Investors now have the very first pure play on fracking sand … as U.S. Silica (NYSE:SLCA) went public on the NYSE on February 1st at $17/share, raising $42 million. Prior to this IPO, the only frac sand companies were either private or held by oil companies.
There is a huge - and growing - shortage on the high-quality silica sand required in the fracking industry. U.S. Silica is the second-largest producer in America.
Thomas Dolley, a mineral commodity specialist for the U.S. Geological Survey, best described what is going on in the industry… "It's a gold rush. Demand for frac sand is jumping through the roof."
Fracking an average well in the Marcellus Shale region alone uses about 7 million pounds of sand, worth an estimated $175,000 each to US Silica.
The company's average cost of production, as gleaned from its prospectus, is only $25 a ton while it can sell the sand for about $50 a ton. US Silica plans to use the funds to do a significant expansion of its commercial silica operations. This makes sense as it looks as if the price for frac sand is not coming down any time soon.
In 2010, U.S. frac sand production doubled to 13 million tons as new mines opened to meet demand from increased drilling activity. Demand for fracking sand soared even more in 2011 - Oilfield market research firm Spears & Associates reported it was about 22 million tons.
The CEO of EOG Resources (NYSE:EOG), Mark Papa, recently told investors, "There's been a sand shortage in the U.S. Those who have sand or access to sand can pretty much charge what they want for that sand." (EOG owns a frac sand company.)
This shortage occurred even though sand production quadrupled in the U.S. between 2000 and 2009.
Fracking Sand Industry
Silica-based sand is a key ingredient to the whole fracking process. The hydraulic fracturing process relies on massive injections of water and chemicals to break open (fracture) rocks. Sand and other "proppants" are pumped into wells as a sort of scaffolding.
Sand specifically is used to stimulate and maintain the flow of gas and oil in horizontally drilled wells.
The growth in demand for silica-based frac sand has created favorable supply and demand and pricing dynamics for the industry. That's why the price for commercial silica has gone up an average of 9% since 2000, with an acceleration to double digits in the last year or so.
Hydraulic fracturing consumed roughly 40% of U.S. industrial sand output in 2010, a rise from only 27% in 2009, according to the U.S. Geological Survey. This increased demand from drillers in turn has led to a race among sand mining companies to expand their operations.
The sand most in demand by fracking companies is the pure white quartz sand of the Upper Midwest. These sands are hard enough to withstand intense pressure and are round enough to let oil and gas escape horizontal wells. Wisconsin, for example, now has 31 sand processing plants planned or already running, up from just 18 last August.
The industry faces possible headaches on the transportation front. In the past, railcars were plentiful and cheap to lease. That is no longer the case, as frac sand companies are today being forced to pay from $500 to $700 each for railcars. It is easy to see how leasing 50 to 100 of these a month could quickly affect the bottom line.
Because sand is heavy relative to its value, the cost of train and truck transportation to remote well destinations is a very real burden to sand mining companies. The trade publication, Industrial Minerals, reported in 2011 that prices for sand were about $50 a ton before shipping, but were over $300 a ton when delivered.
But it might not matter how much money railcars cost - there literally just aren't enough of them to go around. There is an outright shortage of railcars, so getting the sand to well sites at all could be an issue in the near future.
The industry needs lots of railcars. That 7 million pounds of sand for a Marcellus well needs 35 railcars to deliver it. This has led to a shortage of railcars for use by the frac sand industry.
FTS International, a hydraulic fracturing company also planning an IPO later this year, sees a shortage for at least the next year of railcars needed to haul fracking sand to wells.
Railcars are in high demand nationwide … with railcar orders more than doubling to over 20,000 in the third quarter of 2011. According to the Railway Supply Institute, the order backlog for U.S. freight cars more than tripled in the same period to over 65,000.
For its part, FTS plans to increase its number of railcars leased by 28% to approximately 3,200.
Best estimates are that the railcar shortage will be taken care of by late 2013. If so, this will be great news for companies like U.S. Silica, which can then ship all the frac sand the shale industry demands with no bottlenecks restraining profitability.
Despite problems like transportation that are brought about by its rapid growth, the frac sand industry is an exciting new area for energy investors.
The industry has several big players. The largest include U.S. Silica, Unimin, Badger Mining, Fairmount Minerals and Carmeuse Industrial Sands. They were all privately-held companies.
As I mentioned, U.S. Silica is now public via its $212 million IPO, priced at $17 a share. The issue consisted of a total 11.76 million shares, with 8.82 million shares being offloaded by Private Equity firm Golden Gate. They purchased the company back in November 2008. Even after the IPO, Golden Gate will continue to own at least 74.4% of the company.
US Silica traces its origins back to 1900. It traditionally supplied its commercial silica production to a range of industries including the glass-making, building products and oil and gas industries. It now has 13 production facilities in the United States and currently controls 283 million tons of reserves. This includes approximately 138 million tons of reserves that can be processed to meet American Petroleum Institute frac sand size specifications.
Says Brian Shinn, CEO of US Silica, "The U.S. shale revolution is here to stay. We're in the early innings right now."
There are still a lot of innings for investors to catch.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.