There’s a colloquialism, “taking sand to the beach,” because sand is just so damn plentiful—except it’s
mostly in the wrong places. I’m talking about “frac sand” used as a proppant to increase recovery rates
in oil and gas wells. The sand that is desired is Northern White sand, predominantly found in
Wisconsin—the shale wells are spread in various basins many hundreds or even over a thousand miles
away.
The current prevailing view of frac sand producers is that they’re producing a commodity product. They
experienced a few good years as demand for sand ramped up faster than supply, then drilling activity
collapsed—right as a bunch of supply is coming online and destroying margins. This would explain why a
company like HCLP is down 90% in a year. Here is a contrarian view of the sector.
Frac sand producers are really in the supply chain management and distribution business. The ability to
reliably service well operators with the right amount (full unit trains), grade of sand, delivered as close
as possible to their wells and do it effectively and cheaply will create a moat around certain of the larger
players. HCLP is the 4th largest frac sand producer in North America and will be the 2nd largest frac sand
producer in North America following the completion of the Blair facility owned by HCLP’s sponsor. This
dominance shows up in the recently announced third quarter where sales volume increased by 18%
sequentially while costs dropped by 16% sequentially at company owned facilities (1.4m tons in Q3 vs 1.2m in Q2)—showing increased
market share and the scale produced by increased size, even in an industry where demand is currently
contracting and many competitors are going out of business.
On the demand side, over the past few years, there has been a sizable increase frac sand intensity, or
the number of tons used per well completion, due to increases in horizontal well length, number of frac
stages, and the volume of frac sand used per stage. Overall, frac sand usage per well has been increasing
rapidly with 10% to 40% increases per well in just the last year and 2 to 3-fold increases since 2012—
depending on the basin in question—this is the result of repeated experience that more sand used,
leads to better long term recovery and well economics. In terms of well economics, frac sand is the thing
that producers aren’t skimping on and as prices per ton drop—they’re using more.
However, this trend of increased frac sand intensity has been more than offset by a sizable drop in
overall wells drilled. Over the past year, overall frac sand usage has dropped from around 5 million tons
per month to about 2 million tons today (indicating that HCLP has roughly 25% market share based on
third quarter numbers). As a result, frac sand prices have also collapsed (HCLP realized price per ton
dropped from $88 in Q4/2014 to $57 in Q3/2015), creating the current opportunity.
My contrarian view is that current sand usage will stabilize a bit below current levels as a function of drilling
levels stabilizing at a slightly lower level than today—offset by higher frac sand intensity and an
increasing trend of secondary hydraulic fracing of older wells to increase permeability. Many new frac
sand projects will be cancelled, high cost projects shuttered and existing players with high quality
distribution infrastructure in place will have a strong competitive advantage that will allow them to
continue to reduce costs over time as they add to their existing infrastructure—further strengthening
this dominance.