It was the best of times, it was the worst of times. Yes. That's a Charles Dickinson quote from A Tale of Two Cities.
Hi-Crush Partners (HCLP) finally made the move certain investors were clamoring for, which was to progress further on the track towards becoming a C-Corp. I could care less about the move, as investors who think the stock is trading on these news events are foolish.
Both, frac sand players and oilfield services companies, alike, are falling for the same reason: high costs and capital intensive structures, combined with a temporary slowing in completions, are causing margins and earnings to shrink. If that is not the reason, then it is far more sinister...it is due to de-bundling (which we have talked ad nauseum about).
If HCLP is falling for the dividend, then why do other frac sand players who don't have a dividend follow suit? Do you really think HCLP is somehow blazing its own trail with the eventual C-Corp conversion, and therefore it trades with a mind of its own? They fall in sympathy with one another because algos dominate the trade. Then short traders jump on board. It can't be any other reason.
This is why I am staying long frac sand players like HCLP, dividend or no dividend, because PRICING fears are wrong. Let's analyze why a Tale of Two Cities exists with frac sand players, white rail vs. brown trucked, and why this will always create a stable in-basin pricing environment for the long-term.
Please challenge me in the comments section below the article about frac sand pricing. I would also appreciate any other valid reason for why frac sand players are falling. But, odds are, sand stocks are reaching bankruptcy levels due to pricing forecasts, which I will to attempt to dispel.
Just because some analyst (who I've met and spoken personally with) said we overbuilt frac sand to 200 million tons, and that things appear "dire", it doesn't make it the reality for the larger, lower-cost sand producers. He also agreed that the Big 4 public frac sand companies would be safe.
It just means that the higher-cost miners will lose, while the lower-cost miners win. Look at HCLP's recent earnings revision. They are lower, but still healthy at over $200 million in revenue. If the market is six months to a year forward looking, then HCLP should already have the slowdowns priced into shares, as 2019 and a resumption in completions lie right around the corner.
Halliburton (HAL) also confirmed on their conference call today that 2019 is still on track to be the big year everyone is waiting for, as DUC levels are high, and larger takeaway capacity coming online is paving the way for production to grow further.
Schlumberger Limited (SLB), just confirmed that they overbuilt their pressure pumping fleet with OneStim, and pricing struggled as a result. So, pressure pumping has the same problem as in-basin sand; anyone can train a new completion crew or build new horsepower, just like anyone can SUPPOSEDLY build a mine. But, pricing would fall for any service segment who gets overbuilt and taken in-house by E&Ps. So why is sand getting axed more than others?
It must be pricing fears. People fear that a new sand mine can be built in every basin, and then pricing will eventually be ruined. But, this is not possible because sand is heavy and bulky, unlike every other facet of the oilfield services sector, and cannot be moved by truck further than 300 miles.
Since frac sand companies won't do it for us, let's construct a pricing model with which we can base an investment thesis to go on.
Starting from the top:
1.) Sand was sold out at 100 millions tons in 2017-2018, with spot pricing reaching the $90's, at one point (this according to conference call research, it was not necessarily announced outright to the public).
2.) Then, at 150 million tons forecasted to be built, frac sand companies like HCLP said this would not be enough. So, pricing stayed in the $90s at that point (as far as I know, please challenge otherwise). Maybe pricing even fell to the $70s at that point. That is ok. It was in-line with contract pricing anyway.
3.) Then, when we got to 200 million tons, NW pricing plummeted to the teens, apparently (just a rumor), while local brown sand stayed up in the $60s and $70s, according to U.S. Silica (SLCA).
What the heck happened to NW pricing then? Apparently, NW was displaced by brown, and when delays in completions came, pricing woes were exacerbated. So, local, in-basin sand pricing stayed strong, while NW sand from Wisconsin struggled. Sounds like a tale of two cities, where in-basin sand is trucked and NW sand is railed. This is a caveat with huge implications.
This means that in-basin pricing will always remain strong, since E&Ps are making a switch to truck over rail, which virtually takes NW sand out of the equation since it cannot remain in-basin. It has to go back to Wisconsin because no one wants $50 rail costs. Thus, NW is basically swapped with brown, and you have a wash on supply. Yes, NW will struggle as it is displaced. But, pricing is done by basin, not by overall supply. So, in-basin will always remain strong since NW is completely gone from the basin, as E&Ps made the choice to go with truck vs. rail (which saves $500,000 per well).
Those savings are also going away, by the way. As NW gets cheaper, let's say to the $20s, then adding in $50 for rail costs gives you $70/ton, which is almost better than going with brown since NW helps with decline rates, and actually makes more money per well than brown. This delta change should help with NW pricing in southern basins, along with decline rates becoming a bigger issue by the day, which is prompting some E&Ps to use NW again. Also, northern basins will continue to demand NW from the LOWEST-COST producer (The Big 4).
So, I just laid out the reasons for why pricing fell to the levels that they did in numbers 1-3 above. Now, let's predict where they are going.
4.) If we are at 200 million tons now, then that number has to be almost cut in half due to fungibility. Nameplate capacity is never effective capacity. So, take out 25 million tons to be conservative.
5.) Take out another 12 million tons that HCLP and CVIA just idled. Now we are back to about 150 million tons of effective capacity, when adjusting for fungibility and idled tons. SLCA also expects another 10 to 15 million of high cost tons to be idled, which will be positive for pricing.
6.) Remember, at 150 million tons, frac sand companies were still sold out at attractive pricing in the $70s to $90s recently. So, if we are back at 150 million tons, then that gets us right back to where we started- sold out at attractive pricing ($65/ton to $75/ton, where contracts were inked.)
This is what needs to be challenged. Also, take into account that frac sand usage is supposed to climb 10% a year for the next few years (this is the only services segment that is growing instead of being phased out by efficiencies and de-bundling that I can find), and this will require more mines.
But, for the numbered reasons I stated above, as well for the fact that sand is the ONLY service that is impossible to move without a logistics network (which small guys don't have), and investors will start to see that the pricing picture is not only bullish for Hi-Crush, but it is the only services segment that will NOT get hurt from de-bundling. Please challenge otherwise.
I don't have a problem with the algos and short traders taking all services stocks to the woodshed, or bears having an opposing side to frac sand based on fairy tales and myths. As far as I am concerned, it is a free country, and they just create more opportunity in the end.
What I do have a problem with are people pricing frac sand stocks for bankruptcy, because it is hurting people's jobs and portfolios now. Some of these frac sand names, like Emerge Energy (EMES), Smart Sand (SND), and Covia (CVIA), are now in the low single digits, and seem headed to zero, for what? For idling some mines in the North?
The reasons are due to pricing and de-bundling, which, as I articulated above, will work in favor of frac sand players, while other services segments in the oil & gas industry will suffer.
I don't claim to have answers. I only have pieces from a giant jigsaw puzzle that are given to me by my contacts in the industry, and by my old fashioned research from sitting on endless conference calls.
One more important note to make is that after talking to HCLP and some of my partners today, I found out that the idling of their mine before expansion was just a rumor that some of my partners heard, and not necessarily true.
But, whether HCLP knew about the idling or not before hand is really not the issue. The point was, their NW will be needed, even with expansion of brown, and SLCA confirmed that in today's conference call.
Bottom-line, I see a disconnect by Wall Street, and only want to be challenged about my investment thesis in Hi-Crush (that pricing should stay strong long term in the $60s and $70s), since many investors in frac sand think that these stocks are providing some of the best opportunities available in the stock market today.
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Disclosure: I am/we are long hclp EMES CVIA SLCA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.