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Increasing Uncompleted Wells Represent ‘Sand Demand in Waiting,’ for Proppant Suppliers

The pullback in the U.S. onshore has choked demand for all types of services, with proppant volumes declining sharply since the start of the year. Proppant providers are continuing to cut costs and are working with their customers to hold on to market share for the eventual upturn. As to when the market will strengthen, however, it's anybody's guess.

Ohio-based Fairmount Santrol Inc., which has rail terminals in key resource plays across the United States, reported a 10% decline in proppant volumes sequentially. It's not only the use of higher priced resin-coated proppants (RCP) seeing a decline in demand, but cheaper sand as well, said CEO Jenniffer Deckard. She talked about quarterly results during a conference call on Tuesday, noting that competition for customers is stiff, requiring some wheeling and dealing.

"In our proppant solutions segment, we shipped a total of 1.6 million tons, including 207,000 tons of value added coated products," she said. "Within proppant solutions, our frack sand volume was 1.4 million tons, down 7% compared to the first quarter of 2015 and resin-coated proppant volumes were down 39%. During the second quarter, we saw an average decline in selling prices of 13% across all product lines. For that period, that represented an approximate $9.00 to $12.00 per ton decline in the average selling price of raw frack sand."

Fairmount Management has made big investments over the past couple of years to build out rail lines and expand their operations. Positioning products closer to the well has increased "efficiencies of last mile delivery" and reduced customers' "ultimate delivery cost to the well," Deckard said. "During the second quarter, approximately 72% of our proppant volumes were sold in-basin to our own terminal network." Even with more competition, volumes were strong because of its unit train capabilities, which reduced customers' overall costs per delivered ton.

But being nearer to customers wasn't enough to overcome stifling business conditions. Since the start of the year, 20% of Fairmount's workforce has been laid off. The company also has consolidated its onshore frack sand and RCP operations, idling two sand processing facilities in Brewer, MO, and Shakopee, MN, and closing one in Wexford, MN. Work schedules were reduced at three other sand plants. The moves enabled the company to lower its weighted average cost/ton for frack sand by 11% since the end of 2014, said Deckard.

A Fairmount RCP facility in Voca, TX, was idled, while another was closed in Bridgeman, MI. Reducing its RCP footprint, along with some raw material cost reductions, "has enabled us to reduce our production cost per ton for resin-coated products by approximately 20%," Deckard noted.

Fairmount still expanded some of its base operations during the second quarter with two new sand facilities opening in Artesia, NM and and in Pocasset, OK "to better position ourselves to serve to markets" in the Permian Basin and Midcontinent.

Some Price Stabilization

Fairmount's raw frack sand volumes "as we start the third quarter are above where we exited the second quarter," Deckard noted. "Although market pricing for frack sand has remained dynamic, we are beginning to see some price stabilization, particularly within certain grades and delivery point mixes. For resin-coated proppants, we've seen stabilization of volumes in the most recent month, with some continuing pricing pressure, particularly for products which compete within the industry's less differentiated product groups.

"We continue to expect the 2015 total proppant market to be down 20-25%, assuming that the average year over year decline and onshore rig comes in around 50%. This would assume second half rig counts, which are fairly stable with today's level."

The decline in this year's rig count "has been partially offset by a continued increase in proppant intensity, which we expect to be up around 15% year-over-year," Deckard said. "This 2015 increase in proppant intensity is being driven by continued increases in the number of stages per well, and in the amount of proppant used per stage. Further, the change in number of wells drilled, but not completed DUCs [drilled but uncompleted wells] is also a factor which influences the correlation between rig counts and proppant demand.

"We estimate that a drawdown on recently built up DUC inventory will provide an additional and positive tailwind to the proppant market in the second half of 2015."

Houston-based Hi-Crush Partners LP last year secured contracts with the leading U.S. fracker Halliburton Co. (see Shale Daily,Oct. 14, 2014). Hi-Crush's specialty is sand, with the bulk of its reserves consisting of Northern White sand, predominantly found in Wisconsin and parts of the upper Midwest. The decline in activity sent revenues during 2Q2015 down 18% sequentially. Sand sales totaled 1.2 million tons, essentially flat from early this year. The average sales price, however, fell 8% from 1Q2015 to $67/ton.

"While the sequential revenue decline is disappointing and clearly reflects the level of pressure on pricing in the frac sand industry, we believe that maintaining our sales volumes at the same level as in the first quarter reflects our ability to work with our customers on price and in basin delivery in order to make them more competitive when bidding for completion work," Hi-Crush CFO Laura Fulton said during the recent quarterly conference call.

Like Fairmount, the company was able to improve efficiencies, with production costs falling 17% sequentially to $13.45/ton from $16.28. However, "pricing concessions we offered to customers during the first quarter...continued, and in some cases, accelerated through the second quarter," said Co-CEO Jim Whipkey. Average selling prices declined by an additional 10-15%.

"While we anticipate pricing will remain soft, it does feel like prices are stabilizing somewhat here, early in the third quarter," he said. "Customer sand volumes and mesh size distribution were all over the map in the second quarter. For example, we continue to see increased 40/70 volumes moving into the Permian and Eagle Ford, with somewhat softer demand for our coarser product…

Higher Frack Intensity

Hi-Crush also continues to see higher "frack intensity" for wells, he said. "Data points continue to accumulate from customers, industry participants, consultants and experts about the phenomenon of increasing frack and proppant intensity, characterized by longer laterals, more frack stages per lateral and more sand per stage...

"At this point, we think it's fair to say that increasing frack intensity extends beyond a mere trend and is now standard completion protocol. And while it's easy to overlook the importance of more sand per well in the middle of this historic dislocation, it certainly suggests greater demand for our Northern White frack sand going forward."

Before the downturn started in 2014, Hi-Crush already was seeing a buildup of DUCs.

"This theme was particularly true in the Marcellus and Utica shales over the past several years, as these regions were significantly short of infrastructure," Whipkey told analysts. "With the recent pullback in commodity prices, we've seen this trend expand for reasons other than infrastructure constraints, as companies have delayed completion activity with the expectation of a future recovery in commodity prices. As a result, the inventory of these wells awaiting completions continues to expand in many basins throughout the U.S.

DUCs Mount

"The drilled but uncompleted well count is still estimated at 5,000 or more, concentrated not only in the Northeast now, but other areas where we have significant capabilities and a solid footprint, including the Eagle Ford and the Permian. We believe this large inventory of essentially 'sand demand in waiting' represents opportunity for us once completion activity resumes potentially later this year and, more notably, into next."

As to what the recovery may look like, Whipkey said the "timing and shape...is certainly up for debate...The recovery in pricing and demand for frack sand is likely to take longer than we previously thought."

Hi-Crush does expect more mergers and acquisitions (M&A) within the sector, said Co-CEO Bob Rasmus.

"This activity will be driven by our customers, their growing demand for all-in service offering and their desire for an overall reduction in the number of sand providers. Simply put, the large will get larger."

As to Hi-Crush's aspirations, Rasmus said the company was "always willing to grow our high-quality reserve base" if it fits with its frack sand reserves near its rail sites "and not just any rail, but the right rail. Sand production facilities may also be interesting, but we have demonstrated that we can build these assets quicker, cheaper and more efficiently than anyone else. Where opportunities are more likely to peak our interest is on the logistics side of the business, growing our distribution and terminal offerings and expanding our transportation reach."

As a cost-savings measure, Hi-Crush had seen some customers switching to low-cost brown sand, but it was costing the exploration operators initial production (IP) rate performance, said Whipkey. Today, "we're now hearing very convincing evidence that now that we're three months, four months, five months into decline curves, they're coming back and saying, 'yeah, we were kind of fooled by the IPs, because they're roughly equivalent to the Northern White IPs, but these wells are declining more quickly than we had anticipated.'

"So, we think that shift to brown sand is the short-lived phenomenon."

Ceramics Hit Hard

Carbo Ceramics Inc.'s market base consists of premium priced ceramics and RCPs -- both of which cost more than using sand proppants. For the last several quarters, the company had been hit by exploration and production (E&P) companies opting for sand to reduce costs as they increased fracking stages. Carbo also was slammed by imported ceramics from China that are lower priced. CEO Gary Kolstad, who talked to analysts in late July about quarterly results, said the commodity price slump took its revenge during the quarter, with revenues falling year/year by 59%.

However, he remained somewhat optimistic about the path forward. "With E&P operators having seen large well cost reductions, we are cautiously optimistic on the opportunities for increases in our new technology sales," Kolstad said. "Ceramic proppant sales volumes may remain stable in the third quarter of 2015. Imports of the low quality Chinese ceramic proppant have subsided this year; however, we believe the inventory of imported ceramic proppant in the U.S. may still be at levels that keep pressure on pricing."

The last several quarters have been a time of experimentation by E&Ps as they work to improve their well efficiencies, Kolstad said. To boost IPs, though, he said more sand isn't the answer.

"Given the time that has elapsed, there is increasing evidence in the production data that suggests using large amounts of sand is not the best approach to optimize the frack when certain reservoir conditions exist. In addition, we have started to see certain clients returning to ceramic proppant in their completions after having gone through periods of experimentation with other completion techniques."

In July, EQT Corp. reported that its first Utica well in southwestern Pennsylvania broke the Appalachian Basin's previous IP record, averaging 72.9 MMcf/d (see Shale Daily,July 23). The well cost more than $27 million, more than twice as much as onshore wells today. However, it was ceramics that made a difference, according to E&P President Steven Schlotterbeck. He said 100 mesh sand had been used in the first part of each frack stage, "but for all of the large-size proppant, it was 100% ceramic."

That's the point that Kolstad has stressed quarter after quarter. He didn't identify any of Carbo's clients for competitive reasons, but he said ceramics are improving IP rates "in literally every basin…”

E&Ps have begun returning to higher priced proppants after using sand for "six months to one year, and all of the sudden you see the decline side of it compared to other operators. It's quite dramatic. We have some operators where they put sand where it just should never be at certain depths and it starts crushing. We all know the best white sand starts crushing at 6,000 psi, so it's being used in places where it shouldn't be used...

"So these wells just start dropping off so incredibly," but with ceramics, "they're really high IP wells...That's the difference. You have to have both high reservoir contact area and conductivity."

The North American proppant market consumption forecast was downgraded in late July by PacWest, but "increasing frack sand consumption per well is a silver lining." The IHS Inc. company said its most recent ProppantIQ, published in June, indicated that North American proppant consumption would decline by 23% this year. Compared with 2014, frack sand is set to fall by 21%, with RCS off 41% and ceramics falling 59%.

"The one bright spot remains increasing frack sand consumption per horizontal well" as producers use more stages per well and increase proppant volumes per well. "On a related note, over the trailing four quarters, frack sand consumption per horizontal well increased 15%."

PacWest is forecasting proppant prices will decline by 9% a year over the next three years. In part it has to do with the surplus in supply.

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