The practice of hydraulic fracturing has rightly received a lot of the credit for allowing the U.S. to boost its oil production in recent years by as much as 60%. The U.S. is now producing more oil than it has in decades and the boom is expected to continue.
But in order to fracture a well, there is one key ingredient needed: sand. Also called “frac-sand” or more officially known as “proppant,” sand is vital to opening up shale to allow oil and gas to escape.
Here is how it works. When oil and gas companies conduct a fracking job, they send a mix of water, sand, and proprietary chemical cocktails down a well. The extraordinary pressure at which they inject the mixture fractures shale rock, and the frac-sand props open the fissures. With cracks kept open by frac-sand, oil and gas flow out from shale rock and into the well.
Frac-sand often comes from high-purity quartz and is crush resistant, allowing it stay intact while shale rock fractures. A single frac job can require several thousand tons of sand. But oil and gas companies have found that by increasing the volume of sand in the fracturing process, they can increase output, often by as much as 30%. The number of shale wells using that extra burst of sand stands at just 20%, but may rise to 80% according to RBC Capital Markets.
All of this is creating a run on frac-sand, which has turned into a booming industry virtually overnight (see chart).
Prices have climbed…
The practice of hydraulic fracturing has rightly received a lot of the credit for allowing the U.S. to boost its oil production in recent years by as much as 60%. The U.S. is now producing more oil than it has in decades and the boom is expected to continue.
But in order to fracture a well, there is one key ingredient needed: sand. Also called “frac-sand” or more officially known as “proppant,” sand is vital to opening up shale to allow oil and gas to escape.
Here is how it works. When oil and gas companies conduct a fracking job, they send a mix of water, sand, and proprietary chemical cocktails down a well. The extraordinary pressure at which they inject the mixture fractures shale rock, and the frac-sand props open the fissures. With cracks kept open by frac-sand, oil and gas flow out from shale rock and into the well.
Frac-sand often comes from high-purity quartz and is crush resistant, allowing it stay intact while shale rock fractures. A single frac job can require several thousand tons of sand. But oil and gas companies have found that by increasing the volume of sand in the fracturing process, they can increase output, often by as much as 30%. The number of shale wells using that extra burst of sand stands at just 20%, but may rise to 80% according to RBC Capital Markets.
All of this is creating a run on frac-sand, which has turned into a booming industry virtually overnight (see chart).
Prices have climbed as demand has increased. In 2010, frac-sand sold for between $45 and $50 per ton, but that jumped to $54 per ton the following year. Sand prices could increase by 50% in the coming years as demand rapidly rises.
Most frac-sand is produced in the Midwest, which has the most favorable geology. There are other regions that have high-quality sand, such as Appalachia. However, sand in Appalachia has been ravaged by tectonic forces, which has weakened the grains of sand, making it much less suitable compared to sand found in the Midwest.
That means that states like Wisconsin, Minnesota, and Illinois have become powerhouses in terms of frac-sand production, where the most highly-prized frac-sand – Northern White sand – is located. One of the biggest problems with the frac-sand market is transit. Most drilling occurs in Canada, in the Bakken, and in South and West Texas – regions that are relatively far from Wisconsin and Minnesota. That means only the companies with secure transportation links will be the ones that will ride the frac-sand wave over the next several years.
And there are companies that have put the equation together – upstream production capacity, coupled with downstream processing and transportation.
The largest producer of frac-sand in North America is Unimin Corporation, which is a subsidiary of the privately held Sibelco Group. Unimin produces over 4.5 million metric tons, nearly 10% of total annual supply in the United States. But as a privately held company, without much use to investors looking to get in on the sector, let’s not spend too much time looking at them.
Emerge Energy Services (NYSE: EMES) went public in May 2013, and was the most successful IPO for the year with its share price rising 588%. It has seen its share price fall back a bit from its peak, but it is still trading more than four times its initial levels, jumping from $17 per share to over $81 per share in late November 2014. Emerge owns four frac-sand mines, and five processing facilities. It currently has access to two Class One railroads to get its product to market, but by early 2015, it will gain access to two more railroad lines, allowing it to ship to every major shale basin in North America. Emerge also earns most of its revenues from sales to the Eagle Ford, Permian, Marcellus, and the Bakken, which could prove to be some of the most resilient shale plays during a period of lower oil prices.
But Emerge Energy Services was not the only frac-sand company to go public, an indication of the white hot growth in the sector. In the most recent IPO in the sector, Fairmount Santrol (NYSE: FMSA) offers integration across the supply chain for frac-sand development. It has several upstream mining facilities in Wisconsin and Minnesota, producing Northern White sand. Fairmount Santrol also owns and operates research laboratories and processing facilities to turn mined sand into fully processed proppants. Further down the supply chain, Fairmount Santrol controls railcars and terminals to deliver frac-sand to its customers in the oil patch. In its most recent quarter, Fairmount Santrol saw revenues climb 41% largely due to increased sales. The company also sees growth on the horizon. It just opened three new terminals, two in Oklahoma, and one in Ohio, which will allow it to expand into the Utica and Marcellus shales.
Another promising company is Eagle Materials (NYSE: EXP), which just started up a mine in the second quarter of 2014. Eagle Materials saw its revenue for frac-sand jump nearly seven-fold in quarter two of 2014 from a year before. Frac-sand still makes up a small slice of the company’s overall business, but the company is prioritizing this segment because of the growth possibilities.
Eagle Materials also believes that frac-sand will complement its current operations in oil well cement. The company’s customer base is already in the oil and gas industry and it feels that it can leverage this to rapidly grow its frac-sand business. Eagle Materials has access to Northern White sand in Illinois, the most preferred type of frac-sand on the market. And to top it off, Eagle has the distribution in place to carry frac-sand from the Midwest to oil fields in south Texas, and they are building a frac-sand processing facility from an existing brownfield site in Corpus Christi. Eagle Materials has seen its share price rise four-fold since 2012, and despite the recent decline – due to falling oil prices – Eagle is still up more than 20% year-to-date. It has the potential for very strong growth in the coming years.
On the larger side is U.S. Silica Holdings (NYSE: SLCA), a $2.5 billion company based in Maryland, but with facilities all over the country. It has seven mining facilities across Michigan, Illinois, Wisconsin, and Texas. It is one of the top three largest frac-sand producers. Like several of its competitors, U.S. Silica has a fleet of railcars already leased to ensure good transport linkages. The advantage that U.S. Silica has over some of its other competitors is the contracts it has in place. It has over 70% of its sales under long-term contract, which insulates it from risk. The company is projecting compound annual growth rate of 40% over the next several years, outpacing the 22% CAGR for the broader sector.
The frac-sand market faces an uncertain future. For investors, the opportunity with frac-sand is the ability to bet directly on fracking. In other words, overall drilling activity will largely dictate the demand for frac-sand, allowing investors to bet on U.S. oil and gas without having to pick out individual exploration companies.
But with oil prices low for now, that could put some pressure on frac-sand producers. However, demand continues to outstrip supply. Moody’s Investors Service just published a bullish report on the frac-sand industry. They note that the market could turn sour if oil prices stay low over the long-term, but for now, frac-sand producers are optimistic as drillers continue to scramble to secure frac-sand supplies even during the downturn.
Over the medium-term, one major factor could influence the frac-sand market – the international market. Currently, only the U.S. is seeing such frenzied drilling activity, but several European countries, particularly the U.K., are trying to develop their shale gas resources. If drilling takes off across the pond that will open up the opportunity for frac-sand producers to export. As a result, demand and prices – and therefore revenues to the frac-sand industry – will increase. Other potentially huge markets for frac-sand exports include Argentina, Poland, and China.
Even without exports, the frac-sand industry is expecting annual double-digit growth for the foreseeable future.
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