Silica sand miners have had it rough lately, and so has the portfolio. We are down significantly YTD, despite being up over 100% five months ago in some names like EMES, FMSA, HCLP, SLCA, and SND.
However, I think there’s a turnaround in-sight for our beleaguered sand miners. The frac sand industry has been doing fine for the last 4 quarters, but analysts have been grossly neglecting their future earnings potential, I believe.
We already discussed some misconceptions going on with the difference between drilling (adding rigs, building DUCs) and fracking (actually getting the oil out):
But, here’s another round of misconceptions/issues that I have for the opponents of the proppant industry that should debunk current oversupply myths…
Issue 1: The 80/20 Rule Erases Oversupply Fears
As we all know, 40/70 mesh is a very popular grade that’s in very tight supply, if not sold out, in most places.
So, if miners add 25 million tons of (mostly brown) new sand capacity in 12-18 months (that according to SLCA), on top of our roughly 100 million ton current capacity (which is mostly sold out), then that should NOT bring oversupply.
Actually, it’s a ‘plus one situation with new brown sand mines, as white sand supply sources of 100 mesh and 40/70 mesh in Wisconsin’s white sand mines are getting exhausted (SLCA on U.S. driller’s sand needs).
But the kicker… Only 80% of the new silica brown sand being brought on in the Permian (around 15 new mines announced) WILL BE 100 MESH.
THE OTHER 20 percent will only be 40/70 mesh (this stat according to U.S. Silica).
ONLY TWO SAND GRADES being produced (which are some of the most sought after), will not only lead to a further shortage in 40/70 mesh, but it makes the drillers choose the next-best sand grade.
These other sand grades chosen would have to come OUT OF BASIN (which are also mostly sold out, if not ALL sold out) because only TWO grades of brown sand are being produced in the Permian.
There was already a shortage of many grades of frac sand, and this scary REALITY of limited added production (choice of grade-wise), will mean there will be more shortages of 40/70 and coarser grades to come.
This 80/20 idea of ONLY 2 popular grades being produced in the Permian, versus producing ALL sand grades like white sand miners do in Wisconsin, means that white sand is not dead, since there won’t be enough 40/70, or any other grade for that matter, to serve the Permian or other prolific basins.
As Long As Oil Stays In Its Current Range…
(This is all based on oil staying between $40-$50/bl, of course, which I think it will due to the strong global economy).
More importantly, we are also reaching 3 years of under investment in long cycle oil & gas projects internationally, and declining productivity in those long cycle projects, currently.
This leaves onshore shale drilling (short cycle) as the only game left in town to drill profitably. The payback periods (and CEO bonuses) are also nice with short cycle investments, which shouldn’t be overlooked.
So, too much short cycle production in 2018-2019, coupled with too little long cycle production in 2018-2019, will lead to higher oil prices.
Just had to get that straight.
Issue 2: Most New Capacity Is Not Extra Capacity When “A Majority Of The New Tons Are Contracted Out Already”
I think this notion speaks for itself, but why do the analysts keep falling for the whole ‘new mines being added will create over-supply’ line?
If “most new supply is contracted out”, how could there be too much supply? Even if the new capacity added wasn’t contracted, it’s only 2 kinds of grades of sand! The other grains will have to come from out of basin…
Okay, now I am just repeating myself.
Issue #3: Not All Sand Suppliers Are Created Equal
Experience, low-cost production, product mix, and LOGISTICS will force drillers to choose one of the “big four” public sand companies (FMSA, SLCA, EMES, & HCLP), and push lower cost producers out.
We know about how logistics and strategic, in-basin terminals are key for the BIG FOUR miners. But, some analysts overlook the finer details of the logistics puzzle, such as TIME.
Time is MONEY.
U.S. Silica’s new brown sand mine in Crane County has access to I-20, whereas Winkler County mines have to use farm roads to travel.
According to SLCA (and logic), it takes 1-2 hours longer to take sand by farm roads, rather than highways. It also reduces the amount of loads each driver can make daily, which reduces volumes daily.
These extra costs for the truckers, their trucks, and less volume ultimately transported, adds up big.
So, in conclusion, we know there’s NO oversupply of frac sand currently, nor will the addition of new brown sand to the picture sink sand prices- because of the 80/20 rule.
But, experience, and all of the other necessary qualities listed above, is also EQUALLY important.
Maybe if you asked yourself this question, it would answer everything as to why the “Big Four” silica sand miners will overcome supply fears, and keep taking market share from others:
If I told you that you could choose any of the top 10 sand producers to supply your multi-billion dollar oil drilling business, but only the BIG FOUR have the necessary experience, ALL GRADES of sand needed, the proximity to your wellheads nationwide, available rail cars for your convenience, and better logistics options…who would you choose? The big four, or those other guys?
I rest my case.