Date April 2019
Gordon Brothers by the numbers
- Industry experts predict frac sand demand for 2018 will outstrip historical highs; demand growth is expected to be driven by an increase in rig count and increases in drilling efficiencies
- Analysts and investors are optimistic on sand proppant’s prospects as rig counts climb and exploration and production companies use increasing levels of sand as part of accelerated production
- Current valuations are critical in this volatile market
New market for Texas Sand: Because transportation costs are so high, industry operators have opened many new mines in Texas and surrounding states to take advantage of localized product. Corresponding with new mine locations, a new sand product has been moving to market over the past year. Texas brown sand, or “Texas sand,” varies in quality but is significantly cheaper to procure than traditional white sand. Brown sand typically meets American Petroleum Institute specifications for roundness, sphericity, clusters, and turbidity; however, some have reported issues with Texas sand not passing the acid solubility test. Beyond that, the main issue is that Texas brown sand has lower crush resistance—meaning that it does not stand up well under increased pressure during mining and can clog wells, but so far oil companies have been willing to overlook its shortcomings.
Additionally, companies are mining “waste sand” from previous years when coarse sand (20/40) was in high demand. This allows companies to produce more of the 40/70- and 100-mesh sand highly desired in today’s market. Fundamental changes in sand procurement will likely not change unless oil prices move to a higher range. Operators plan to bring approximately 40 million tons of new sand supply online by the end of 2018. While Wisconsin Northern White sand is still dominant, it now accounts for only two-thirds of the market. When compared to 100 percent only a few years ago, this indicates significant displacement for traditional sand.
Transportation most significant cost: The United States is the largest producer and consumer of frac sand in the world. Two-thirds of domestic production in 2017 came from the Great Lakes region (particularly Wisconsin, Minnesota, and Illinois), but most fracking takes place elsewhere in the country, thus sand must be shipped to shale basins up to 1,000 miles away or more. Moving sand from mines to transload facilities located near oil and gas plays is the most significant expense of production, accounting for upwards of 75 percent of the final cost for some producers. Further, mines that lack direct access to a railroad spur are forced to truck the sand to rail yards where it can be loaded onto railcars; therefore, it is advantageous for frac sand mines to have a railroad spur on site.
Wet sand warrants special appraisal considerations: To produce frac sand, raw sand is removed from the ground and then run through a wet plant that separates it into different grades (typical mesh sizes include: 20/40, 30/50, 40/70, and 100). Once sorted, the wet sand is run through a dry plant to reduce moisture prior to transport. Wet sand, therefore, is considered “in-process.” Lenders considering wet sand inventories as eligible collateral should consider that a conversion valuation scenario, in addition to an as-is valuation scenario, be completed in any inventory appraisal they engage. This would allow a portion of the wet sand to be dried so it could be sold through to customers. In the current marketplace, depending on the proximate distance to other dry plant operations, wet sand on an as-is basis may have little to no value.
Liquidation period: The liquidation period for frac sand inventories is primarily dependent on three factors: the volume customers are taking, how much wet sand is on hand, and how long it will take the company to convert the wet sand to dry sand. Often, bottlenecks in the production process constrain companies’ ability to convert and ship product. Considering the above, Gordon Brothers’ appraisers typically assume a four- to six-month liquidation period for the inventory.
Seasonality impacts inventory levels: In high-producing regions, such as those around the Great Lakes, long, cold winters impact the ways frac sand mines operate. Wet sand can only be processed when the weather is warm enough, typically April through November, with the exception of companies that have moved their wet plant operations into temperature-controlled buildings and can process wet sand during the winter months. To keep dry mills running throughout the winter, processors build inventories of wet sand throughout the summer, typically peaking in November. As Texas-based processors encroach on market share, this will become less of an issue. However, lenders should be aware of these fluctuations when analyzing collateral. Lenders should further note that dry sand inventory does not fluctuate in the same manner as wet sand. Most plants store dry sand in silos or covered rail cars and maintain capacity near or at the maximum for those containers.
Drilling impact: The demand for frac sand depends on drilling activity. Baker Hughes noted that crude oil rigs hit a low during the last week of May 2016; however, from that point through July 2017 counts were largely up-trending, which supported strong volume growth for frac sand. Crude oil rigs for the second half of 2017 were flat to marginally down, but 2018 has seen a turnaround. As of April 6, 2018, U.S. drillers had added oil rigs for the seventh consecutive week; the weekly count increased by ten rigs to 1,003, reflecting growth of 164 rigs from the prior year. Additionally, the sand proppant those companies use in hydraulic fracturing may enjoy its best time yet. With crude oil prices hovering near a three-year high, exploration and production companies are gaining confidence and spending more money on capital expenditures. Increasingly, analysts and investors are optimistic on sand proppant’s prospects as rig counts climb and exploration and production companies use increased levels of sand as part of accelerated production. This phenomenon has been the single biggest driver of improved well production in the United States.
Industry forecast: Driven by an increase in rig counts and drilling efficiencies, industry experts predict frac sand demand for 2018 to outstrip historical highs. The consensus estimates put expected demand at 102 million tons in 2018, which is a significant increase from the prior consensus estimate of 74.4 million tons. Forecasters remain optimistic on sand demand based on a number of secular trends, including longer laterals, more stages per well, and more sand per foot/stage.
The latter of these trends has started to become a concern, at least in some basins. At some point, there is likely to be a point of diminishing production return relative to how much sand is pumped downhole. Additionally, rising sand prices will likely inhibit ever-increasing sand use per well. Similar to the focus on expense savings that drove the shift to regional sand, higher-cost sand will likely force operators to be more creative with how sand is used in an effort to reduce costs. All in all, industry experts predict sand use per well will begin to slow down some time in the next 18 months.