Leading fracture sand provider U.S. Silica Holdings Inc. is “completely sold out” and “literally selling everything that we can make,” CEO Bryan Shinn said Tuesday.
Business has never been better, but with the increase in activity, particularly in the Permian Basin, it’s a two-edged sword, said Shinn, who led a conference call to discuss first quarter results.
U.S. Silica provides sand for all types of commercial endeavors, but the demand for sand used by exploration and production (E&P) companies to fracture wells “is probably the strongest that I've seen, in terms of demand,” Shinn said. “The market is as tight as I've seen it in my several years in the industry.”
U.S. Silica sold all of its operated transload facilities and operates as an asset light firm, with flexibility to take or not take transloads as needed. In a sector where logistics is imperative, the company chose to control the last mile by investing in sand mines sited near major oil and gas basins. So far, so great, with oil and gas sand tons rising 3% sequentially in the first quarter.
“We sold a record 3.3 million tons in oil and gas during the quarter, despite some extreme winter weather conditions and a sluggish start by some of our oil and gas customers,” Shinn said. Because of the “breadth and depth of our mine and transload network, we were not adversely impacted by the widespread rail disruptions that many in our industry experienced in the first quarter.
“It’s a difference in philosophy, perhaps, between us and our competitors...We have chosen to establish a network of trusted partners. We let them invest the capital and then we utilize the facilities and have contracts of varying lengths with those suppliers. And we think that works really well.”
The oil and gas industry is cyclical, but “what we don’t know is when the cycles are coming.”
Fracturing activity also is not static. As E&Ps move from location to location, the company isn’t locked into a series of transloads in which it has invested a lot of capital.
“It seems like it's better to let others do that for us,” said Shinn. “I'd rather take our capital...and invest it in other growth projects and return that to investors.”
The company has increasingly directed its efforts to Texas. It bought New Birmingham Inc. affiliate NBR Sands to serve its East Texas customers, allowing it to more than double operations to 2 million tons/year. It also snapped up Sandbox Enterprises LLC, a fracture sand logistics company, to manage the proppant supply chain.
Sandbox has proven its worth, with the contribution margin up 23% sequentially in the first quarter, driven by higher volumes, lower costs and targeted price increases. About 71 Sandbox fleets were deployed between January and March, and March set an all-time record for monthly Sandbox loads shipped, Shinn noted.
“Demand is really strong right now. We've got...probably 25 to 30 fleets that we're currently in discussions with a variety of customers on. I was actually talking to a customer just the other day that was thinking about switching 10 fleets to Sandbox. So, there's a lot of momentum there. There’s a lot of interest in the last mile of delivery, and particularly in containerized solutions...What a lot of folks recognize is that there are just tremendous savings there, certainly versus the pneumatic systems.
“We're seeing maybe 50% fewer trucks and truck drivers to deliver by containers versus pneumatic...Typically, the way we think about is, we'll share those savings with the customer, so we make a good profit, but customers also see reduced costs and improved service.”
Most of the business is in West Texas, where U.S. Silica has two in-basin sand mines underway. An oil and gas sand mine in Crane County started up in the first quarter and is running at about 500 tons/year. It should ramp to 1 million tons/year by mid-year and reach full capacity of 4 million tons/year in the fourth quarter. The second facility in Lamesa is on track to reach full capacity of 2.6 million tons/year also by the end of the year.
Building sand mines in the rugged Permian has not come without drawbacks, however.
“Generally, we've seen a couple of different kinds of issues out there,” the CEO said. “The first was vendor fabrication issues, and there's an awful lot of steel when you look at what's involved in putting these type of facilities up…
“Labor is certainly an issue out there right now. We're hiring people as fast as we can, but it seems like for every 10 people we hire, one resigns to go work somewhere else. Unemployment is really low in the Permian.”
Another challenge is in the mines themselves, as the deposits in the Permian “contain clays and muds and a lot of other things that are difficult to properly process, especially in a low water environment like most of us are running in West Texas.”
Local sand production is expected to come online “much slower than many predict and...demand will grow much faster than our industry can bring on capacity, further exacerbating the current very tight market,” Shinn said.
In the oil and gas market, the management team continues to see strong demand for northern white sand, regional and local fracture supply.
“More rigs, longer laterals, more sand pump per foot and greater rig efficiencies from pad drilling are driving sand volumes per well up and to the right,” Shinn said. “We estimate that the total fracture sand demand run rate to date is greater than 100 million tons per year, and we expect demand to ramp throughout the year at a faster pace than capacity additions. Accordingly, we expect the market to remain extremely tight throughout 2018 and into 2019.”
U.S. Silica’s second quarter oil and gas sand volumes are expected to climb by 10-15%. The company has contracted slightly more than 70% of its total oil and gas sand volumes, with a weighted average length of about two-and-a-half years.
“However, given the projected tight market into the future, several customers have recently approached us about extending and upsizing some of the contracts that we have just signed, as well as adding Sandbox delivery services to ensure uninterrupted sand supply,” Shinn said.
Based on demand, spot pricing should continue to increase in the second quarter at “mid-single digit rates,” with some of the contract volumes, indexed to the horizontal rig count, reset at higher prices too.
Net income was $31.3 million (39 cents/share) in 1Q2018, versus $2.5 million (3 cents) in the year-ago period. Revenue climbed by 2% sequentially and 51% year/year to $369.3 million.
The company anticipates capital expenditures for 2018 will be $300-350 million, mostly because of capacity expansion projects that were started in 2017 and from continued investments in Sandbox.