Pressure pumping companies experienced a "monster" year in 2010 but even with new equipment being readied, demand is forecast to increase through the year, driven by growth in horizontal drilling and increased hydraulic fracturing (fracking) intensity, energy analysts said Monday.
"The pressure pumping party ain't over yet," wrote analysts with Raymond James & Associates Inc. J. Marshall Adkins, Collin Gerry and Michael Noll said they "unequivocally agree" that at some point the industry will overbuild. However, "we believe that this is more of an early 2012 event, as opposed to the growing consensus opinion of mid-2011."
In addition to higher demand, equipment "attrition rates are meaningfully higher than the industry has ever seen, which should cushion the effects of incoming supply," said the trio.
"The market is missing the impact of higher equipment attrition rates," said the analysts. "How long would your grandmother's Cadillac last if [race car driver] Dale Earnhardt Jr. took it for a couple of hundred laps around Talladega [Superspeedway] without a pit stop?
"That is what the industry is doing to pressure pumping equipment today. We believe equipment attrition rates are set to explode (no pun intended) in 2011 and 2012. This is the single biggest factor the market is not talking about and does not fully understand."
According to Raymond James data, annual attrition rates for pressure pumping equipment "are set to climb from mid single digits to upwards of 20% by 2012, which could equate to the equivalent of over 2 million hp per year being removed from the market."
Analysts said there should be "at least" two more quarters of expanding margins and higher earnings estimates.
"Remember, less tight does not mean oversupplied," wrote Adkins and his colleagues. "This should lead to strong pricing, margins and upside to current estimate for at least the next two quarters. That means there is still some meat left on the bone for the stocks to appreciate in this environment."
The Oil Services team at Tudor, Pickering, Holt & Co. Inc. (TPH) noted that 2011 began poorly for "last year's darlings." Pressure pumpers a lot of new capacity is being added and at some point the market will be oversupplied."
The U.S. drilling rig count "has been at a plateau (1,700 total U.S. rigs) for about a quarter (and number of frack stages per well or number of wells per rig don't change that much over such a short time frame) while the frack market continues to deliver new equipment, so yes, the market isn't as tight it was."
The question, however, isn't whether the pressure pumping market will be looser, because it will -- "unless the rig count surprises us and takes another leg up," noted the TPH analysts. A better question is "how long until it is oversupplied and how long are 'good' margins sustainable?"
The pressure pumping sector has been "much debated and much [is] not really known," said TPH analysts. "This frustrates us as it doesn't seem like counting trucks or horsepower is a terribly tough game."
However, there are a lot of moving parts, they said. Pressure pumpers have indicated they expect to add "as much capacity as it can in 2011...but we are skeptical of the 4.5-5 million hp numbers that get quoted. We think the three largest equipment builders can only construct a little over 1.5 million hp, and we struggle to see a bunch of service companies (which we don't know all the names of) aggregate to being able to build two times plus what the three largest suppliers can."
In addition, some exploration and production companies are moving into the market, and when producers "get in the game you know things are getting toppy. Our best guesstimate is that the industry can construct more like 3 million hp in a year," said TPH analysts.
When will the market become oversupplied? It's a difficult question to answer.
"We get bogged down in the myriad of variables in calculating demand and that leaves us lacking complete confidence in the numerical output," said the TPH team. "It depends on the number of frack stages per well in 2011" -- and gas drilling is declining while oil drilling is heating up.
"It is hard for us to see the market out of balance till late 2011," said the TPH analysts. "Pricing has likely peaked on a leading edge basis...The companies that can differentiate their horsepower with expertise beyond just the raw equipment and service at the well site will win share/better preserve margins."
The losers, they wrote, "will be those pumpers without contracts or without the ability to differentiate what they are offering the customer."
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