Ceramic proppants have been under great duress recently, both literally and figuratively. Though acknowledged for their higher quality and performance, ceramics currently face decreased demand as more drillers are leaning towards the much cheaper frac sands instead. In this article, we will explore the proppant industry, specifically the current state of ceramics and its future outlook. Before we jump into that however, let me start by giving a brief overview of fracking as well as useful terms in describing proppants. I believe the introduction will be beneficial for our discussion later on.
Overview of the Proppant Industry
Hydraulic fracturing, also known as "fracking", is a process by which petroleum fluids can be extracted from deep underground. This is done by pumping large amounts of proppant mixture-typically a slurry of 90% water, 9% proppants, and 1% chemicals-into the drill hole; the hydraulic pressure forms fractures in the rocks. Once the well has been sufficiently stimulated, the pressure is released, and the proppants in the fluid keep the cracks open by serving as props, without which the closure stress from the weight of the rocks above would quickly close the cracks. The network of cracks creates a large surface area through which petroleum fluids can flow and be extracted to the surface. As a result, fracking has enabled previously non-recoverable resources to be successfully retrieved. The primary beneficiary of this process is the extraction of resources from shale rock formations which, with their high porosity (capacity to hold fluids) and low permeability (ability to let fluids flow through), have historically prevented oil and gas to be extracted at economical volumes.
A consideration in the fracking process is the type of drilling performed. Traditionally, vertical wells were used because of their simplicity and relatively low cost to drill. For those types of wells, pressurized fluids form horizontal cracks in the rock. Over time however, technology allowed for horizontal wells to be drilled. This is done by slowly adjusting the angle of the drill bit at the kick-off point, until the drill is running horizontally. The key advantage of horizontal drilling is the increased exposure to the source rock, and hence increasing fluid extraction; this is especially true for formations such as shale which run horizontally, as seen in the image below. As a result, horizontal drilling is preferred.
Proppants play an integral role in the fracking process. As their name suggests, they serve to prop the fractures created in the process of pumping pressurized fluid into the well bore. Without them, the closure stress from the weight of the rock above would quickly close the cracks and prevent the extraction of petroleum fluid. Evidently then, proppants must be able to withstand considerable pressure. They must be durable. If the external pressure of the crack is too great, it crushes the proppant into small grains called "fines", which clog up the cracks and impede fluid extraction. As a result, fine generation is extremely unfavorable, as the key function of proppants is to maximize fluid conductivity. Fining is generally more common the deeper the well-as the increased depth proxies the increased rock weight that must be propped-and is measured as a weight percentage of the initial stock of proppant.
Other important characteristics of proppants are their shapes and sizes, which also play a factor in conductivity. Proppant shape is measured by roundness and sphericity. Although these two terms can be used interchangeably in everyday conversation, they represent two very specific terminologies in the industry. Roundness is classified as the relative sharpness of the grain surface. Sphericity however is defined as how close the grain shape compares to a sphere. Hence, a smooth pancake-like object would be more round but not more spherical compared to a cube-like object. Using a little bit of spatial imagination, it is not too difficult to imagine that the most conductive proppants are those that are both round and spherical. Lacking one or the other leads to excessive proppant packing, which reduces the gaps between proppants and hence conductivity.
In addition to proppant shape, size is also a major factor in conductivity. Size is generally measured by the mesh size that could be used to sieve the particular particles. The larger the sieve size, the larger the gaps in the sieve, and hence the larger the grain. Typically, grain sizes range from 8 to 140 mesh (106 micrometers to 2.35mm) and are represented in intervals such as 16-30 mesh and 20-40 mesh, or 16/30 and 20/40 for short. Again with a bit of spatial imagination, it is not hard to see that the larger the grain size, the higher the conductivity. An exception is that when the closure stresses are too high, larger grains are more prone to being crushed, leading to increased fine generation. Another exception is that when the width of the crack is too narrow, larger grains cannot be effectively transported down the fracture to increase the crack length; "bridging out" usually occurs when the crack width decreases to less than twice the diameter of the proppant. Due to these complex considerations, choosing the appropriate grain size is also an important decision in the fracking process.
Frac sand is the most common and the most basic type of proppant. The particles are simple, durable, and relatively round quartz sand, and are typically mined from the ground, processed to remove fine particles, and sieved into specific size fractions. Because nature never cultivates perfect shapes, frac sands are neither very round nor very spherical, and though durable, they are relatively more prone to fining at a given pressure and grain size. As a result, frac sand is generally the cheapest type of proppant and is advised for use at shallow or intermediate depths--above 6,000 to 8,000 ft. Examples of frac sand are the Northern White and Texas Gold sand.
Recently, drillers have discovered that pumping more sand than needed into wellbores typically results in higher initial flow rates. As a result, together with frac sand's low cost and the massive quantities of it- about four million pounds- required for a well fracture, demand skyrocketed. This has led to many predictions that frac sand demand will outstrip supply in the near future, driving up sand prices. EMES, HCLP, and SLCA are examples of sand miners.
Sand can also be coated with resin to increase the strength of the proppant. Additionally, by covering the frac sand with a resin coat, even if the crevice stress were to crush the proppant, the fines would be contained within the resin coat. This can be greatly beneficial as research shows even 5% fines generation can impede conductivity by 60%. Currently there are two types of resin-coated sand: pre-cured (PRCS) and curable resin (OTC:CRCS). The former has a higher crush resistance, and because the resin is fully cured, it does not have a tendency to react and bond with other resin particles, resulting in less interaction with the fracking fluid. However, the latter has the ability to interact with other particles. The implication of this is that by sticking to other resin particles, CRCS is less likely to "flowback" to the surface when hydraulic pressure is released and damage collection equipment. These advantages over frac sand allow resin-coated proppants to command significantly higher prices.
Ceramic proppants are by far strongest of the three. Man-made, typically from a ceramic like bauxite, a component of aluminum, ceramic proppants are created by fusing powered ceramic at very high temperatures to form tiny beads of high sphericity and roundness. Additionally, because much control can be exercised in this process, size and specific gravity can be highly customized to the specific environment. This allows for superior conductivity and crush resistance. As a result, ceramic proppants command a significantly higher price than even resin-coated sand and have historically been about 10 times the price of frac sand. Currently, drillers mainly use ceramic proppants at intermediate or deeper depths-over 8,000 ft-where significant closure pressures exist.
The Bakken is a shale formation that lies under North Dakota, Montana, and the Prairie provinces of Canada. The Middle Bakken, the target of much of the fracking activity, consists of pyritic mudstone, a siliceous mineral that is very brittle. Coupled with the fact that Bakken reserves are located relatively deeper compared to other high-growth basins, the formation is particularly suited for ceramic use: the hardness of the rock allows for larger width when cracks are propped open, and at those depths, the threat of fine generation is very real. As a result, Bakken is currently the largest market for ceramic proppants. According to Goldman Sachs, roughly 50% of the wells drilled there use ceramic proppants, or 30% to 35% on a proppant volume basis. Another report shows a similar market share.
However, even in the Bakken, we can see increased interest in ceramic alternatives. A large driver of this is EOG's recent success in the region using an all sand approach. EOG's Three Core wells in Mountrail Country, completed during Q2 2014 ending June, had initial production rates of 1505, 2410, and 2690 BOPD. To put that in perspective, only about 6.1% of wells in Mountrail have an initial well production rate of greater than 2000 BOPD; and EOG had two of its three wells in that category. It is unlikely that this will cause a radical shift to frac sand in the region as the basin is already quite mature, and switching costs-both monetary and those associated with straying from a well-proven practice-are significant. However, for ceramics, even a slight decrease in demand in its largest market will have considerable effect on prices.
Most other high-growth basins, unlike the Bakken, have a low Young's modulus and a high clay content; that is to say, they are made up of "soft" rock. Such basins consist of the Eagle Ford Formation and the Permian Wolfcamps B/C/D (Cline) among others.
When rock is ductile, it has a tendency to wrap around resistance. In the case of proppants, this results in embedment as the rock wraps around the proppant, increasing the possibility of partial fracture closure and taking away much of the conductivity advantage of ceramics. This is especially true in narrow cracks propped open by only a single- or double-layer of proppants, as you can see from the image below. The set-up on the right depicts a soft formation where the rock wraps around the proppant, greatly decreasing crack width; the set-up on the left depicts a brittle, hard rock formation propped at the full diameter of the proppant.
[Image created by author from stock image]
In response, oil drillers have come up with the technique of increased proppant loading. Using this method, short, wide cracks are preferred over traditional long, thin ones, and an overdose of proppants is injected to essentially plug the short, wide cracks. The benefit of this method is that a multi-layer of proppants is formed, and only the outside layers would be embedded in the soft rock. More about the benefits can be found on page 415 in this book. Empirically, this technique has yielded great initial production rates, and more and more drillers in soft formations have been switching to frac sands as a result. Although ceramics can be used here as well, lower-cost frac sand is preferred due to the large volumes required for this process.
Perhaps the most recent high profile switch to this technique was that by Rosetta Resources (NASDAQ:ROSE). Earlier this year in August, ROSE announced that it would be changing its completion design for its Eagle Ford wells from using ceramics proppants to frac sand. The move was estimated to save ROSE 250 million to 400 million pounds of ceramics per year, or roughly $500,000 per well; Pioneer Natural Resources had switched over to frac sands as well a year earlier, which also resulted in $1.1M of savings per well. ROSE will be joining other drillers in the Eagle Ford including EOG Resources, ConocoPhillips, and Anadarko who are already using frac sand-a group that represents the majority of operators in the region.
This change in proppant use could be sign of a secular shift away from ceramics and to frac sands, at least in the short-term. In the following section however, I will be looking to the future and presenting reasons why I believe this trend is not likely to continue in the long-term. The ceramics market is only in temporary duress.
The Future of Ceramics
From previous sections, it is clear that ceramic proppants have very distinct advantages over frac sand and resin-coated sand. Not only are they more durable hence less prone to fining, ceramics can be custom engineered into specific and uniform shapes and sizes that fit the drilling performed: the strength of the ceramic chosen for a specific depth; the size adjusted for the desired fracture width to minimize bridging; and the shape tailored for the fracking fluid used to prevent flowback. In fact, studies have shown that under all relevant stresses, ceramics allow for much higher conductivity than frac sand and RCS; and in certain formations, ceramics are irreplaceable because of well characteristics. The key question is whether ceramic's advantage will justify its historically 10x price tag for future drillers.
When looking at the future of ceramics, we can't just look at current trends. As Steven Jobs famously said, he never relied on market research reports because what he was looking for was not yet on paper; the job is not to understand where the market is right now but predict where the market will be. Doing so for the proppant industry, I believe there are two key signs in current trends that point towards a more ceramics-friendly future: rapid well declines with the increased proppant loading method and the inevitable depletion of easily accessible wells.
Rapid Well Declines
Although the practice of using increasing proppant volumes enables drillers to achieve higher initial production rates, it also results in a much steeper drop in production afterwards. Take Eagle Ford wells for example. Because of the new hydraulic fracturing paradigm-aided by more effective use of geologic data in pinpointing optimum drilling locations of course-production rates after the first full month of operations have soared to almost 400 BOPD in 2014 compared to around 325 last year, and 275 a year before that. However, the decline after the first month is much steeper as a result.
The steeper production drop-off is alarming because its implications could be disguised under the good fortune of increased initial production rates. As an EIA operations research analyst puts it in an interview , "It remains to be seen whether the expanded use of proppants will lead to long-term production increases… It's still unclear what effect this sort of approach will have five or ten years down the line." This is not to say that increased proppant loading is definitely detrimental to the ultimate recovery of a well; but if anyone has conclusive research arguing the opposite, I would love to see it.
I do not claim to know the exact long-term effects of increasing proppant loading, but I dare to venture a guess as to why we are seeing a trend towards this new fracking technique-why there is an emphasis today on higher initial production rates even if it could be at the expense of total recoverable volume. We must first however look at the history of oil in the U.S.
The U.S. used to be the powerhouse of crude oil production. In fact, all the way up to 1971, it was the Texas Railroad Commission that served the function that OPEC does today-regulate global crude production and hence prices; and regulate it did all the way back from 1930 when Dad Joiner discovered the East Texas oil field. However in 1970, U.S. crude production peaked at what was dubbed the Hubbert peak, named after the fellow who predicted it. As a result, the leverage shifted to the OPEC nations who were delighted at and not afraid to wield their new power. Just a few years later, in response to political catalysts, several OPEC nations stopped supplying crude to the U.S. Domestic oil prices spiked due to the supply cut, leading to panic among U.S. consumers who have learned to depend on oil. OPEC's dominance in global crude supply continues to this day, and it was only in 2007 that the U.S. crude production begin to rebound. Though it was not known at the time, the rebound would be fueled by what is now referred to as the U.S. shale revolution.
With this information in mind, it seems that perhaps the shale revolution has given the American people the power again to determine their own energy future-a power lost not even a full lifetime ago, remnants of which still lingers in the minds of many. That, coupled with the realization that the huge influx of crude supply from the shale revolution will drive down global prices, could reasonable incentivize producers to pump as much crude as they can today even if they know full well the detrimental effects to total recoverable volume in doing so. We can draw an analogy here to a child with a strong sweet tooth once again allowed by his mother to buy his own candy; we can also include the fact that he knows candy prices will soar (be less favorable) in a few months. I doubt cavities are at the top of his priority list, much less the long-term effects on his oral health.
We can see evidence that suggests this today. Producers are refusing to cut production despite tanking oil prices, each afraid that it will be disadvantaged if it does-disadvantaged if it doesn't maximize its production today. If this hypothesis were the case, there would be a time in the future-with a different global oil consumption and price environment-where the current utility of higher IP rates no longer outweighs the future utility of maximizing total recovery per well by drilling with more conservative methods.
Transition to More Unconventional Plays
It is widely documented that humans, in their endeavors, usually go for the low-hanging fruit first, pushing off effort to the future. Drilling for oil is not an exception. As you see in the chart above, offshore drilling, a task that requires large amounts of capital with no guarantee of comparable returns, in the U.S. is producing less crude today that it did more than three decades ago in spite of numerous technological advancements since then. Of course, a considerable part of it has to do government regulations and increased safety concerns, but it is safe to say that producers found little incentive to engage in such risky endeavors when there were onshore opportunities ripe for the plucking.
Even in tight oil plays, we see the easy wells drilled first. Take the Bakken again as an example. The formation actually consists of the Bakken formation on top of the Three Forks formation. It has historically been the Middle Bakken, at a depth of 4,500 to 11,000ft, that was most worked and that produced mind-boggling volumes since drilling exploded at the start of the millennia. However, it was only in mid-2008 did producers begin targeting the deeper Three Forks formation. As time goes on, it is inevitable, given our innate tendency to prefer the easy road, that we will be forced to dig deeper and deeper for our treasured black gold. At depths of 4,500 to 11,000ft, producers can still cheat by substituting frac sands. But when we go even deeper, I doubt that option will still make sense.
A key consideration in speculating the inevitable transition to more unconventional plays is the timeline at which it will play out; such a transition happening in the next few years will have a much greater effect on ceramics outlook that one happening next century, at which time renewable energy may likely be a feasible, complete alternative for oil. From my readings, I am inclined to lean towards the former.
The Monterey shale formation in California was hailed as the next Bakken; technically recoverable volumes were consistently estimated at the low-mid teens billion barrels and had represented about two-thirds of total U.S. shale reserves. However, earlier this year, the EIA reduced the 13.7 billion estimate by 96%, hence effectively cutting total U.S. shale reserves by 67% as well. In addition, the remaining oil is reported to lie at significantly lower depths-pushed by frequent seismic activity-compared to other popular formations. News such as this has checked the bullish outlook on U.S. shale production and points towards a not-so-distant future in which we likely have to try harder for our oil.
Offshore drilling is an alternate source of oil in which ceramic proppants can play a big role. Fracking techniques are already being used underwater by offshore drillers to help with returns on capital. In addition, even the government seems to be pushing for it. 21.6 million acres in the Gulf of Mexico were recently put up for auction by the Obama administration. Much of that acreage contains oil and gas in the Lower Tertiary, which is located in ultra-deepwater reservoirs more than 5,000ft underwater. At those depths, not only is rock weight significant, but the crushing pressure of almost a mile of ocean-water is also considerable. When global crude prices once again justify capital investment in offshore endeavors, I would not be surprised to see increased activity in offshore fracking. And as easily-accessible shale reserves deplete, and producers look towards deeper formations and offshore opportunities, it will likely be ceramics not frac sands that are up for the task.
Demand for ceramic proppants faced a sharp decline recently. Much of this was the result of a shift towards using increasing volumes of proppants to create short, wide fractures, which many producers have found to yield higher initial production rates. However, the physical advantages ceramics have over frac sands remain indisputable. In addition, there are signs that the current trend of increased proppant loading many not be sustainable in the long-term: sharp production declines point to potentially debilitating effects on well health, and the rapid depletion of easily-accessible sources forces producers to drill at deeper depths and in more unconventional plays. From these observations, I believe ceramics will bounce back and steal the spotlight from their oppressor. They will not be crushed by the pressure from frac sands.
Disclosure: The author is long CRR.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.