Dallas-based Pioneer Natural Resources Co., one of the largest Permian Basin producers, has secured fracture sand reserves near its West Texas operations in a 15-year deal with U.S. Silica Holdings Inc.

The contract guarantees long-term supply from U.S. Silica’s mine now underway near Lamesa, TX, which is close to Pioneer’s Midland sub-basin operations. Pioneer also took a stake in the Lamesa mine, but no details were disclosed.

“Strategically located in close proximity to our Midland Basin acreage, delivered sand from the Lamesa mine will cost approximately half that of our current delivered sand, reducing well costs into 2019 and beyond,” CEO Timothy Dove said. “The long-term nature of this agreement will benefit both companies. U.S. Silica has been a trusted partner for many years, and this contract solidifies their position as one of our key suppliers of proppant.”

Pioneer, the largest acreage holder in the Midland with an estimated 750,000 gross acres, last month increased its Permian capital spending by about 15% for the year to $3.4 billion.

U.S. Silica CEO Bryan Shinn had said during a 2Q2018 conference call that customers were hungry for in-basin sand, when possible, as it reduces costs and logistics. By the second half of 2019, “I think we could see maybe 50-60% of the Permian demand being supplied locally,” he said.

The sand mine, underway about 60 miles north of Midland, is expected to produce about 6 million tons/year of predominantly fine-grade 100 mesh and 40/70 mesh sand, with initial production expected before the end of the year.

Pioneer is set to receive its initial sand volumes from Lamesa in early 2019, with estimated supply for the full year of around 1.4 million tons. U.S. Silica agreed to supply up to 2 million tons/year of sand in 2020 and beyond.

“The committed volumes de-risk a quarter of Lamesa’s 2019 and a third of 2020 capacity, and likely puts U.S. Silica’s combined Permian Basin capacity of 10 million tons/year within striking distance of its 75-80% contracted target range,” Evercore ISI analysts said Wednesday.

U.S. Silica management had disclosed during the 2Q2018 conference call that it had more than 30 contracts for a mix of northern white and local sand at fixed prices. It also recently signed four contracts expected to generate $250 million of contribution margins over four years.

“While we expect investors to continue questioning contract sanctity in an oversupplied market, not to mention pricing and margins given the deluge of ‘in-basin’ volumes coming online, we view U.S. Silica’s and Pioneer’s agreement as a positive sign completion activity will rebound in the Permian in 2019 and beyond,” Evercore analysts said.

Tudor, Pickering, Holt & Co. (TPH) also sees positives from the agreement, which it said was a boon for U.S. Silica.

“Long-term sand contracts typically shake out in the four-to-five-year ballpark,” so the contract length of 15 years, more similar to those for pipeline/master limited partnerships, “is eye-popping and quite the feather in U.S Silica’s cap…

“Beyond the impressive contract duration, U.S. Silica also gets a modicum of cash up front and we estimate contract margins of $20/ton ($40 million gross margin/year).”

Pioneer historically has used Brady, TX-area brown sand, “but materially lower delivered costs via Lamesa,” which TPH estimated would save 40-60%, “coalesce with Pioneer's desire to go to a finer, slick-water completion making Permian sand an optimal solution.”

Pioneer might be able to save up to $400,000/well for its Midland wells using the in-basin sand, according to TPH. 

Additionally, analysts “see further downside to well cost as finer grain, in-basin sand should allow for more slickwater completions, versus Pioneer’s more expensive cross-link gel design,” allowing the producer to leverage its  Permian water system and potentially reducing water disposal needs.