Frac Sand Production & Demand
Date April 2019
- Industry experts predict frac sand demand for 2019 will remain flat, but frac sand supply is likely to increase by approximately 30%
- Given increased supplies and flat demand, prices are forecasted to remain stagnant or even decrease in 2019; Free on Board origin pricing from the mines is not expected to surpass the $30-per-ton mark
- It is likely that Northern White sand mine idlings will take place in 2019 in response to the over-supply issue and increased market penetration from in-basin brown sand
- Current valuations are critical in this volatile market
Gordon Brothers by the numbers
Industry forecast uncertain: Driven by volatile oil prices, there is significant uncertainty in the market for 2019. With the long list of in-basin mines in the Permian and other basins, total U.S. frac sand supply could reach 250 million tons by the end of 2019, a 25 percent increase compared to 2018 totals. However, industry operators are only expected to increase demand slightly over 2018 levels, causing prices to remain depressed or in some cases even to decrease.
Increased demand for Texas sand: Because transportation costs are so high for Northern White sand, industry operators in the Permian Basin have increased their demand for in-basin sand, known as brown sand or “Texas sand.” It is estimated that by 2022, approximately 70 percent of the Permian Basin frac sand demand will be filled by brown sand. This is a significant change considering that as recently as 2018 approximately 75 percent of Permian sand demand was for Northern White sand. While brown sand often varies in quality, it typically meets American Petroleum Institute specifications for roundness, sphericity, clusters, and turbidity. However, brown sand has lower crush resistance than Northern White sand—meaning that it does not stand up well under increased pressure during mining and can clog up wells. However, oil companies have been willing to overlook its shortcomings due to the significant price savings.
Industry experts have predicted that by 2022, it is likely that Northern White sand will be completely pushed out of the Permian, Eagle Ford, Haynesville, and Oklahoma shale plays, and will be replaced entirely by in-basin brown sand. It should be noted that the demand for Northern White sand in the Bakken, Marcellus, and Canadian oil and gas plays should not be disrupted as there have been no substantial discoveries of suitable sand deposits in these locations.
Transportation most significant cost: The United States is the largest producer and consumer of frac sand in the world. A large percentage of domestic production comes 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 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 lending against wet sand inventories should request a conversion be conducted in an appraisal that would assume a portion of the wet sand would be dried so it can be sold through to customers. In the current marketplace, depending on the proximate distance to other dry plant operations, wet sand 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. Because of these considerations, Gordon Brothers’ appraisers typically assume a four- to six-month liquidation period for the inventory.
Seasonality impacts inventory levels: In Northern White sand 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 Texan 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 affects demand: The demand for frac sand depends on drilling activity. From mid-2016 through mid-2017 North American rig counts were largely up-trending, which supported strong volume growth for frac sand. Crude oil rig counts for the second half of 2017 were flat to marginally down. In 2018 there were positive and negative swings in rig activity throughout the year ranging from a high of 1,300 in early February to a low of 1,106 in late April. However, as a result of the decline in the price of crude oil, among other factors, drill counts have retreated somewhat in 2019. Baker Hughes reported that the North American rotary rig count as of March 29, 2019, was 1,094. This takes into account rigs in the United States, Canada, and the Gulf of Mexico. In the aggregate, rigs drilling for oil are down 2.9 percent from the same period one year ago. As of publication date, there were 33 fewer North American rigs drilling for oil than for the same period in 2018.
With crude oil prices in February 2019 approximately 12 percent lower than 2018 and with a backlog of supply on hand, it is likely that pricing will not be favorable for frac sand manufacturers at least in the near-term.