

Q So for the last decade, Certainly in the public and political realm, there's been a very big shift in ESG movement and how people were viewing natural resource investments. How did that impact what you were doing in your investment activity and then as a business at Grey Rock?

A That's a really great question. So we've been really blessed. Our partners have been phenomenal and true partners. They tend to be endowment foundation, pension, insurance, capital, We started in 2013, roundabout, call it 2018. I had, independently, several partners. They kind of looked like Lauren Messer, or Amy Diamond, or Mike Berry and Christy Craig, or Elisa Maul. And they said, hey look, there's a voice on our investment committee, and they're saying the word carbon. And we're friends. I want you to know this conversation's over before it starts. That actually gave GreyRock a significant advantage relative to other energy firms. By virtue of starting to search for how are we going to invest in the low carbon economy starting in. The ESG pressures at your typical endowment foundation, the vast majority didn't take the form of you have to divest all of your natural resources. It typically took the form of you're not allowed to invest again in natural resources. So our partners were very supportive of saying, Hey, you helped us navigate shale, which was an overcapitalized commodity oil and gas. And typically the average investor in that space got burned. I have the same gut instinct about carbon, that decarbonizing investments are also overcapitalized. Can you help me figure out where we can put money to work? Because they were coming to us with a real challenge, which looke…

AI assessment note: “That actually gave GreyRock a significant advantage relative to other energy firms.”

Q As you looked at supply demand characteristics of different environmentally friendly ways of investing, as you were going down the path to where you ended up with carbon emissions, What are some of the simple math equations that led you to pass on wind or solar or some of the other projects that you see?

A Let's start with renewables. Renewables are overcapitalized, and it's not even close. It's massively overcapitalized. When you look at areas where renewables are built, you're not creating too much electricity. You're creating too much electricity at a certain time. They are time-delimited electrons. So some specific examples are power prices in western Oklahoma are -20% of the time today. They will pay you to take the power. What in the world? That doesn't sound right. Well, if you think about it this way, hey, I'm a Google or I'm a Meta, and I want to be a hundred percent renewable power, but my data center might sit in Illinois next to a coal plant. I'll finance a wind farm in Oklahoma with renewable energy credits or something along those lines, I've cleaned up my power, even though I didn't use those electrons. Not a lot of folks are moving to Western Oklahoma, so there's nobody actually in terms of a demand or load sink for those electrons, and the federal government says, hey, I'll pay you 10 dollars if you produce a renewable electron, and somebody uses it. Well, if there's nobody to use it, then Matt pays Ted five dollars. I get 10 from the government, so I'll pay you five, just find some use for this electron, and it creates negative prices, which is really weird. That happens at high noon in California as well. So that's where I say renewables are a phenomenal thing …

AI assessment note: “Renewables are overcapitalized, and it's not even close. It's massively overcapitalized.”

Q firms moving to Ridgeline gain a decided advantage. That's why customers call it miraculous, game-changing, and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now back to the show. So we take it to a higher level of what the case is on carbon capture. What are the characteristics that make carbon capture something that's attractive as an investor?

A It starts with the purity of CO two emissions. There's three component pieces of carbon capture, capturing the CO two, transporting the CO two through a pipeline and sequestering it. So drilling an injection well and getting rid of that CO two. What is a variable that we really look at is this transport piece. That pipe is super expensive. What we're trying to do is sequester the CO two that comes out of a plant gate as close to that plant gate as possible. The idea here is it reduces capex for pipeline transport. It also reduces the number of stakeholders you have. So those are the component pieces. And then you have to have an emitter who's aligned with you. So those are the component pieces of what makes a good project. I guess that might be a good time to hit on who pays you to do this. How in the heck do you make money doing carbon capture? And it's actually through a tax credit. Tax credit's got a really weird name. It's called 45 Q. Really what that tax credit says is, hey, if Ted goes out and he takes one ton of carbon dioxide gas, and he injects it into the earth, permanently getting rid of it, we'll pay him 85 dollars per ton that he does via tax credit for a period of 12 years. This is an old tax credit. This thing was created under George W. Bush at 20 dollars a ton. Too low of a price to really do anything with. It got increased in price again, 50 dollars a ton. Un…

AI assessment note: “It starts with the purity of CO two emissions... we'll pay him 85 dollars per ton”

Q What are the complexities of the operations of making this work?

A Let's start with, what are we doing? When you say sequester CO₂, really what you're doing is you're taking CO₂ from an emitter, And you're drilling an injection well down into the earth. It goes about a mile into the earth. And what you're looking for is you're looking for geology. The geology looks something like a cap rock, which means an impermeable seal of rock. So you could think of a slate patio or something. You could spray gas at that thing all day long. No gas molecules are getting through that. You're looking for that seal of rock. That portion of rock might be a ten-story building of rock. The earth's crust is enormous. And you're looking for that rock sitting on top of a porous sedimentary rock. If you've ever held in your hands like pumice or sandstone, it has little nooks and crannies in it. The problem we're trying to fight as humans is the CO₂ actually wants to go to the area of lowest pressure. It wants to go up in the atmosphere. It does not want to go one mile into the earth. So we've got to add some energy to it. So we're going to compress that CO₂ and we're going to send it down a mile into the earth. Now think about how heavy one mile of rock pushing down on you is. It's a lot of pressure. Let's go back to chemistry class. What happens to gas under pressure? It's no longer gas. It's actually fluid. That CO₂ is going to flow through that rock. One of my par…

AI assessment note: “you're taking CO₂ from an emitter, And you're drilling an injection well”

Q What was it about the energy space that caught your attention?

A It was probably that I had it wrong. So I started out at McKinsey being solar is the answer. I meant this at my core. I just thought we got to build solar tomorrow, and I'm super concerned, and we've got to get this done. And then getting inside of an actual energy transaction. In this case, we were investing in Marcella Shale natural gas. Getting inside of that and understanding, oof, there are some real trade-offs involved with a one-size-fits-all solar solution. So understanding these butterfly effects that are really complicated. I'll give you an example. What's a butterfly effect in energy? In the North Sea, so by the United Kingdom, they've built out a lot of wind power. And a couple years ago, there were insufficient wind speeds to produce enough power. That means we've got to fire up some natural gas power plants. Okay, so they import natural gas from the Middle East to fire up in United Kingdom power plants. Not a big deal so far. Well, the Middle East still needs power. What do they use? They use crude oil. So in this butterfly effect of the system, you actually have created more carbon emissions. You didn't see that one coming. So we see those butterfly effects of how the energy ecosystem is actually completely intertwined with each other. The energy is like pharma. If you're a tourist, you're probably going to get your face ripped off. And if you don't know a compon…

AI assessment note: “It was probably that I had it wrong. So I started out at McKinsey”

Q So in that initial thesis, what was it? And then how'd you go ahead and implement on it?

A So non-op is really just a fancy way of saying you're a participant drilling wells, and you're para pursue with the operator. So the operator might be a name that you'd recognize like Exxon or Chevron, but it may be a name you don't recognize like an Admiral Permian or something along those lines. And this was the advent of shale. So shale was just a large theme in upstream, a lot of capital chasing it. And our perspective was there was too much money chasing it. It sounds ironic to say, hey, we're going to go out and raise money against a shale investment thesis when our core thesis was shale was overcapitalized, but it was overcapitalized on that operated side of the ball. Really, who's drilling the wells? There was tons of private equity capital available, tons of public equity available, tons of debt options available, and you were overcapitalizing a commodity. What we saw is the opportunity to get our partners into effectively the same geology, the same kind of upside economics, But at a really material discount because nobody was trying to buy that asset. Sounds really weird. And you might say, well, okay, so you're buying maybe a 10% piece underneath EOG. Why is EOG selling you a 10% of their asset at a discount? That doesn't make any sense. So we had to explain to investors just the nature of how these assets actually come together is due to the private mineral ownershi…

AI assessment note: “our core thesis was shale was overcapitalized, but it was overcapitalized on that operated side”

Q So walk me through how you lay out the risk reward of the investment opportunity. So you're putting in this pipe that helps you extract carbon. You're going to get a tax credit from the government for it. How do you think about money in money out?

A A good project in carbon capture might be an unlevered 20 to 30% rate of return might be somewhere around three to six times your money. These are competitive with traditional private equity economics. The weird thing about 45 Q is it's not a supply demand thing. It's 85 dollars a ton. If one plant gets built, it's 85 dollars a ton. If 1000 plants get built, it's 85 dollars a ton. And it goes up with CPI. I like to say in the energy transition, we've all become government contractors. We're all working for the DoD because the only folks that have deep enough pockets to do this at scale are governments. For some sense of scale, the voluntary carbon market. So you're Microsoft and you go out and you say, hey, I'm going to buy X tons for saving this rainforest and offset our corporate emissions. That global market is about three billion dollars a year. For some sense of scale of how big the IRA is, the IRA is about a trillion dollars. It is a tactical nuclear weapon against the energy transition. That's why you're seeing very large firms in red states having very large investment programs against this. So that looks like Duke and Dominion and DTE and Southern Company and Exxon and Chevron and Shell and Air Liquide and CF and Nutrien and Koch Industries and Little Old Grey Rock. When you talk about project economics, our mission from our partners is you have a material impact on ca…

AI assessment note: “A good project in carbon capture might be an unlevered 20 to 30% rate of return”

Q So when you've developed this thesis and clearly understand in the weeds how this all works, how have you gone about implementing that as an investment strategy?

A At the end of the day, at Grayrock, we own a couple of development firms that have their own teams of technical experts, management, finance, accounting, land, geology, et cetera. So those teams are at the forefront of talking to emitters. Several of our portfolio companies we just created, one was started with friends and family money, and we came in and massively capitalized them, let's say. So then they're approaching emitters. Your goal is to make this a great deal all around. You're trying to make sure the landowners make money, the emitter makes money, our firm and investors make money, and that's really what's a component piece of pulling a deal together. So a lot of times these are structured as joint ventures, things of that nature where you definitely want the plant incentivized to stay online. They are financially healthy. So that's really the component pieces is it's a Venn diagram of where do you have an emitter that's emitting Pure CO two. Where do you have geology? That's local landowners that will cooperate and are aligned with you. There's two portfolio companies that we have that work on this vault. 44.01, which is the molecular weight of carbon dioxide and then carbon cycle and vaults really focused on ethanol plants. Carbon cycles really focused on chemicals and natural gas processing. And that's how a deal comes together with an emitter. I had to say, what'…

AI assessment note: “we own a couple of development firms that have their own teams”

Q What are some of the other, say, misperceptions that you see in the space?

A Natural gas. Oh man, people hate fossil fuels. They just hate them. What we try to tell people is natural gas globally has been the largest decarbonization project by far. The United States, by virtue of fracking, has natural gas prices that are just structurally lower than the rest of the globe. They are 80% lower than Europe. That's why you're seeing people like BASF move to the United States. It is actually genuinely cheaper for folks to operate here. When I turn off a coal plant and turn on a natural gas plant instead, I'm at 50% less CO₂. And this is one of the largest decarbonization projects, and there's no carbon credits attached to this thing, there's no IRA, there's no nasty incentives. It just got cheaper to burn natural gas versus coal. And when you look at the delta between, if I move from a coal plant to a natural gas plant, and a natural gas plant to a renewables plant, That first step has 2.5 times the environmental impact. It is still labeled as an evil fossil fuel, but I actually think natural gas is the battery that's going to get all this stuff done. It is dispatchable. It is online. It's reliable. It's cleaner. It does emit some CO two, but I tend to say, hey, look, let's move from a hundred units to 50. Let's worry about the next 50 next. People tend to lump oil and gas. Well, they're used for two totally fundamentally different things. Oil is used for tra…

AI assessment note: “What we try to tell people is natural gas globally has been the largest decarbonization project”

Q So what was that process like deciding to launch on your own and then making it happen?

A When we started Grayrock, we had a thesis focused on natural resources, which is code for oil and gas. It's illegal to call it oil and gas these days. So it's natural resources. It's all been rebranded. We had a thesis around a little niche asset class called non-operated working interests, something most people probably never heard of. I saw a space that was very large in terms of capex that's happening every single year. I saw a space that by virtue of having that background and land, people didn't understand. And then I had that McKinsey toolkit to make a really pretty PowerPoint. That was really it. So really it was about having faith that you had a correct investment thesis, having faith that There was a disjointed and durable structural investable opportunity and understanding that you were going to be able to win for investors by virtue of putting money into that part of the ecosystem. It was a unique investment thesis.

AI assessment note: “it was about having faith that you had a correct investment thesis”

Q How do you manage the business part of that? Because you've put investments in the ground as they come off. Revenues could go away. You've got a team of people that are doing one thing, and now you got to start looking at another thing. How did you navigate through all that?

A What we did was we rolled up the assets from our oil and gas private equity funds and actually did a de-spec transaction with them and created a public company out of it called Granite Ridge. Get at Gray Rock and Granite Ridge. We're excellent at branding. And we were able to take that public in fall of twenty-twenty-two. That actually solved for a handful of things. Number one, that's all for called a fee stream for our employees to make sure that if I'm a traditional reservoir engineer, I'm a traditional landman, you know, not necessarily as plugged in on our net zero thesis, but I still have hundreds of millions, if not billions of dollars of value I need to be looking after as a fiduciary. It also solved for another thing, which is a little bit nuanced for the endowments, which is if you put your CIO hat on, You say, okay, I actually really like the exposure that Grayrock's given me. It's high cashflow yield. It's not levered. It's diversified. It's an inflation hedge. So by virtue of handing shares in a permanent capital vehicle to those endowments, they can actually maintain that exposure at their will. So if they need to sell and get liquidity, that's phenomenal. If it's I need a spot in my portfolio. That's permanent capital exposure to this inflation hedge. You have the option of doing that. I still see things as super rosy on upstream. This may sound like I'm talking …

AI assessment note: “we rolled up the assets from our oil and gas private equity funds and actually did a de-spec”

Q How did you go about the process of finding that niche?

A If you phrase a question in the right way, that's 90% of the answer or something like this. It starts with us writing down, there's a real problem here, and it looks like X, Y, and Z. I tend to be a nerd, so we write pretty in-depth quarterly letters that are effectively energy surveys. Here's what's going on in the entire energy ecosystem. And I mentioned that these things are interconnected. Really what you're trying to find is where is there a durable dislocation? There could be dislocations in energy, but they might last 90 days or something along those lines. Where is there a durable multi-year dislocation? That takes a lot of study. There really isn't a shortcut. You're going to spend hours reading, talking to people, looking at transactions. Losing almost all of those transactions, by the way, the best thing to be in energy is cheap. So that's really what we do is we're very diligent on trying to find dislocated energy opportunities that provide great full cycle returns for our partners. That includes entry cost. There's this concept of half cycle. How much does it cost to just do a project? And then there's the full cycle. What do I have to pay to get access to that project? And that's where a lot of people lose in energy.

AI assessment note: “You're going to spend hours reading, talking to people, looking at transactions.”

Q If you look at a single one of these projects, how do you think about laying out probability distribution of outcomes?

A When you're analyzing one of these projects, there's effectively a handful of component pieces you need to worry about. From an operational perspective, you need to worry about things like what is the capex to drill well? What is your cost to lease landowners? What's the OPEX to power the compressor to send that CO two down hole? What's your power costs there? What's the royalty rate that you got to pay the emitter or what's the deal structure there? Those are all important, vital underwriting things. And then I'd say there's the idiosyncratic. Does this law get repealed? Does the law change? Does a spill happen? Theoretically you're saying they don't happen, but there's a good friend of mine, John Cox says, risk is the price you never thought you'd pay. So be ready for it. Those are the component pieces of underwriting, and then really at the end of the day, you're taking technical expertise on geology and candidly whether or not that rock can support that volume of CO₂, or if you need to go to a different rock, and that will drive a lot of your unit economics on these in terms of how far does the CO₂ need to go. We were looking at an ethanol plant. Great ethanol facility, but it's bounded by a river on one side and a town on the other. Do you want to build a CO₂ pipeline under a river or through a town? So that's the thing that deprioritizes a project, is to say, it's not imp…

AI assessment note: “there's effectively a handful of component pieces you need to worry about.”

Q With the broader energy transition investment opportunity set overcapitalized, how do you think this plays out over the next five or 10 years?

A I tell investors, despite the fact that we raise money in the energy transition, I'd argue vehemently there's too much money in the energy transition. It's just concentrated in the hands of very large funds who can't get out of bed without writing a billion dollar equity check. What our goal is, is to try to build seedlings for those platforms to eat. My hope is that LPs don't get burned in the energy transition, because I think if they do, it sets us all back on what's common goal for everyone. I think that you're going to see government stepping in and creating more and more policy. So the United States under the IRA has picked a carrot strategy. We're going to reward you for behaving in a way that we want you to behave. Is there a stick strategy down the road? Probably. Look, the SEC is making people measure their emissions. Scope one, scope two, scope three. When the government's asking you to measure something, I got news for you. That thing's going to be taxed. That thing is going to be taxed at some point in time, which is a whole different revenue source for the energy transition over time. I think that there will be low hanging fruit to achieve in the energy transition, but I think it'll take decades. This is not something that's going to happen overnight, especially when you consider things like energy equity. The impact on raising people's energy prices too fast. Bil…

AI assessment note: “I think that you're going to see government stepping in and creating more and more policy.”