Bret Kugelmass
So we are here today with Brooks Klimley, who's an Adjunct Professor of International Affairs at Columbia University, and also the president of his own consulting firm as well. We're here to talk today on the topic of project finance. Brooks, welcome to Energy Impact.

Brooks Klimley
Thanks very much. Glad to be here. I look forward to the conversation.

Bret Kugelmass
So let's just get started. First, by establishing who you are, what's your history and career been like? How did you ever even get into the finance world at the very beginning?

Brooks Klimley
That's interesting. I went to Columbia as an undergraduate, and then spent a couple of years in England studying for a fellowship, came back I was going to go to law school, got married, and decided maybe I'd better get a job. So at that point in time, this would be early 80s. I, you know, looked around, talked to a bunch of banking firms and joined at that point Chemical Bank, which is a predecessor of JP Morgan. And at that point in time, the energy business was, you know, evolving very rapidly, you know, post OPEC, you know, things that historical norms in life were being unwound. And so I came off the original training program, thinking you were going to go work someplace, and I decided that the energy business was probably about the most interesting one out there. And it's very different, because the assets are different, the way people look at it is different. And so I sort of raised my hand and said, I'd like to join the project finance group, which is this very sort of esoteric, special, special realisation, and they've never taken a junior person. I said, I get it, you know, if it doesn't work out, I understand. And it was just kind of the right time to be there, because you had one of the first big oil crashes. And Bob Horton of BP came out, well, the price has gone $5. And I inherited sort of these boxes of documents of all these project finance loans, which I knew nothing about. But somebody had to kind of muddle through it and figure out, you know, what's actually going on, and you know, what recourse is there like and I had some fledgling knowledge of this thing called a personal computer that was new to the scene. And so I was able to model up things. I mean, this is about as rudimentary as you could be, but it was pretty clear. Err, that the banks have taken positions based on, you know, very technical analysis of oil and gas reserves in the North Sea, and this very elaborate tax code that will allow them to get very comfortable with the cash flows from the reserves and not worry too much about, you know, the entity that was taking the data center. So, drill non recourse, project finance, acid based, very granular analysis,

Bret Kugelmass
Can you double click on that for a second, non-recourse? What does that mean, in the project finance world, the term non-recourse?

Brooks Klimley
So when you think about a project, you're actually as a lender, you're lending into an entity that would, that is ring fenced, it's closed in and of itself, so it can be owned by someone, but you don't have recourse to the owner. So take an oil and gas project, or a mining development project,

Bret Kugelmass
And what is recourse even?

Brooks Klimley
That's actually who you can pursue the credit with, if you will. So it's a if it's if there's a balance sheet obligation on an energy company, and it's directed to a project, but it's recourse to the parent that if the project doesn't work, lenders can go back and say, okay, I'm not coming to the company itself, I have recourse credit standpoint.

Bret Kugelmass
So recourse means a way to get your money back, you know, you invest in something and you want to be able to if something goes wrong, be able to salvage something out of it. That's what recourse is.

Brooks Klimley
Exactly, it's what you can go to above and beyond the investment you made in the project itself. So when you think about projects, the reason the banks are comfortable with them is there's a tremendous amount of technical diligence, tremendous contractual review, to make sure that the environment of the state below the federal level, is all in place, contracts with the off take, contracts with the inputs, and then they're very comfortable saying, okay, based on these contracts, including most importantly, which is the EPC contract, that is, big engineering firm will stand up and say, I will deliver this project on time, on budget and on spec. With all that in place, the banks are comfortable that they're taking risks that they know are either laid off to somebody like the engineering firm, or that they can get their hands around.

Bret Kugelmass
Okay, and you mentioned three terms there that I want to break out a little bit further for our audience. You mentioned offtaker. And the offtaker is who is saying that they are going to purchase power from you. They're off taking the power, they're taking it off your hands, they're buying electricity, essentially. And that could be a utility, or it can be an industrial customer. That's an off take. And then you mentioned input. Input is like a fuel source, right? So I'm buying oil or diesel, or whatever else. Biomass stuff, you know, that's, that's the input. And the worry there essentially is that input, as we all know, oil prices go up and down, gas prices go up and down, that price can go up and down. And so that's why the contract for the input is important to mitigate some of the risk on what your fuel costs are going to be.

Brooks Klimley
Right. Now, the way to think about it is banks are interested in determining a cash flow profile that looks pretty consistent over time. That's the whole game, because the more volatility is, the more risk there is. And remember, the banks, they have no upside, right, they get paid interest in principle on time, that's their upside, that's the best they can do. You know, if you're an equity player, on the other hand, then you can assume a lot more risk in pursuit of a lot more upside. So with the project finance, in particular, what the banks are trying to do, and it is a bank market, by and large, is trying to codify well, to identify dimension, and then allocate the risk in the best way possible in order to get the longer longest term stablest cash available for debt service. And then they say, okay, I have some coverage ratio, and that will be comfortable. What goes into that is very elaborate, because not only do you need inputs, in the energy business, you physically need the inputs, you also need the price of the inputs, right? So one of the things we always and there's a great case I teach, which is the Law of Murphy's Law, anything that can go wrong will and it's fun, because students are like, oh my god, how can that happen? Is it well, in this case, you know, there's a mine that was gonna get built, but it wasn't built. And it was a coal fired power plant. And by the way, not only was it not built, but the guys who were building it didn't actually have all the experience of building it. And by and large, even above that, they didn't have the money to build it. So you know, if you read the offering memorandum or everything it's fine, we got the you know, the coal's there, etc, etc. But at the end of the day, and in that case, you know, everybody kind of missed the fact that the mine wasn't actually built in the the financing for the mine wasn't actually in place. So you couldn't assume that this amount of coal, the spec was going to be at the plant in the timeframe.

Bret Kugelmass
I see. So people were looking at the project from the building of the coal power plant side, but they didn't go all the way upstream to double check on where the fuel is coming from and to see if all the infrastructure was in place to support the input that the fuels were actually right.

Brooks Klimley
And so there was a coal contract, it hadn't quite been signed, that's a red flag. But when you really dug into it, it's like, yeah, but these guys were small coal miners, and there was a reserve there, but they were going to double their production, who knew that they could do it? You know, technically, if you will? Probably not that big an issue. But more importantly, where's the money coming from?

Bret Kugelmass
And isn't there? Like shouldn't there be a, like a checklist, you know, like, pilots have like a pre takeoff checklist, you know, make sure that, you know, the wheels are, you know, pumped up? Like isn't, shouldn't there be like a project finance checklist where it's like, make sure you know, the mine is built.

Brooks Klimley
The lenders are very sophisticated about this, you know, as I say, the thing about project financing is, you know, you're financing a development project. So there's, there's basically dirt when you start, and there's a library full of contracts. And those contracts are meant to establish both the physical and the financial volumes, if you will, and flows. And so normally, there's a tremendous amount of work that goes into these things in terms of articulating the specs, etc. As I said, the EPC contract, you know, I can't build

Bret Kugelmass
An EPC just to break that out for our audience, EPC stands for engineering, procurement and construction. This is like an engineering firm that will serve as the general manager of all the things to get a project physically built.

Brooks Klimley
So there's lots of offshoots in terms of operating ladder. But basically, the EPC contract, do you want one of the big engineering firms with a credit rating? These are all big engineering, Siemens, Bechtel are sort of the big ones. And you want them to step up and say, yes, we're gonna provide you this, you know, 2000 megawatt coal fired power plant with this heat rate at this time for this cost, period. And then there's obviously, negotiation around the size. But for lenders to move forward, they want to be sure that that EPC contract is with a credit worthy party, and covers time, specs, and cost. And they don't want to assume a lot of that risk. All right. So that way, there will be provisions for cost overruns, and sharing, etc. But basically, at the end of the day, if you think about the lender, they want certainty. And the one thing they really want certainty is this thing can be built on time for a price and have the specs that match. And so any variance that goes in this case I teach, there's obviously a new technology, and everybody thought it was going to work if it didn't, you know, they're gonna want assurances for that. And then the contracting company, you know, it should be, you know, the more technical risk there is, the more there's going to be negotiation around what the actual terms of that EPC are.

Bret Kugelmass
And what is a common type of assurance, when you're dealing with a riskier project, you know, you're bringing in a new technology and they need some extra assurance, what form would that assurance take?

Brooks Klimley
There's a couple of different ways you can do it. One is you have undertakings by the contractor then if there's outright money, you know, money good guarantee that this thing will be there, that's fine. The banks will certainly accept the credit risk. There are provisions that in case of cost overruns, who actually picks them up. There are at the same time liquidated damages, if the project isn't on time, is delayed, the banks will have insurance at the same time. So there are various mechanisms that are trying again to allocate the risk to those parties that can bear it the best.

Bret Kugelmass
And what is a liquidated damage is that like if everything goes up, you have to sell all your physical stuff liquidated and get some money for it. Is that liquidated damage?

Brooks Klimley
Oh, well, it's not actually quite that because you don't want to, the banks can assume the project as well because they'll have all these contracts that are conveyed to the banks in the case of fault. But what liquidated damages are, say you're not done yet. You know ought to be done and this will be completed as of this date for this price with these specifications and specifications are important the heat rates are important in a power plant. If for whatever reason, you're not there, then you sort of go into this position where liquidated damages, say, okay, if that's not done, then the contractor will pay into the project liquidated damages of X dollars a day or some mechanism.

Bret Kugelmass
I see. So it's kind of like a financial penalty, if you're not keeping up to the terms that you set forth in your original contract.

Brooks Klimley
That's right now, it's never gonna get, you know, the, it'll be kept at some level, because the contractors don't want to give an open ended. So that's a negotiation. But it's, it's sort of the first line of defense to make the project money good at that

Bret Kugelmass
I see. So this is a form of like incentive structuring to make sure that the developer or the EPC, they're acting to the best of their ability.

Brooks Klimley
Yeah, and there's a real risk. I've been involved with, you know, look, like a very straightforward development project. But it was a technology that was not new, but new ish. And, you know, it just didn't happen. And so then you get this discussion about, okay, whose fault is it? Right? It's not the owner. Because in this case, the contractor said, we will build this plant for you at this time, for this amount of money, liquidated damages only goes so far. And then you get into, okay, what are the terms of the contract and, you know, litigation, etc, we can start to say, okay, who's going to clean up, you know, this very unfortunate situation, in this case, if it's just a matter of time, or weeks, or you know, something happens in the, you know, system of, you know, supplies coming in, or something that can generally be worked out construct?

Bret Kugelmass
And you mentioned, not new but newish, can you kind of walk me through from, like, the eyes of a bank or the eyes of a project developer, what is yet the range of like innovation that is permissible in new projects, like what's a standard cut and dry project, and we're then you toeing that line, and then wherever you go on into, like, this is a totally new technology.

Brooks Klimley
A lot depends on what part of the energy spectrum you're talking about, let's say in power. There are various technologies developed over time, you've been building coal fired plants for a long time, not for a long time, and we built one. But there can be some new technology in terms of the burn, carbon emissions, etc, better technology, things that are a variation on a theme, and the contracting partners probably gonna feel pretty good about stepping up for that. I think the banks are gonna, you know, the banks don't want to assume any technology risk, per se, you know, it's kind of like the oil and gas business. The analogy is, if you're drilling a well, and there's 1000 wells around, and all of which we have all this great data, all of what you're producing for a long time, you know, it's pretty easy to say, okay, I anecdotally, I think this is going to perform like this. That's really good. Yeah, in absence of that, you know, a run of the mill technologies, okay, it's been done 1000 times these guys did it, they're credit worthy, that's gonna be very comforting. If it's a variation on a theme, it's still different. And the banks don't want to assume a lot of that risk, because they have the risk business, you know, if you're gonna assume that risk, say, okay, I've got a little technology play here, then I'm gonna, you know, I'm much more of an equity investor.

Bret Kugelmass
I see. So back to your earlier comment, you know, the banks, they get all these special privileges, they get these assurances, they, but they also, and they, they don't make as much money, they have a very fixed amount of money that they're going to make if the project is successful, and they don't want to take a lot of risk. That's, that's on the bank side. But the advantage of getting money from a bank is that the cost of that money is less relative to what you would pay an equity investor. Is that correct?

Brooks Klimley
Oh, far and away and even more than just an equity investor who's looking for a much higher return. There are, you know, innumerable situations that you can say for take a small oil and gas company probably isn't particularly credit worthiness, certainly in today's world, to a bank and on a balance sheet basis, would I lend BRAC oil and gas $100 million, so he can go develop answers based on his balance sheet in his credit, goodwill and handshake and the answer is, maybe not in today's world, definitely not. Historically, the banks however, have said, what I will do is I will lend money secured directly by the portfolio of oil and gas assets that BRAC controls. And so there's this thing called an engineering report and a professional engineer goes in there. This case Ryder Scott, evaluates the data, evaluates the history, evaluates all the geology and geophysics and says, we think these reserves are going to produce along this level. When you discount all the cash flows back in the bank say, great, I'm secured in that I feel very comfortable. Because the buyers are going to be there, the costs are established based on precedent. And I'm probably either directly or indirectly going to hedge prices, in which case, I'm willing to lend not just some money, I want to lend more money to the secure basis. Like project financing, where you're lending, nothing to start off with, you're lending to a bunch of contracts, I'm willing to advance more money there than I would do the owner of the project himself on a balance sheet basis.

Bret Kugelmass
I see because nothing is perfect. But banks have a lot of money and they spread the risk across many different potential projects, just in case some perform some don't perform, is that right?

Brooks Klimley
But the real, the real thing is, if you're secured, and you're in a project where nothing can come outside that project, right, you're you know, so the dividends come out everything that operates in that project, that's you, and you're first in line to the cash flow. I said, so you say, okay, if I'm first in line for my cash available for debt service, and I'm comfortable that I've addressed dimensioned and allocated, the risk on top price inputs, outputs, you know, environment, all that's going to be taken care of, well, then I want to lend, you know, and it again, it depends in particular on what your offtake agreement is, but if you have a, you know, a take or pay contract, right, with a credit worthy call, you don't take or pay contracts, you know, with a credit worthy utility, the banks will be great, you know, I've got single layer double a risk for my revenues, I'll end, you know, 70-80%.

Bret Kugelmass
So you mentioned this concept of first in line, so walk me through that a little bit more. So a project, you know, takes in money, it builds something physical, and then the engine starts humming, it's producing energy, someone's paying for that energy. And then based on the money that comes in, now, whoever owns that project has to start paying back out money to all the people who lent him money. And the bank, because they're offering you know, these better terms on their loan are first in line to get a payout. So if there's, let's say, your $10 million a year that's being paid out to all different types of investors, and you know, the bank is entitled to 5 million of that. And maybe that one year, they only produce 8 million, the bank still gets its 5 million, and the next guy in line doesn't get his next 5 million. Is that right?

Brooks Klimley
That's exactly right. And the way it works is there's money that flows into a project. So there's debt, and there's equity. And let's say in this project contract, and it's, you know, relatively straightforward. It's a CCG,

Bret Kugelmass
Gas plant, combined cycle gas

Brooks Klimley
Exactly right. So lots of technology, it's getting better being out there, and you've got Bechtel is going to build it for you, and someone's gonna off take it. So the bank says, this looks pretty good. You know, we've seen it before, very comfortable with the guarantees from the EPC contract, we know we've looked at all the permitting, all the local laws, we understand where it is, how it operates. And we understand that we're gonna be selling it to a credit worthy party, the power, so we're not taking merchant risk, if you will, merchant risk being selling a commodity into the grid

Bret Kugelmass
Into a market where the prices may fluctuate.

Brooks Klimley
That's exactly right. And hold that thought for a second. So we got this great project, everybody's in the bank, save your money, good, we'll lend you 70 cents on the dollar. So 70 cents of debt goes into the banks, its senior secured, right on top of the heap, nobody can get to, it's the highest part of the capitalization in terms of credit perspective. And it may have some depth below that subordinated and then you get to the equity, which is waiting outside the ring fence for any kind of return. So you got to go through what's called a waterfall. And literally, you negotiate this waterfall, and it says, okay, there will be revenues from the project, price times volume, it goes in. What do you do? You have to pay your operating costs. First, you have to pay for, you know, anything to keep the project alive. You have to pay your interest, have to pay your principal, then there'll be a series of provisions that the banks will require, like a debt service reserve that says, hey, if there's little extra money, and in the early years, let's put that away for a rainy day and that'll come out of this waterfall. It literally is a waterfall, just watch the money keep flowing down. And then you say okay, projects, their reserves are funded, etc. interest in principle, the bank's number one interest first, then principal. Then if that's all settled up, then you go down to the subordinated debt, say okay, interest on the subordinated debt, right principle probably going to be way out in the future. That goes well. Then you go and get down to the bottom and say, I like to say what's in the cash register at the end of the day, then there'll be some permissions that it can or can't be dividend out to the equity. And the equity is the last guy in line. Right first guy in line is the banks, and they're looking for their interest in principal.

Bret Kugelmass
And who comes in for subordinated debt? It sounds like they're not getting as good a deal as the primary debt lender, why would they get in on the deal?

Brooks Klimley
Well, it's, uh, you know, it's like anything, it's all about risk and reward. So the banks are gonna get, you know, a floating rate a lot more plus two, or three or some number and those markets change, but not get a return, that makes them fees upfront, and they'll syndicate the loan. So this is their business and they're very happy with it. Beyond that is, okay, if we need more capital, you know, the equity returns are going to be really high. If there's a, think of it as an infrastructure investment, so we're not taking a lot of market risk. This is new esoteric stuff, we're not drilling up the next gray shale play or anything, we're basically building a power plant that's going to produce electricity and sell to local utilities. If that's the case, then you've got infrastructure investors that say, hey, you know, I'm first I'm a fixed rate player, I'm not a floating rate player, like the banks, and I'm looking for, you know, double digit kind of return, maybe with little upside if things work out. But I'm willing to put in, you know, subordinated or preferred stock or some junior security, because that kind of return to me is pretty good. I'm feeling okay, then I've got the risk perspective, that my 10% return will look great. Or if it's got some kind of a kicker,

Bret Kugelmass
How is subordinated debt then different than an equity player, if they're looking for a higher level of return, but also willing to take on more risk,

Brooks Klimley
Big difference is in a debt security, in the case of a, you know, institutional piece of warning will have interest in principal payments made, and if you don't make it your default, is, okay, if you go down to preferred stock, which is sort of almost a hybrid, you have a designated payment to be made. But you know, if you don't make it you can accrue, so it's more equity in that standpoint, that you don't collapse and go bankrupt, right?

Bret Kugelmass
I see. And so they get even higher interest rates.

Brooks Klimley
They should but also there's some tax stream, but they'll also in equities case, you know, you can take your dividend out, or if it's actually still in the company, and the company grows more quickly, you want to, you know, kind of hone the equity over time, that's compounding that much more quickly, you know, it's growing, if you will, you know, nobody wants a dividend from Amazon. Everybody wants to see, you know, another 300% of growth. Right. And then banks, oh, by the way, you know, the only thing they're gonna lend to an Amazon is, you know, the receivables of the inventory or the, you know, the data center, and it's secured in some fashion.

Bret Kugelmass
Got it. So, okay, we've been talking a lot about, you know, the basic structure of these projects, which has been amazing. Tell me just more about this type of stuff you've been involved in through your career, is it primarily energy related infrastructure,

Brooks Klimley
I worked on Wall Street running investment banking businesses for the likes of Kidder Peabody and Citi and UBS and others, Bear Stearns for about 25 years, and I was in the private equity business for about the last five or so. So most what I have done is really more in the public markets. So dealing with, you know, stocks, bonds, convertible securities, wherever, which is a hybrid security, which has a debt instrument, but also an equity play. And then I started off doing project finance purely in a bank. What's happened in the energy business in energy businesses, you know, as I tell students, it's the largest business in the world's most interesting, its most complex. And it does have these very articulate financing strategies developed because you finance the assets themselves, right. And so, you know, leveraged buyouts became a notion where every guy in the oil and gas business is taking his net worth putting a hole in the ground secured by, you know, revenues from that. Well, bootstrap finance is kind of the background, the LBO, all the securitizations that you've heard about CLO, CM, CBO, CMOs, it's really a perfect reserved baseload energy business. You have that reserve report, it tells you what the expected production is, you have a view on price. So you hedge, you know, what the costs are the development costs. You sit down, make a bunch of adjustments and metrics to constrain your risk from different perspectives. And then you say great, that's, you know, Alinea 70 cents on the dollar or whatever. That's kind of you know, securitized financing. So that all comes together the markets themselves, you know ebb and flow, as do energy markets. You know, we like to say, when they're good, they're too good when they're bad, they're too bad. We're now right now, it's, it's very interesting because in the upstream oil and gas business, in particular, the drilling side of the oil and gas business, there is tremendous pressure from both institutional investors and equity owners to reduce carbon emissions in general, but to if you're if you're a money center bank, historically, those reserve base loans have been a big part of your business, you're under pressure just to reduce the aggregate outstandings. And what that's led to is real drying up of capital, especially in the shale plays, and, you know, the shale plays were go go, and it's remarkable what's happening United States in terms of production,

Bret Kugelmass
Well, the last 10 years,

Brooks Klimley
The great story is a step back, there was a shell engineer named Hugh Bear in 1958. Or so he came out with a theory that's called Hugh Bear’s Theory. And it basically says that for any natural resource reservoir, there's a production curve that's basically bell shaped. And it's a finite reserve. And so you, you put money in and capital goes in, and production will go up. And then ultimately, it'll just come back down, because it's a finite reserve. And he plotted this curve, and he predicted in the late 50s, that the US would hit peak oil production, I think 1970 1974, the US produced a little over 10 million barrels of oil a day. By 2008, the US produced less than 5 million barrels of oil a day. And then you discovered the shale? Yeah. And so at the beginning of last year, we actually, as a nation produce 13 million barrels of oil a day. Wow. Yes, the largest oil producer in the world, as well as the largest natural gas producer,

Bret Kugelmass
Because natural gas is found in the same places as the oil

Brooks Klimley
It is the same, yes. But they never, you know, historically, gas prices were regulated, it was known as a byproduct, nobody wanted it. Nobody knew what to do with it. It wasn't all pipeline infrastructure. So if you drill an oil well, and you find some gas, that's not so good. What's happened is, the gas business has just exploded. And it was really the forefront of hydraulic fracturing or combining hydraulic fracturing with horizontal drilling. And so reserves production, the United States, it's unparalleled, what's happened, and then that technology and kind of morphed over the oil side, and it's been easy, is as pervasive. So now, we're able to produce all this. Hugh Bear was wrong. And the reason is that we've always known that the reservoirs had these reserves in them, the shale, you know, people think about, there's a great analogy, when you drill conventional wells versus shale wells. So conventional wells, it's kind of like drilling into a jelly doughnut, right, you get in there, and you stick in the middle of your vertical here, and then you get all the jelly around the hole, right. And you know, you perforate your wellbore, and then all the jelly comes in and goes up. The shale plays are much more like tiramisu. They're a series of strata, right? And these different plates, and rather than drilling in the middle, and then pulling the jelly out, you actually come down, you know, seven or 8000 feet, and you turn sideways. And, as I like to say, Antero, where I'm on the board, you know, we drilled 15,000 feet sideways in one day recently, wow, that's three miles underground. And so you can imagine, when you're going this way, the strata that you're in can be a whole lot less robust or large, because you're perforating and all the way along.

Bret Kugelmass
So the change in technology in, you know, the, you know, around the 2010, a little before the 2010 timeframe, around 2010. Changed the economics and the interest in different types of, you know, land that maybe wasn't as useful before, but also the fuel supply. All of this shifted, led to rapid growth of this industry, and shot up the US economy in many ways. But now things are different and things are slowing down, you're saying you're saying it's harder to get capital, it's harder to invest in new projects.

Brooks Klimley
And there's really two big drivers now when you discovered the shale, the model was go drill it and so that engineering report that I talked about, the banks have always led against the proved reserves. Different categories proved developed producing, it's actually coming out proved undeveloped as we know it's there. We know we can get it, it's gonna cost some money. And so banks will discount the PUDs more than the PDPs. When the shale came around, there was no current production because it was all new. So you couldn't finance just the PDPs. With the PUDs, you had to kind of get out a little bit and say, okay, that is probable reserves.

Bret Kugelmass
Sorry, what are those two acronyms that you were saying PUDs and PDPs.

Brooks Klimley
Starts with proved reserves, which is an engineering standard and basically, while it's all numerical. It is a qualitative standard, because it's an estimate of the hydrocarbons, oil and gas natural gas liquids that can be produced at a point in time from a portfolio oil and gas reserves at today's prices, to this technology in today's regulatory environment in today's costs, so it moves over time when prices rise, reserves rise in metal production. When prices fall, reserves fall, when you start the shale phenomenon. It's absolutely fascinating, the United States, gas prices crashed, oil prices crashed, what 14 going into 15, 16. So you have 3-40% decline in prices, reserves in the United States went up. And it's because the technology was changing, the experience was so much greater that your knowledge of the commercial properties of the reserves themselves was growing. And so you say well, yeah, prices are down, but I can develop this much more reserves at these prices. So it is from a physical standpoint, it's pretty wild what's going on. What's happened in the industry is massive drilling, you know, very liquid, you know, tremendous interest in investment, private equity, the public markets, the equity markets, massive amounts of capital flow in chasing the shale and production went from 5 million barrels a day to, you know, north of 10. The shale is short lived, so you got to keep drilling to go right. So that tiramisu, you got to keep drilling wells to keep that going to get your share of the cake. And there was no big return coming back in terms of free cash flow, basically, people were issuing more debt, more equity, growing the company that way, then prices moved to OPEC Plus or whatever. And, you know, the industry really came under concern, say, Well, you know, what's the game here? If we're just continuing to throw more and more money at it, and there's not anything coming back? Is that really sustainable? And you got into and that was really the debate that came into 19. And as you turned into 20, you know, the industry was reconciling to, you know, we need some kind of return. It's not just chasing growth, growth growth, and a private equity firm would buy some, you know, acreage, put together more acreage, and then flip three times the money because everybody was going like this. It's a no, now this is actually, you know, it's going to be a manufacturing business, we got to see some cash on cash return. So that was the start of 20. And then you hit the COVID, which, you know, basically eradicated demand to a substantial.

Bret Kugelmass
So yeah, there was already a concern of oversupply, which was making people worried about getting their returns back because prices, you know, were low. And now with COVID, demand also dropped, which doesn't help the situation.

Brooks Klimley
Remember, in the middle of last year, for reasons that, you know, OPEC Plus, basically turned on the spigot. So in case in COVID, demand as we're eradicating this massive flow of products. And oil prices literally went below zero in the United States. So what's happened is the industry in the energy industry is incredibly resilient. Right when prices go up, and there's, you know, there, there's peak oil and you know, OPEC was, you know, prices went up technology change would roll up the North Sea, the Gulf of Mexico, and prices, then got back in balance, prices went down, you take some players out. What happened in the shale is as bad as tough as it was, and you had a big price break at the end of 14 going into 15, 16. And then you had, you know, basically 19 really going into 20. So, you know, yes, you had bankruptcies in the like, the first time that it was accompanied by a lot of liquidity that was still in the business hedge funds coming in and saying, you know, I'll put up my bet, maybe I'll end up with the equity, but I still believe in this. This time around, there's no liquidity. And it's really a function of a couple things that post 15, 16 returns didn't come because the model hadn't changed. And so the model is changing. There is, you know, valuation wise prices are still pretty beat up. So you know, people have lost a lot of money. And there's a resistance to it. And then importantly, you have the global universal conversation around climate change has become more polarized, and has led to, you know, discussions not so much about adaptation, and, you know, the transition over time, we're gonna bounce from subfields. And so, today, you know, as we said, the banks in particular, financial institutions, you know, any in it, it's across ESG perspective.

Bret Kugelmass
And ESG stands for environmental and social governance, is that right? And that's, that's essentially, that acronym. Essentially, what that means is that companies or banks, which are companies, are trying to market themselves to their customers, they're trying to say, hey listen, we care about more than just, you know, the single bottom line. And so we are going to adopt a series of practices that actually will affect our business, to prioritize and value ESG environmental and social issues, and a lot of that's really just environmental issues.

Brooks Klimley
Well, it's changed over time. Governance was a big part of it originally, then, you know, as boards were changing reflection like, and the environment has risen to the forefront. And so they're now saying, you know, we're going to invest our $7 trillion. And we're gonna look at this, and we want to know what you're doing about it. And if you read the fine print, you know, it's not calling for absolute abolition, although you do have these very strong views about fossil fuels, that are forcing behavior. So I think it's fair to say, you know, the banks are, in retreat, someone had to get in retreat, because the economics were so bad. Texas banks in particular, but the big money center, banks are under pressure to reduce outstandings to the upstream business. That has led to almost an existential crisis in the oil and gas business, which is, you know, we've been, we've done all this stuff, the technology's been unbelievably, you know, developed. Yet, you know, we're now in, in, in the penalty box somehow. And that's what I think we have to

Bret Kugelmass
Doesn't just create an opportunity, though, for lenders who don't have an ESG focus now to have less competition for their deals. I mean, I can't imagine that every financial institution is putting such a big focus on ESG. Especially because, you know, it's politically, you know, divisive. And, you know, different banks and companies have different political alignments. So, tell me, like, it doesn't just create an opportunity for half of the financial institutions.

Brooks Klimley
It could, in the past, you you had, you know, more institutional money hedge fund money, in particular, fill up some of this need, as I said, in a crash, you know, 14 going into 15-16, hedge funds came in the big way, more junior securities, you know, they could only equity, etc. But they're just today with a real lack of interest.

Bret Kugelmass
And is it also possibly, because, you know, this has been a steady march, especially on the climate topic, it's been a steady march of not just public interest, but governments making specific regulations and policies that follow the public's will, and that maybe some of these banks might see it coming, where they want to, you know, get on get on board the ESG train, so they don't find themselves, you know, you know, caught with their pants down when, when regulations might change. Is that part of it, or no?

Brooks Klimley
I think it is part of it. I think the, you know, the move to ESG, you know, I chair the Antero ESG. You know, I don't think anybody's in denial, and I think it actually is a very good thing, because the issues of ESG need to be addressed. And part of it is just communicating, you know, what's going on, what's actually doing so environmental standards. And Antero does a great job. So part of that is getting that story out there. And then part of it's also, I think, this is where it gets interesting. You have to develop the narrative around your business, right? So you know, if you're, it's very difficult to embrace the outright, you know, some of the some of the stronger proclamations about the evils or you know, the right and wrong and the oil and gas business, for instance, because if you're looking, you know, over a longer term period, we really have two goals. I think, as a world as a community, one is to eliminate or radically reduce carbon emissions over time, but at the same time, we want to continue to have ample supplies of energy and reasonably priced energy in order to continue the development of the world. And if you look at the two of those, those have to be in harmony, right? And those two in harmony, then say, Okay, now we can actually deal with the heavy lifting of what's the physical parts of the energy paradigm that we're going to endorse? How's that going to work? What are the implications of going in one direction or another, which is massively complicated. But if you hold both those goals in mind, and I think getting to a solution says, okay, we need to continue to evolve, and the upstream business, a very important part to play in energy, not only on top.

Bret Kugelmass
Okay, so let's talk about this evolution, and where you see things are going specifically, you know, in, in the world of project development, and project finance, you know, as we start taking the ESG concerns more seriously, as we start, you know, entering into the clean technology revolution, as some are calling it, how does this? How does this impact the finance world specifically, or new structures being put in place? Or is it just, you know, clean infrastructure, you know, different technology, but same story? Or is there more profound change happening?

Brooks Klimley
I think the profound change is where people are being directed into these different markets for, for lack of better description, political reasons. All right. So there is pressure on, you know, really scrutinize your outstandings to the upstream oil and gas business. And that's without looking at the specifics of anyone coming to the coal business in terms of steam coal, right. You know, every bank that's out there, so the normal end of the steam coal business, just as a matter of policy, and, you know, coal, coal fired power is a lot dirtier than natural gas fired power twice as dirty, and renewables, obviously have no emissions. So I think, you know, separating the politics aside, there will be different areas. And then I personally think the ultimate solution is going to involve the evolution of each part of the paradigm. So I think, you know, longer term natural gas, pretty sure anybody who's involved on the physical and the political and the financial side would argue gases can be around for a long time. And it really is, in some ways, the backbone of renewables, because they already are where you're seeing investment change, this is not so much the lending, the lending structures are pretty much the same. And so better projects with better participants with stronger returns will get better financing, etc. But, you know, in terms of equity investment, venture capital, like, you know, there's some big moving issues under climate change better, that are gonna get a lot of attention, battery storage, you know, absolutely. If you could crack the code, that could be a real game changer. I think you'll see a lot of interest in hydrogen over time. And, you know, we're at the same time, I like to think that we'll continue to pursue carbon capture, use, and storage cc us, because whether it's in the effluent coming out of a power plant, or the effluent coming out of cement, or a steelmaking facility where there's a lot of CO2 being released, if you if you could develop the technology at the right cost, and either, you know, take carbon out, but then put it someplace. And after all, it did come from the ground originally. I think that those are that that can be, you know, really game changing and how we get the whole thing decided kind of morph into something that's more compatible with both economic development and these climate change goals.

Bret Kugelmass
Yeah, I couldn't agree more. I've never understood the criticism against carbon capture from the environmentalist side. It's like, yes, you've correctly identified the problem. We're emitting carbon into the air. And then so here's a solution to that exact problem that you've identified, but for them to then go say, well, no, now this is giving people you know, a license to continue, you know, burning fossil fuels. Well, yeah, burning fossil fuels isn't the problem. The problem is the carbon going into the air so like, you know maybe you just don't like those companies. But you know, like, let's get serious here. Like let's try to solve problems. Let's not just try to, you know, promote things that we emotionally like and discount things that we don't emotionally like.

Brooks Klimley
I think that's the root of the argument. The other thing is, and by the way, if we take these emotional issues right, or we just don't like something for perfectly understandable reasons, in some ways you have to think about, you know, what are the implications, right. And, you know, the global energy business is about as complex as anything that you can imagine. And, you know, if you want to continue the development of the developing world in particular, but if you want to keep rising, the standard of living in the developed world as well, energy is going to be backbone up, right.

Bret Kugelmass
Which, by the way, you know, also when it comes to climate issues, like, the big issue there is that, you know, climate change, you know, it looks like, so, problem solving, climate change is so astronomical, we're going to be dealing with climate change, it's almost just a matter of like, to what degree and if what you care about with climate change is that it has disproportionate impact on the poorest in the world, then the most important thing is to give the poorest people the resources to adapt to it. And that only happens through cheap energy.

Brooks Klimley
Yes. You know, it's very interesting. So, you know, we also do energy and are gifted with wonderful government sponsored research and the like, I don't know of any other industry that has the Energy Information Administration, United States, or the International Energy Agency, for the OECD countries. But you know, this is good as it gets in terms of data accumulation and bright people studying these, and they have projections, and what we know about projections, as I tell students is, we know one thing, they'll always be wrong, but they are, they're grounded in the assumption that in the case of the man, you know, today's you know, today's technologies, today's prices, today's costs, today's results, the IEA predicts we won't be anywhere near getting to that 2% cap.

Bret Kugelmass
Not even close.

Brooks Klimley
If you look at it, it's called a sustainable development scenario, the STSs, which is aspirational, technology doesn't exist today. But it's aspirational, incredibly well, you know, directed thought through, and like, you still have fossil fuels, north of 40 million close to 50%, of the primary energy in the world in 2040. So I think, what we need to do is we need to take some of the emotion out of the discussion, understand where we want to get to, right, and understand that it can't be sustainable, and it's not feasible. And it can't be feasible, and it's not commercial, because it's not going to get financed. And then let's figure that out. So somebody's got to pick up the boat, the oldest now, you know, if the world decided to go, you know, governments could, you know, just make declarations, and they can, you know, raise, financing or investment, you can go there, I just think the hurdles are large. And the discussion needs to be very calibrated strategically to this intersection between sustainable development, growth, economic development, growth, and reducing carbon emissions. And the win win is when you get all that moving in the right direction. If you drop off one of those pieces, then you will fail.

Bret Kugelmass
Yeah. So, Brooks, as we wrap up this conversation, can you you know, we've talked a little bit, we've talked about the past, we've talked about how things are transitioning now, if you could look forward into the future 5-10 years, what are some areas that we should all be keeping our eyes on that are exciting new emerging areas for project finance?

Brooks Klimley
Well projects will get financed, to the extent they comply with these, this notion of risk identification and allocation the capital will go there, and project finance itself, you know, banks come in and come out of the place. So I think the areas that are most interesting, I think, are like battery storage, because if you could solve battery storage, then the intermittency of renewables is, you know, certainly reduced. And if you could actually get that battery storage to work in harmony with the grid, then you'd have you know, what is ubiquitous intelligent grid, whereas, now, you know, the old model where we produce a lot of energy, sell it and the grid goes one direction, and you know, you have to sell it, the moment you produce. So, like battery storage is very important, I think CCUS is really important idea, because it addresses not only capturing CO2 from power plant emissions, or from steelmaking and cement which are very CO2 intensive, but you know, in the past what sorry, this That CO2 is then recycled back into oil and gas properties where if you know it's an older field, or depending on the geology, a lot of secondary recovery has to do with pushing things back into the ground to move the hydrocarbons to the wellbore and produce hydrocarbons. In this case, the majority of the jobs go, and so those are projects that have been tried, that would be really interesting if you could not only capture it, and store it, use it. I mean, that would really be interesting, right? And so I like that.

Bret Kugelmass
Brooks, thank you so much for your time, your insight and I look forward to talking to you soon.

Brooks Klimley
All right, Bret, thank you very much. Cheers.