Industry Trend Analysis - Sand Project Pipeline Racing To Meet Fracking Demand - SEPT 2017

BMI View: US sand production will ramp up over the coming quarters, supported by rising prices and a robust project pipeline in response to growing demand from the oil and gas industry. Sand producers will prioritise projects in close proximity to active shale operations around the Permian basin to integrate logistics and boost cost competitiveness .

Demand for sand from the US oil and gas (O&G) industry is accelerating due to a recovery in well completions and the increasing intensity of sand usage per well ( see 'Sand Demand Set To Boom', April 4). As such, sand prices will experience continued upside pressure, providing a boost to sand suppliers' profit margins while raising input costs in the O&G industry. In Q217, sand producer Hi-Crush Partners reported a 42.2% y-o-y increase in average prices to USD64/tonne, contributing to the firm's first positive profit margin of 12.1% in six consecutive quarters.

Rising Prices To Boost Sand Industry Value
US Producer Price Index - Hydraulic Fracturing Sand Nonmetallic Mineral Products (USD)
Source: Bloomberg

Frac sand - highly pure, crush-resistant silica sand finer than that used in construction - is predominantly produced from sandstone units in the upper Midwest (Wisconsin) and south-central regions (Texas) of the US. Frac sand is used as a proppant during hydraulic fracturing (fracking) to maximise output from unconventional oil and gas deposits.

In 2016, fracking accounted for approximately 72% of US industrial sand consumption, or 66.0mnt. Major domestic sand producer US Silica estimates total industry demand will increase to 70-75mnt in 2017 and to over 100mnt in 2018. Based on a high of 110mnt produced in 2014 combined with planned projects from major sand suppliers, we expect US sand output will meet demand in 2017, with the market balance to tighten thereafter.

Fracking To Eat Up Sand Production
US - Industrial Sand And Gravel Production & Sand Used For Hydraulic Fracturing (mnt)
Source: USGS, BMI

New Projects Targeting Nearby Shale Plays, Improved Logistics

Major US sand producers will prioritise greenfield projects located near active shale operations to reduce transport costs and boost their competitiveness. In particular, the pick-up in drilling in the Permian Basin in West Texas will attract investment and encourage project development. With rising service costs in the US shale sector, of which sand accounts for approximately 5-10%, shale producers will expand their in-house sand capabilities to benefit from vertical integration. Key project developments include:

  • In June, US Silica announced plans to build a USD225mn frac sand mine and plant in the Permian, near both the Delaware and Midlands basins to target long-term supply contracts with leading oilfield companies. The firm expects production to begin in Q417, with total capacity of 4mnt per year.

  • In 2016, US Silica acquired proppant transport logistics firm Sandbox Enterprises to more efficiently and cost-effectively service well site operations.

  • In July, Hi-Crush Partners began production at the Kermit operation in the Permian basin, where output will total 3mnt annually. Hi-Crush is also developing the Pecos unit train terminal in the Delaware basin to support its Permian service offerings.

  • In July, Fairmount Santrol announced plans to develop a USD100-110mn sand mining facility in the Permian basin. The firm estimates annual production capacity of 3mnt, with construction to be completed by Q218.

Spending Uptick Targeting Texas Projects
Select US Sand Producers - Capital Expenditures (USDmn)
Est = Bloomberg estimate. Source: Bloomberg

Imports Will Prove Insufficient, But Long-Term Export Opportunities To Emerge

Silica sand imports will not be sufficient to offset the near-term deficit in the US market due to minimal production in other countries and higher costs associated with transporting the material that render it uncompetitive. In 2016, the US produced over half of global industrial sand supplies and imports accounted for only 1.0% US consumption.

On the other hand, as domestic production ramps up and US shale progress supports development outside of the country, US sand producers will see modest export opportunities in both North and South America ( see ' Shale Progress To Boost Development In Argentina, Canada ' , March 21). Indeed, in Q217, US silica sand exports increased 44.7% y-o-y to 1.1mnt.

The majority of US silica sand exports go to Canada, Mexico, Japan and Argentina, and our Oil & Gas team highlights Canada and Argentina to be the main beneficiaries of growing US unconventional expertise given the strong existing foothold of US companies in these countries. While Canada and Mexico produce small amounts of silica sand domestically, the build-up of unconventional O&G production would require additional sand imports.

Sand Exports On The Rise
US - Silica & Quartz Sand Exports ('000 tonnes)
Source: Trade Map

Risks To Outlook

We note two key downside risks to our otherwise positive outlook for the US frac sand industry. First, lower than expected oil prices could result in sand substitution or a shift in shale-focused companies to target gassier wells to reduce proppant needs altogether, as oil companies look to keep costs low. Any shift away from frac sand use, whether in favour of higher quality, albeit more expensive, ceramic proppant or to target gassier wells, would dent the demand outlook and leave the US sand market with a sizeable oversupply given the robust project pipeline.

Secondly, tightening environmental and health regulations could delay project development. While the push for deregulation under the Trump administration will likely improve permitting times, sand mining operations in more densely populated regions such as the Midwest, compared to remote operations in West Texas, could experience additional pushback from local communities. In 2016, the Occupational Safety and Health Administration passed new regulations to restrict exposure to crystalline silica at mine sites, to be implemented over 2017-2021.