Shale Bonanza Subsiding For U.S. Frac Sand Miners As Low Prices Bite
There was a time when the price of frac sand, a critical component of the hydraulic fracturing mix, appeared to be highly correlated with the price of West Texas Intermediate crude oil. However, the last 12 to 18 months have been anything but.
No matter which data aggregator you turn to, chances are recent records would rarely indicate prices exceeding $30 per ton for all frac sand types. These include the Northern White, Brown Sand from Hickory formation, and in-basin sand from West Texas mines. That’s because a supply and demand imbalance in tandem with capital expenditure (capex) constraints of majority of U.S. shale players are hammering the market.
For starters, frac sand supply is forecast to increase by around 25-28% in 2019 on an annualized basis. A number of in-basin mines in the Permian and other basins currently being developed, but which are not yet operational, could boost total U.S. frac sand supply to 250 million tons. It has prompted rating agency Moody’s to predict low frac sand prices for the “foreseeable future.”
At the same time, with just 10% of shale oil companies being cash-flow positive, according to analysis firm Rystad Energy, which examined the finances of a 40-company sample; a further squeeze on the price per ton they would demand of frac sand producers coupled with lower tonnage they ultimately require for tempered drilling activity is to be expected.
Inevitably, frac sand producers will feel the heat as prices continue to weaken. Based on market sentiment and available data, many U.S. miners have revised their revenue and earnings expectations downward, says Emile El Nems, Senior Analyst at Moody’s.
“Meanwhile leverage has increased, valuations have collapsed and access to the capital markets has softened – all of which limit the prospects of frac sand producers for mergers and acquisitions.”
Intra-market dynamics are having a bearing too. “Ultimately, U.S. frac sand companies remain challenged by an oversupply of cheaper brown sand closer to basins in which oil wells are located and by the ongoing displacement of more specialized Northern White Sand,” El Nems adds.
Furthermore, in-basin sand does not require much transportation and thus is more than 60% cheaper than Northern White Sand, making it economically compelling for oil and gas exploration companies regardless of its quality. These factors as well as volatile oil and gas prices have caused the price of frac sand to fall more than 20% over the past 12 months alone.
There is evidence of mine closures and production cuts as well as relatively higher oil prices, but Moody’s does not see any significant price recovery on the horizon. Oversupply from in-basin sand production will likely keep current prices range bound, the rating agency says, limiting upward profitability, particularly at a time when demand is constrained.
The correlation between the price of frac sand and the price of WTI crude oil is “permanently reduced” owing to such supply-demand imbalance and displacement risks, Moody’s adds.
And if the miners were betting on an uptick in drilling, Rystad Energy sees challenges there too, making a huge spike in activity unlikely. Only four shale companies in its examined peer group of 40 companies reported a positive cash-flow balance in the first quarter of 2019, bringing down the share of companies with a positive cash-flow balance from the recent norm of around 20% to just 10%.
“Total cash-flow from operations fell from $14 billion in the fourth quarter of 2018 to $9.9 billion in the first quarter of 2019. That is the lowest we have seen since the fourth quarter of 2017,” says Alisa Lukash, Senior Analyst on Rystad Energy’s North American Shale team.
“The gap between capital expenditure and cash-flow from operations has reached a staggering $4.7 billion. This implies tremendous overspend, the likes of which have not been seen since the third quarter of 2017.”
Dismal first quarter earnings of shale producers have only served to cement negative market sentiment. That said, Rystad Energy expects drilling activity to pick up in the second half of 2019. “Larger diversified operators, which have multiple cash generating engines and are more resistant to volatile commodity prices, will be especially poised to open up to acquisition of new acreage,” Lukash adds.
But that won’t substantially boost the fortunes of frac sand miners facing multiple circumstantial headwinds in a cutthroat industry.