A Frac Sand Mine Lands In The Permian. This Could Transform The Competitive Sandscape [Exclusive Details]
February 24, 2017 Infill Thoughts 4 Comments
After the market closed Thursday evening, Hi-Crush Partners quietly dropped the equivalent of an atom bomb on the frac sand business. Few seem to have noticed yet – Hi-Crush is less widely followed than some of the other large miners, yesterday was a busy earnings day, and they announced the news with little fanfare.
But make no mistake, this is big news for and from Hi-Crush. It is yet unclear if this is the start of a trend, but if it is, then it has disruptive implications for the entire frac sand value chain.
The First Frac Sand Mine Lands In The Permian
In an industry first, Hi-Crush announced plans to build a frac sand plant in the heart of the Permian Basin, the world’s busiest frac market. The new $50mm plant will produce 3mmtpa of 100 mesh frac. For context, that’s approx. 10% of expected Permian proppant consumption this year. The production will come from a 55mm ton deposit Hi-Crush has just purchased for $275mm. The plant will be built between closing in 1Q17 and early-4Q17 when it is expected to open.
Hi-Crush did not disclose the precise location of the reserves, but industry sources tell us the plant site is located just outside of Kermit TX in Winkler County off Highway 115. In a quick glance at Google Maps, the sand deposits literally jump off the map. Per their announcement, Hi-Crush bought a 1,226-acre frac sand reserve with options on additional acreage.
(click image to view in Google maps)
This Has The Potential To Transform The Competitive Sandscape
If this deal is a one-off, then it’s good for Hi-Crush and won’t impact the market much. But if this new plant is the start of a trend of regional mines entering the Permian, then this news will transform the US frac sand business. If this takes off, it has implications for the entire sand value chain.
Much of the sand consumed in the Permian originates in Wisconsin, and rail transportation is the highest cost component of this sand (see chart below). If you can eliminate rail by placing sand mines in the heart of the Permian… the possibilities get interesting.
If Hi-Crush can built a plant capable of producing 3mmtpa in the Permian, others will try to follow. If our sources are accurate, they will follow quickly.
Over the past several weeks, we’ve been picking up chatter from multiple industry contacts in West Texas about the descent of dozens of buyers interested in the region’s sand deposits. Land owners sitting on sand in the Permian have been approached by buyers from established miners to private equity firms. We understand this particular Hi-Crush purchase was a hotly contested bidding process where at least one other big sand mine participated.
If others can repeat Hi-Crush’s approach, we can imagine a world where 25-50% of Permian frac sand demand is supplied locally. Here are a few implications if this trend takes off and scale in local mining capacity is achieved:
· Wisconsin reserves will be devalued.
· It could eliminate the biggest cost of sand (rail transportation) for a portion of proppant consumed in the Lower 48’s biggest frac sand market.
· That is a game changer because the Permian is expected to consume half the frac sand produced in the US going forward.
· Wisconsin minegate sand prices could face some new headwinds.
· Rail transportation demand could fall shy of current expectations (implications for cars and trains)
· If it takes off, Permian transload demand could be adversely impacted.
· More hauling would start at the mine not the terminal.
But there is work to be done before this becomes a trend. There are potentially limiting factors that could cap the rise of Permian mines. Here are a few that come to mind:
· Transportation infrastructure. If our sources are correct about Hi-Crush’s location, then it is right off the highway in a prime location. Deposits further away from the road may be harder to develop (and more costly).
· Access to water. It is essential in sand mining (perhaps especially if the mines amount to scraping dunes) and could become constrained around these sand deposits in West Texas (especially those in more remote locations).
· Stubborn Owners. We’ve heard that land owners sitting on sand have been hesitant to sell – continuous acreage around infrastructure may not be for sale at a reasonable price.
· Seller’s Market. Hi-Crush paid a pretty penny in a hotly contested bidding process for this sand. Will other buyers be able to float the price to play in the Permian sandbox?
· Regulation. As you move south in the sand deposit chain we believe Hi-Crush bought into, you approach the Monahans State Park (see map below). This area will likely be preserved from development by state law.
· Geology. Hi-Crush has identified pay that it obviously believes it can develop – they wouldn’t buy this sized deal without geological conviction in the pay. Broader West Texas geology may pose limits to this trend. There are obviously dunes in the area, but how deep is the pay in other deposits? How good is the quality of the sand? What are the grain sizes and what does that mean for import mix in the basin? It is yet unclear if the mine capacity Hi-Crush disclosed (3mmtpa) is repeatable in scale in the Permian.
This is HUGE. Where’s The Fanfare?
In a busy press release that disclosed two other transactions, Hi-Crush discussed in muted tones its plans for this game changing mine. They also released the news on one of the busiest earnings days of 4Q16 reporting season.
There is a reason Hi-Crush slipped this announcement out with little fanfare: this is a transformative development, and they are now the first mover. If our sources are correct, others will soon attempt to follow.
The End Justifies The Means (Mostly)
At $5/ton, the purchase price Hi-Crush paid for these reserves might seem a bit high to folks used to seeing reserves trade at half that level. But the Permian Basin is expected to consume >40% of total US sand production this year and in 2018. Permian sand demand is as close to a sure thing as you will find in the oilfield these days. The next closest frac sand mine is more than 200 miles away in Brady, TX. This mine is within 75 miles of the Midland and Delaware Basin hot spots.
Water access may play into the price, however details are limited at this point. As a first mover, Hi-Crush will be able to charge a premium by eliminating rail costs and selling its products FOB the plant to customers that are primarily completing wells in the Midland and Delaware Basins. Or they may even try to sell at the well site given proximity.
All of the above factors support the price Hi-Crush paid. On the flip side, while finer grains have been en vogue lately, 100 mesh may be too fine in some cases. And 100 mesh is what Hi-Crush says they’ve bought here. We’ve recently heard talk of conductivity issues at 100 mesh, which has caused some E&Ps to mix slightly coarser grades into the blend. That said, these issues have been one-offs, and Hi-Crush can address with Permian imports.
What’s The Over / Under On Permian Mine Capacity Announced By June?
There’s big potential for a Permian mine trend to develop here, and the Hi-Crush deal proves it. This isn’t the last we’ll hear about it, but whether it marks the start of a Permian sand grab remains unclear at this point. If the E&P industry is an analog, perhaps the next acreage valuation bubble will form around Permian sand deposits.
If you are familiar with West Texas then you know these sand deposits in the heart of the play as recreational areas where families play and camp out on the weekends among the sand dunes.
On a personal note, this author spent plenty of time riding the dunes among the sand hills of the Monahans State Park as a kid growing up in Odessa, TX. In those carefree days, we never could have anticipated a more productive use for the sand than the quick adrenaline rush from whizzing down a dune on a perfectly waxed board.
But the guys in suits have been knocking on land owner’s doors out in West Texas in growing numbers this year. We’ve heard of some property owners getting as many as 20 inquiries for their sand.
There is a large sand formation that spans about 30 miles from Monahans in the south up to Kermit in the North. The deposits around Monahans are part of a state park and would-be exploiters will likely face regulatory challenges there. But the further up you go, the more these deposits are held by private interests with discretion over the mineral rights.
There are also a few other deposits around the Permian that may have some potential, but it looks like Hi-Crush took the sweet spot in the first sand deal in the area.
Will the Hi-Crush transaction thaw the new Permian dune market resulting in a rash of transactions, or freeze it because they took the sweet spot and priced others out of the marekt? It’s too early to tell, but this may be the beginning of a highly disruptive trend in the competitive landscape for sand supply.
Now just imagine if US-style hydraulic fracturing starts to take off in Saudi Arabia… they’ve got an ocean of sand… 100-mesh you think?