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Frack Sand Operators Say U.S. Onshore Outlook Just Beachy

As the oil and natural gas recovery takes hold in North America, proppant operators are seeing better-than-expected demand, which in turn is driving up sand pricing and tightening the transportation market.

Proppant deliveries to help fracture (frack) onshore wellsbegan to accelerate toward the end of 2016, a trend that has continued into 2017, said U.S. Silica Holdings Inc. CEO Bryan Shinn.

"We're seeing surging demand for sand proppant and last-mile logistics, driven by the continued increase in U.S. horizontal rig count, longer laterals and a double-digit increase in proppant per foot drilled," Shinn said during the recent quarterly conference call. "If these trends continue, 2017 demand for sand proppant may be greater than our current forecast of 60 million tons." Sand demand also is "driving higher overall sand pricing and a tightening of the last-mile trucking market," which makes efficiencies more valuable.

U.S. Silica's fourth quarter contribution margin in oil and gas was $18.5 million, up $20.4 million sequentially on sales volumes of 2.1 million tons, which represented  a 29% sequential increase in volume. It also outpaced U.S. rig count growth by about 6%, Shinn said. Revenue for the company's oil and gas segment improved 58% from 3Q2016 from higher volumes and two key acquisitions.

The company began to lay plans for a recovery last July, spending $210 million for NBR Sand, an East Texas proppant sand facility, to beef up the customer base in the Haynesville and Upper Eagle Ford shales. It also paid $218 million to buy Sandbox Enterprises LLC, a sand logistics company, to manage the proppant supply chain.

"We plan to have all of our oil and gas sand asset operating at maximum capacity in the near future," Shinn said. In the next 12-18 months, U.S. Silica also plans to invest "in the mix of expansions at existing sites, new greenfield sites and acquisitions that will collectively approximately double our...capacity to more than 20 million tons per year." Also planned are more investments in Sandbox this year, with an expectation to have more than 80 total Sandbox fleets online by the end of 2017.

Logistics Key

"From a greenfield perspective, we're going to focus on sites that are near the Delaware and Midland basins" of the Permian Basin, Shinn said. "We've got several opportunities in the pipeline there," with more merger/acquisitions planned. Capital expenditure guidance is $125-150 million, but "depending on how fast some of these projects proceed, the number could be even higher."

The decision to build out logistics capabilities through Sandbox has proven its worth, CFO Don Merril said. When U.S. Silica bought Sandbox, it had 18 active crews out of 23 total. The decision was made to double the business to 46 crews. "That's going so well...we've decided to double again, which will take us up to about 90 Sandbox fleets," with 80 fleets or more deployed by the end of 2017.

At competitor Fairmount Santrol Holdings Inc., overall oil and gas market conditions continue to improve and "trend specific to driving demand for proppant further strengthened," CEO Jenniffer Deckard said during the fourth quarter conference call.

"So far in 2017, volumes have further increased from fourth quarter average levels," she said. "Proppant demand continues to be strongest for the finer grades, but demand has also increased for coarser grades of sand as well. Importantly, we are seeing continued strengthening in demand for our coated proppants in the context of both a renewed focus on proppants providing flowback control as well as an uptick in tempered products for added strength.

"Further, these trends match the correlations that we’ve observed during previous market upturns between coated proppant volumes and higher rig counts. And we expect those trends to continue."

Proppant Demand Not Slowing Down

Fairmount expects the U.S. horizontal rig count to continue to move higher, but "we would expect very strong growth in market demand for proppants even if rigs were to remain at current levels due to multiple factors," Deckard said. We believe that drilled but uncompleted wells continue to grow during the fourth quarter and will ultimately provide further proppant tailwinds as the industry completes wells from inventory...

"Given these trends, we believe that market demand this year could reach levels similar to the 2014 peak, or over 60 million overall tons, with rig counts even below one-half of the 2014 rig count and, of course, proportionately higher with larger rig counts."

Like its competitors, Fairmount continues to invest in a logistics network, particularly its unit train capabilities to lower overall delivered in-basin costs. During 1Q2017, Fairmount added a unit train-capable destination, bringing its total destinations to nine, with two more in process.

Hi-Crush Partners LP CEO Robert Rasmus said it is "undeniable that we're seeing a substantial improvement in demand for our products and services, even though we are only in the early stages of a market recovery."

The December exit rate was nearly 10% higher than the monthly average, Rasmus said. "Since mid-January, we have been sold out of every grain and grade of sand. We expect volumes to stay strong throughout the year..." He said companies that had prepared for the upturn by hiring people and adding railcars "will be the ones with ability to restart and deliver product to the market in the spring...Higher cost facilities will have a much harder time profitably restarting until pricing reaches levels similar to 2014..."

Hi-Crush doesn't expect "any giveback in sand pricing, and we anticipate continued gains in volumes." Sand facilities are expected to run "at or near capacity," with idled facilities restarted. "Given our current capacity utilization of approximately 52% across the four facilities, our ramp up to nearly 100% utilization by the end of the second quarter is a dramatic increase in volumes," Rasmus said. "Our customers are seeking surety of supply, and operating our four facilities will allow us to meet the increased demands of the market."

Hi-Crush has started up operations at distribution terminals in the Denver-Julesburg Basin and in Odessa, TX, which is the heart of the Permian. They "quickly are becoming our highest volume terminals," Rasmus said.

Smart Sand Inc., which launched as a public company in November to supply northern white sand, also is doing a bang-up business, CEO Charles Young said during the quarterly conference call. The company sold 274,500 tons of sand in 4Q2016, up 19% sequentially, with fourth quarter revenue increasing 170%.

"Market demand for raw frack sand has started out strong in 2017, especially for finer mesh grades, and we expect this trend to continue," Young said. "With our reserve mix of approximately 81% finer mesh sand grades and our strong balance sheet, we are well positioned to take advantage of the expected growth in raw frack sand demand in 2017 and going forward."

Prices Escalating with Volumes

"Generally, we're starting to see positive momentum in pricing," U.S. Silica's Shinn said. "We saw that from 3Q2016 to 4Q2016...and that trend is continuing in 1Q2017, and I would say probably accelerating...And I would expect based on everything that we're seeing that the market is going to continue to tighten in terms of supply and demand over the coming quarters."

Shinn cautioned on the amount of pricing that is being "thrown around. I've seen reports out there issued by various industry sources talking about $45 or $50 [per ton] mine gate pricing, and certainly we're not seeing that. We've gotten some good price increases, but we're not at that level at this point."

U.S. Silica CFO Donald Merril said the price increases since October have been 15-20% higher than they were a year ago but not above $45/ton.

At Hi-Crush, however, the company already is "seeing leading-edge pricing approach $40/ton at the mine gate and [we] expect further increases as we continue through the quarter," Rasmus said.

Price Trajectory May Slow

As mines restart this spring, "the trajectory of price increases may slow a bit during the second quarter but quickly pick up again as the industry adds more rigs, completes more wells and continues using more sand in each well," Rasmus said. "The industry is using record levels of sand on a per stage and per well basis, and there is limited inventory of low cost supply currently idled. So we expect demand to still exceed supply and pricing to continue on a steeper upward trajectory."

Fairmount's Deckard said the company had "implemented price adjustments across all raw sand products...and we’ve now completed our customer communications for our second-quarter price movements...Market demand and pricing have continued to trend upward, and we expect there will be further opportunities to achieve a more sustainable pricing position for our business as the year progresses."

U.S. Silica has become Halliburton Co.'spreferred provider, and that's key as the OFS giant is the largest frack provider in North America. Deckard also said interest in securing long-term contracts has risen.

"As demand forecasts across the industry have moved higher, customers have been increasingly interested in agreements to assure future supply," she said. "These discussions generally follow our long-held practice of including pricing constructs that comprise some function of market-based pricing. This gives us the flexibility to quickly adapt to changing market conditions and allows us to share the benefits of a rising market along with our customers. Most of our contracts have been, and will continue to be, structured to have minimum volume elements with established shortfall provisions where appropriate."

At Hi-Crush, Rasmus said existing contracts should renew at a higher price that could be 50-100% higher.

Smart Sand's Young said spot pricing is as high as $30-40/ton for 2Q2016 delivery. The finer grade 40/70 mesh sand is priced at the upper end of the range.

Pressure Pumper Concerns

"Sand remains the biggest source of concern for pressure pumpers, but this could prove to be a temporary bottleneck given additional supply and an inadequate seasonal inventory buildup last fall," Evercore ISI analyst James C. West said. He and his team spent several days earlier this month with various OFS players to get their view on North America.

Overall, executing "superior sand supply/logistics" will win the day, as producers pump up the volume on fracture stages and more newcomers attempt to gain market share, West said. For example, Schlumberger Ltd. is addressing its fracture bottlenecks by vertically integrating its supply chain, from sand mine to last-mile trucking. The company plans to purchase and activate four Wisconsin white sand mines, in addition to adding railcars, transloads and pneumatic trucks to "completely control sand supply."

Logistics are Halliburton Co.'s biggest concern as well. The largest fracture specialist in North America secured U.S. Silica as its preferred vendor, but as business began to ramp late last year, the lack of 40/70 mesh sand is an issue because sand operators don't mine in the winter.

"Mine operators didn't expect the ramp we saw," West said of Halliburton's concerns, and they were "not overly concerned about long-term capacity given 19 mines coming on line this year." Halliburton is able to self-source about half of its logistics requirements under its "peak demand" scenario. The biggest costs are associated with trucking, which U.S. Silica has alleviated with Sandbox to manage the proppant supply chain.

Expect more competition in the months to come as demand eclipses supply. Besides more sand players getting into the business, more logistics providers want to grab some market share.

On Thursday, Solaris Oilfield Infrastructure filed an S-1 Form with the U.S. Securities and Exchange Commission to publicly launch on the New York Stock Exchange under "SOI." The company, which provided no pricing details, manufactures and provides mobile proppant management systems that unload, store and deliver proppant at oil and natural gas well sites, similar to the capabilities of Sandbox.

Solaris systems now are deployed in many onshore basins, including the Permian, Eagle Ford and Oklahoma's stacked formation. Since beginning operations in April 2014, Solaris has grown its fleet to 33 systems from two. It plans to increase its fleet to 60-64 systems by the end of 2017 "in response to customer demand."

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