We are adding more to our Frac Sand plays today, as shale drillers continue to improve efficiencies by using more rare Frac Sand.
This talk about rig counts increasing each week as being bearish is false, and I will prove that adding rigs does not necessarily mean more oil is coming, but more sand is.
Shale drillers ARE getting their DUCs (drilled but uncompleted wells) in a row, which is great for our Frac Sand names.
Let me explain why this is not necessarily bullish for drillers, but very bullish for our Frac Sand plays Emerge Energy (Emes), Fairmount Santrol (Fmsa), and U.S. Silica (SLCA).
Debunking Myth #1
Adding rigs just means drilling more holes, not necessarily producing more oil or profits.
In fact, the very claim below that bearish analysts use to drive, now even Permian players down, is flawed.
It’s the same old tune; “shale drillers are becoming a victim of their own success as they continue to add more rigs and drill, drill, drill, flooding the market with too much oil.”
First of all, more rigs doesn’t mean more oil. Second of all, drillers are using more rare Frac SAND to improve efficiencies and stay competitive in a low oil price environment.
But, they aren’t fracking the wells with sand until they have a clear market to export to or are able to even do so (shortage of Frac Sand and crews).
Do you really think these guys (drillers) would add more rigs each week to their own demise? Of course not.
That’s why Wall Street is either getting confused, or manipulating these stock prices down.
More rigs doesn’t mean more oil, just increased DUC’s; and drillers (who are smarter than us and started this business), aren’t seriously going to add more rigs in some last ditch effort to make everything they can this year, but go bankrupt next year.
Makes no sense.
No, on the contrary. They have not even hedged next years prices to ensure bonuses because of “backwardation”, where prices are higher now than they are in the future. Why would they hedge at lower prices and receive lower bonuses?
But, more importantly, why would they drop prices even lower by flooding the market with rigs and oil, only to sow their demise next year?
They are not. They are just building up their DUC inventories for when the inevitable spike in prices comes from lack of offshore development.
(Don’t forget, a geopolitical crisis could also spike oil prices, which is very plausible at the moment with tensions flaring in Iran and Syria).
So, again, why stop drilling now?
With DUC’s, drillers are firmly in control as they can now turn production on and off like a faucet. They will FRACK with sand when they NEED to, or when it becomes possible to even do so (again shortage of frac sand and crews is very real).
Drillers realize that there is a shortage of Frac Sand and Fracking crews. So, they couldn’t even produce more oil now if they WANTED to, because stimulation/fracking crews are in short supply; translation: buy frackers like Keane (FRAC), and the sand that they use (our Frac Sand players).
You can always build more rigs and parts, but not fracking crews and sand because those are a finite resource that you must develop.
Debunking Myth # 2
That brings me to the next myth I’d like to debunk: “production gains are peaking as service costs are set to rise 20% in 2018”.
Frac Sand is the lowest input cost of the well that improves efficiency gains (EURs as the industry calls it).
Usually a well takes between $2-$5 million to produce.
But, SAND only accounts for .06% of the costs (while tripling recovery rates).
Even if those costs increase 20%, that still comes out to less than one quarter of the overall costs to frack a well (peanuts, especially compared to the increased reward of tripling recovery rates/EURs).
Lastly, this is all playing right into our Frac Sand player’s hands. As I mentioned above, Frac Sand/Silica Sand triples recovery rates.
But, guess what? The more sand drillers use, the more oil they extract. More sand= more oil, and there’s no end to this phenomenon in sight.
Drillers are now using 3,000-5,000 lbs per lateral* foot, and they STILL haven’t reached diminishing returns.
And as drillers use more sand, sand miners use more railcars to ship it, lowering their mining/ logistics costs even further as the costs are spread out more evenly by each railcar; which, by the way, doesn’t have to be stored (incurring more costs for the miners, about $5 million per month).
Using more train cars and sand lowers costs for BOTH drillers and sand miners AND helps boost the margins of the Frac Sand miners, essentially allowing sand miners to print money hand over fist once all railcars are out of storage.
In conclusion, we are adding to our Frac Sand plays because there is still no limit to how much drillers can use and NOT reach diminishing returns.
Even if diminishing returns do occur at some point, which they will, drillers will be using so much sand (now they are drilling more than 2 miles out laterally, and using and average of $3,000 lbs per square foot to stimulate the oil reservoirs/increase EURs), that sand companies will have trouble filling all of the orders.
That’s why miners are expanding mine capacities, not because of greed or being cavalier. They HAVE to; drillers are begging them to expand and are even asking to help pay for the expansions to ensure supply.
We don’t want drillers or other service names in the industry because they have too high of overhead costs, shrinking high graded land (as the most economical areas to drill/ picking the low hanging fruit will inevitably run out over time), and lower oil price realizations.
However, Frac Sand will be the key ingredient for U.S. drillers to stay competitive with OPEC in a lower oil price environment, and will emerge (no pun intended) as the new winners in the oil & gas space.
Disclosure: We are still long Emerge (EMES), Fairmount (FMSA), and U.S. Silica (SLCA), and adding to positions in wider swings. For more background information on these frack sand names, click here http://wallstreetstocksolutions.com/frack-sand-silica-sand-stocks-feast-or-famine/