A fall off in Lower 48 exploration activity has slammed the sand mining sector, but some stability should return this year, according to Moody’s Investors Service.
In an in-depth analysis of the sector, analysts said the fracture (frack) sand industry already has been pressured because of low oil and natural gas prices, as well as by supply/demand imbalances and “irrational” pricing behavior. Over the past year, mining capacity has been idled, and some operators have reported dwindling funding sources. It should be better this year, however.
“Despite persistent weakness, we believe the industry hit bottom during 4Q2019 and will reach some stability by mid-2020,” the Moody’s team said. “We project demand for frack sand will increase from current levels once exploration and production (E&P) budget exhaustion fades away, leading the way to higher drilling activity resulting from a record number of wells that were drilled but remain uncompleted (DUC).”
Usually, the number of DUCs has been a “good predictor of future demand,” Moody’s analysts said. “We expect these wells will be completed, considering their average cost of $7 million each and the fact fracking represents a small fraction of the total cost of drilling a well (10-15%).”
Halliburton Co. CEO Jeff Miller, who helms the No. 1 completions expert in North America, said during the 4Q2019 conference call on Tuesday that the U.S. onshore rig count had contracted 11% sequentially, while “completion stages had the largest drop we have seen in recent history.” The reduction in activity led to layoffs and forced the company to stack equipment.
Last summer, proppant sand operators Hi-Crush Inc. and U.S. Silica Holdings Inc. said they were preparing for a decline as E&Ps cut back in U.S. land operations into 2020. The return to a more stable environment for the proppant operators is expected in the second half of 2020, according to Moody’s.
“We project pricing to improve as aggressive behavior from financially distressed operators diminishes and supply is reduced via ongoing production cuts and mine closures,” analysts said.
However, over the long term, “only bankruptcies and consolidation will provide the industry with relative pricing discipline.”
In the past two years, frack sand supply grew at a faster clip than demand, particularly from new in-basin production capacity in the Permian Basin, Eagle Ford Shale and Midcontinent.
“The new in-basin capacity has come to the market sooner than predicted by operators and miners at a time when growth in demand was slower than expected and in-basin sand gained momentum in displacing northern white sand (NWS), driven largely by its lower costs,” said analysts.
This year, the oversupply, when considering idle capacity, may limit upward price movement and profitability.
“Despite some recent mine closures and production cuts, we do not expect any significant price recovery in the coming months, with many miners committed to higher volumes at lower prices,” according to Moody’s analysis.
Sand prices at the shipping dock, aka free on board shipping, is likely to remain rangebound this year, from the low $20/ton price range for NWS and in the high $20s to the low $30s for in-basin sand.
Moody’s expects U.S. well drilling this year to remain “modest” with rig counts remaining below 1,000. Demand is expected to be stable, driven mostly by the high number of DUCs.
“There are more than 22,000 wells in the U.S. that have been drilled (at a cost of more than $7 million a well) with the expectation that they will be activated at some point in the near future.”
To activate, i.e. frack, the wells would require 5,000-10,000 tons/well of sand. Assuming the midpoint, demand to frack the wells alone would require more than 165 million tons of proppants.
There also is expected to be continued demand for higher frack intensity by the domestic E&P sector, which would drive sand demand higher.
“Since 2014, the required amount of sand to activate a well has risen with higher proppant intensity, longer lateral length and more stages per well,” analysts said. “This alone should add about 15-25% to yearly demand.”
Expect in-basin sand services to grow too, led by the Permian and Eagle Ford, according to Moody’s.
“On one hand, we expect in-basin supply in the Permian, Eagle Ford and Midcontinent basins to almost meet in-basin demand, forcing many sand providers without significant in-basin capacity to shut production down or idle some capacity.”
Because transportation costs are sharply cut with in-basin facilities, the sand is often priced at a 60-70% discount to NWS when all shipping costs are considered. Concerns about using lower grade commercial silica from in-basin mines versus NWS have “slowly dissipated with time” because there has been “little detriment” to wells.
However, sand demand in the Bakken and Marcellus shales and in the Rockies is expected to be “almost entirely served by NWS,” as the quality of local sand is considered poor and mining economics are unattractive.