[Editor's note: A version of this story appears in the August 2018 edition of Oil and Gas Investor. Subscribe to the magazine here.]
The giant Kermit Sand Dune in West Texas, northwest of Odessa, is an aeolian sand deposit dating back eons. It is the northernmost dune of a 200-mile-long sand deposit laid down by millennia of winds blowing sediment from the Pecos River to the west. The sandy terrain in the Texas desert had for years been used as a dune buggy park and recreational area. It wasn’t until 2016 that the dune and the trend of sand deposits southward became the epicenter of the Permian Basin’s oil and gas industry.
Even with the oil price downturn dampening local drilling activity that year, in 2016 operators were still increasing the amount of sand they were pumping downhole in completions, and by a lot. The demand for sand had jumped by a factor of three over recent years, and the price of Midwest supplies—the most common source of frack sand—was costly and took weeks or months to be delivered by rail. Some regional operators turned to regional Texas sands, such as from Brady or Kosse, Texas, to mitigate costs, but others considered those lesser in quality for completions.
Surely, someone had tested the Kermit Dune sand for hydraulic fracturing?
In fact, multiple entrepreneurs were jockeying to be first to get a piece of the dune, which proved to hold finer grades of sand more suitable for downhole stimulations. Since then, 20 new mines have been announced and are built or under construction, according to Seaport Global Securities. Houston sand company Hi-Crush Partners LP (NYSE: HCLP) would ultimately be the first in-basin sand provider in the Permian, having secured two sections of the Kermit Dune for $250 million, with operations beginning in July 2017.
E&P veteran Bud Brigham would also join the sand fray. Brigham’s newest enterprise, Atlas Sand Co., scooped up an opportunity on the Kermit Dune as well as a 50-section position on the Monahans Dune to the south, making Atlas the largest in-basin sand acreage holder in the Permian to date.
Brigham, of course, has engineered his own entrepreneurial successes, having founded and sold Bakken Shale-focused Brigham Exploration for $4.7 billion in 2011, and more recently, southern Delaware Basin-focused Brigham Resources for $2.5 billion in 2017.
“Having lived it—drilling and completing wells—we recognized how important the proppant was to the success we were having as an industry,” Brigham said. “That gave us a lot of confidence to move on it when the opportunity presented itself.”
The Drivers Of Demand
Sand demand is increasing at a rapid pace in oil and gas basins across the U.S. and Canada. Spears & Associates Inc., an oilfield research and strategy firm based in Tulsa, Okla., anticipates proppant consumption in North America to reach 120- to 130 million tons in 2018, nearly tripling the demand of 45 million tons in 2016, just two years prior. That appetite for proppant, largely sand, should ratchet up another 20% next year, assuming oil prices stay at or below $70 West Texas Intermediate (WTI), according to the firm. Higher than that, “and we’re going to kick into a higher gear than we are today,” said Richard Spears, vice president.
Black Mountain Sand’s El Dorado sand mine in Winkler County, Texas, came online in January with a second in May and a third expected in September.
Combined, they will have a capacity of 13 million tons per year. Below, Atlas Sand, formed by industry icon Bud Brigham, is a new entrant. It’s Kermit, Texas, plant, the first of two planned, came online in July with an initial capacity of 8 million tons per year.
Three factors are driving the voracious appetite for sand, said Spears. First is the sheer volume of drilling activity. Second is lateral lengths—“that’s getting longer every year.” The third component of demand is “how much sand we’re cramming into each linear foot of lateral.” For the past few years, each one of those demand drivers has been rising. “It’s the fastest growing market in the entire oil field.”
Sonny Randhawa, an equity analyst for Seaport Global Securities (SGS), has covered public sand companies since 2014. “We loved them, we hated them, and then we loved them again,” he said.
Even during the downturn, he saw upside in the space.
“We saw this as more secular than cyclical, and figured the area that was going to recover first was going to be the area that made wells more profitable in a lower commodity price environment, and that was going to be frack sand. If you talked to Core Lab or any of the operators at the leading edge, the more sand they pumped downhole, the better their results were. We knew sand intensity was going to keep increasing.”
After joining SGS, he initiated on every sand company with a Buy rating last December. Through May, the group was up 17%. “Our thesis has never changed; we think there’s going to be secular growth.”
And companies are moving to the leading edge in sand intensity, said Randhawa. “The leading edge a couple of years ago was 10,000 tons. Now you’re seeing companies pumping 20,000 tons.” The leading edge previously for laterals lengths was 10,000 feet. “Now you’ve got ExxonMobil [Corp.] testing 15,000-foot laterals in the Permian and the Bakken.”
That metric alone could account for a 50% increase in sand demand, he said. “Chances are you’ll still see an increase in sand intensity from closer spacing, more stages and more sand per stage. That can lead to incrementally higher sand demand.”
Before it sold to Diamondback Energy Inc. (NASDAQ: FANG), Brigham Resources increased proppant loading from 1,800 pounds per lateral foot in its initial wells to as much as 3,200 and, in turn, doubled well recoveries.
“It’s hard to say where it goes,” Brigham said. “We were not seeing the break over as we were increasing the amount of sand we were using. We were continuing to see improvements in our estimated ultimate reserve recoveries each time we increased the sand loading per well. We think the industry is going to continue this trend to increase the deliverability and enhance the economics of their wells.
“Where it plateaus, I don’t know.”
And nowhere has the demand for sand been more intense than in the Permian.
Permian Sand Grab
“The one item that is in shortest supply in the Permian right now is sand,” said Rhett Bennett, founder and CEO of Black Mountain Sand. “There are quite a few jobs that you hear about that are waiting on sand. The year-over-year growth has made it challenging for sand suppliers to keep up. It’s a very on-demand environment, just-in-time arrangement. Sand is a crucial link.”
The Permian “dwarfs everything else,” said Spears. “It represents 40% of the demand for proppant.”
Since Hi-Crush took the pole position in developing in-basin Permian sand, an additional 100 million tons per year of capacity has been announced and permitted, per Seaport Global, although delays have stifled some start-ups.
“Demand for sand in the Permian has just been skyrocketing,” said Laura Fulton, CFO for Hi-Crush. “Today and for the near term, demand is going to be very strong, and supply is going to struggle to catch up, even with all this new construction of sand mines in the Permian Basin.”
The Permian accounts for about half of total demand, she said, growing more quickly than other basins, but “all the other basins are growing as well.” She projects some 55- to 60 million tons for the Permian in 2018, increasing to 60- to 65 million tons in 2019, “but it has the potential to be higher with increased proppant intensity.”
The fear has been that oversupply will occur when all these new mines come online. However, the buildout is taking longer than advertised. “Those mines have not come online,” she said. “They’re still being built, slowly getting into the production of sand, and so we have not seen pricing slow down at all; prices are still increasing for all grades of sand.”
Most of the sand sourced in the Permian is 100 mesh, a fine grade of sand once considered throwaway but quickly gaining favor. Historically, courser grades of sand of such as 20/40 or 30/50 were believed to provide better fluid flowrates, but with the shift to slickwater completions in the past few years, finer sand is believed to reach further into the frack wing.
But for now, the 40/70 grade continues to make up the bulk of completions in the Permian and elsewhere. And while Permian mines can produce some 40/70, most continues to come from mines in the Midwest, known as Northern White. That sand comes at a price.
Fad Or Fortune?
Black Mountain is a new entrant sand company. With access to 29,000 acres in Winkler County, Texas, its first of three Permian mines came online in January, a second in May, and another is scheduled to start producing in September. Together, these will have capacity of 13 million tons per year, making Black Mountain the largest in-basin sand provider at present.
Like with Atlas, Bennett’s roots are as an operator. He built and sold Black Mountain Oil & Gas, an NGP-backed E&P in the Delaware Basin, to Marathon Oil Corp. (NYSE: MRO) for $700 million in 2017.
While drilling wells in New Mexico’s northern Delaware Basin, Black Mountain’s management team noticed that leading operators such as Pioneer Natural Resources Co. (NYSE: PXD) and EOG Resources Inc. (NYSE: EOG) were drilling wells with regional sand with no adverse well effects. And although regional sand had a stigma as being lower quality than Midwest sand sources, “EOG has been pumping regional sand for years, and no one has been complaining about their well results,” observed Bennett.
So he posed the question: Was regional sand a cost-cutting fad that would wane after the downturn? “We took the position that it was an evolution, that it was fit-for-purpose and good enough. You didn’t need Cadillac white sand in a lot of these formations to propagate the frack.”
Yet no one had established a sand mine in West Texas. With 100-mesh sand being relatively new in completion designs, was this an overlooked opportunity? Bennett took and tested more than 450 cores from the sand trend from Marfa to Winkler and determined that the Winkler sand dune deposit was a close cousin to Northern White sand. “We had a lot of conviction that this sand would be in high demand. This was going to be a massive event in the Permian.”
While still actively invested in Black Mountain Oil & Gas, the team convinced its equity sponsor, NGP, to back the sand company—an atypical investment for the capital provider.
“It was a Eureka! moment. Everyone recognizes this is a billion-dollar idea,” Bennett said.
Black Mountain is spending $200 million per mine for a total investment of $600 million.
In addition to Black Mountain Sand, Bennett has since re-upped on the E&P side with Black Mountain Oil & Gas II. It holds 18,000 acres in Pecos County prospective for Bone Spring sands and Wolfcamp A. Its first well, the Atticus 1-H, is a proof-of-concept well into the Second Bone Spring at 4,900 feet in the lateral sporting 39 stages and 2,900 pounds of sand per foot. It is still flowing back. Its second well, the Boo Radley, will drill in August into the Wolfcamp A Formation. That well will feature a 10,000-foot lateral with similar proppant intensity.
Black Mountain Sand wasn’t operational when the original well was drilled, “but our second well will absolutely use sand from our facility in Winkler County,” he confirmed.
“There is no more of a dynamic space within oil and gas right now than there is in the sand sector,” said Bennett. “There is a dramatic shift occurring in the sand space.”
The primary driver for sourcing sand in-basin is cost. And the primary cost of Midwest sand is transportation, or more specifically, rail, which accounts for anywhere from $40 to $70 per ton on top of the cost of mining.
Having an in-basin source eliminates this cost factor. “From an operator’s standpoint, they’re not paying the rail anymore, and that $40 per ton goes straight to the operator,” said Randhawa.
As an E&P and before in-basin Permian mines existed, Brigham Resources sourced sand primarily from Illinois and Wisconsin, Brigham said. “The problem with that was two-thirds to three-quarters of the cost of the sand is just transportation to get it down there. The opportunity was obvious with local sand—you eliminate $60 to $70 a ton off the cost. It was just too compelling to pass up.”
Bennett concurs. “Even on in-basin’s worst day, it’s still better than Northern White’s best day in regard to pricing.” Rail and transloading “is a huge component of the cost per ton of sand.”
Adoption of in-basin sand within the Permian has been immediate and universal, he said, with cost savings approximately 50% over Northern White. “In our view, Northern White continues to get pushed out of the marketplace as just an expensive substitute that only fills incremental demand on top of what the Permian does itself.”
For operators, “the savings are phenomenal. You’ll save on the order of $500,000 to $600,000 per well. The impact on your economics is through the roof. The half million dollars per well translates to $3.5 billion in proppant savings on the cost side for operators in the Permian alone.”
But Northern White suppliers are not conceding the Permian as yet.
Hi-Crush was the first sand company to establish a sand mine in the Permian Basin and has been operating now for a year. An established sand provider to the industry with four existing mines in Wisconsin, its Kermit mine can produce 3 million tons per year, mostly the finer grade, 100-mesh sand.
“Our purpose for locating a mine in the Permian Basin was that we needed more of the finer mesh sand to complement our product portfolio to make sure we could offer all the grades of sand in the Permian that operators were looking for,” said Fulton.
Demand for sand in the Permian has been skyrocketing, she said. “Today and for the near term, demand is going to be very strong and supply is going to struggle to catch up, even with all this new construction of sand mines in the basin.”
Fulton projects some 40% of Permian sand will be supplied by in-basin mines by year-end, and that will continue to grow. But unlike her Permian competitors, she doesn’t see it going to 100% as capacity is further built. Far from it, in fact.
“More capacity will get built, but I don’t know if it ever completely takes over the market,” she said, “because most of what is produced in the Permian Basin is 100 mesh, and what’s in demand is a combination of 40/70 and 100 mesh. We still see a market in the Permian which needs a lot of 40/70 sand, which is not being produced in the Permian Basin; it needs to come from the Northern White mines. We see operators focused on wanting the highest quality sand, which Northern White sand typically is, and making sure they’re getting the best possible completion design.”
She projects 60% to two-thirds of the sand used within the Permian ultimately will be sourced from the Permian. “But there is still a good 33% to 40% that is sourced from the Northern White mines.”
Northern White vs. All Comers
Crush strength is the ability of the proppant to hold open fissures in the rock under extreme pressure, and it is the reason Northern White 40/70 mesh will continue to dominate, even in the Permian, said Seaport Global’s Randhawa. While 100 mesh will be supplied by local mines in the Permian, he believes, the coarser 40/70 will have to come primarily from the Midwest. “The crush strength for local 40/70 just isn’t high enough.”
Northern White 40/70 typically has a crush strength of around 8,000 to 11,000 pounds per square inch (psi); Permian-sourced sand is closer to 5,000 to 6,000 psi, he said. Local sand might work in the lower-pressured Midland Basin, but in the Delaware, and in other basins like the Eagle Ford, Scoop/Stack and Bakken, “I don’t think you’re going to see local—or non-Northern White coarser grades—go downhole.” That’s because wells are expected to produce for 30 years. “What happens after a couple of years when you have enough time and pressure on that sand? If your ultimate recovery is lower, then your return is lower.
“And the only place to get quality 40/70 is going to be from the Midwest.”
Many operators, given a choice, will continue to source Northern White, Spears said. It is more spherical, higher strength and has better flow characteristics than West Texas sand, he said. “Just because there’s sand right next door to a well near Pecos doesn’t mean that sand is going to be used in the next frack job.”
Alternatively, operators might choose to give up some performance for lower cost. “You don’t always put premium gasoline in your car,” he said. “It’ll run just fine on regular. That’s a decision being made by a bunch of E&Ps.”
Spears believes the oncoming new Permian mines at least are a necessary balance to the overall sand market.
“The amount of sand we have available in Wisconsin was not going to be enough to satisfy demand of the industry in 2018,” he said. “Now that we have West Texas sand mines opening, it’s going to make it possible for sand to be delivered in the proper quantities across all of North America for the balance of the year.”
But even if the Permian was completely self-sourced, Wisconsin mines remain the closest source of sand for all of Canada, the Rockies, Oklahoma and the Texas Panhandle and Appalachia, reminded Spears. “Those are the areas that the Wisconsin mines will absolutely continue to serve.”
At some point that Northern White might start to get displaced out of the Permian Basin, Fulton conceded, “but in the meantime you’ve got increased activity in the Marcellus/Utica, and in the Rockies, and in the Bakken, and other basins where we think there is plenty of demand to soak up any excess supply that might be generated from in-basin sand in the Permian.”
Atlas’ Brigham heralded the Permian sand venture as “the best opportunity I’ve seen in my career”—a bold statement considering his prior multibillion-dollar E&P victories. Initially, Brigham funded Atlas with his own money, but he eventually brought in outside equity from strategic family and friends investors—many Permian players themselves. He also secured a $150-million credit facility from BlackGold Capital Management to fund the construction of its two plants and start-up.
“We’ve seen an evolution in proppant for drilling and completing wells. I’ve not seen anything like it,” said Brigham.
Its first plant near Kermit is scheduled to begin shipping sand to in-basin producers in July, while its second, next to Monahans, is expected to come online in September or October. Initial capacity between the two is some 8 million tons per day.
And sand from the large open dunes is the best supply available, he believes. “It’s right there on the surface ready to be shoveled. We recognized, and it’s since been confirmed by scientists at the University of Texas and Baylor University, that the open dunes provide the highest-quality, lowest cost-to-mine sand available.”
Atlas secured its southern position on the Monahans Dune from the Sealy & Smith Foundation, a benefactor of hospitals and schools, which like Champion Lone Star became equity owners in the company. Royalties from the partnership will flow into the Permanent School Fund for Texas school children.
The majority of the sand mined from the two locations will be 100 mesh, with about 20% 40/70 grade. “Increasingly, operators are going to 100 mesh,” he said, but “there is still very good demand for 40/70.”
Atlas has guided it will ramp up to 14 million tons per year in capacity by 2019 and up to 24 million tons per year “if the demand is there” in the coming years. “We know in this business that oftentimes we have supply exceeding demand, and in these times pricing can get driven down. We think we’re going to be well-positioned when that inevitably occurs. In those downcycles, we’re going to be the low-cost, high-quality, reliable sand producer.”
In addition to Atlas Sand, Brigham founded Brigham Minerals and Brigham Exploration, a nonoperated E&P model partnering with independents in the Permian. He’s also an investor in Austin-based ATX Energy, run by his former management team. “I don’t have any aspirations to be an operator again,” he said.
Surety of supply is personal for Atlas COO Hunter Wallace, formerly Brigham Resources drilling and completions manager. “We’ve been burned before by vendors when drilling and completing wells,” he said.
As such, Atlas is upsizing its capex in the buildout of its sand mines to ensure reliability for its equipment and to minimize downtime, a nuance Wallace believes is unique in its design. “Of course it costs more to add an additional sump pump, but if it saves three hours a year, it pays for itself. Why wouldn’t you do that?”
One of the most destructive things for a piece of machinery is to put sand in it, noted Wallace, “and that’s what our equipment deals with 24/7. Redundancy is not a luxury, it’s a necessity.”
One major design difference is the elimination of bucket elevators, the buckets on a circular belt that lift sand to the tops of the silos. “Bucket elevators are a higher failure and higher maintenance piece of equipment,” he said, “so we just took the bucket elevators completely out.” Instead, the plant design relies on conventional conveyor belts, which require a larger footprint and added capital to build, but again, Wallace says this is easily justified by the increased up time and reliability of the plant.
Atlas is spending an additional $15 million per plant to increase reliability. “If your plant is located right there, and a truck pulls up and the silo isn’t full because the plant is down, your end user knows about it immediately and has to scramble to buy sand at the last minute from someone else. So the reliability and the surety of supply is another reason for us to justify the additional capex for our plants,” he said.
Traffic Jams In Pecos
While rail issues could constrict supply once again, as they did this past winter, the biggest potential constraint to Permian sand supply is trucking logistics, said Hi-Crush’s Fulton.
“Trucking is a very critical component to the movement of sand to the well site,” she said. “So far it appears to be working and manageable, but with increased demand and growth in the Permian, you could run into some real issues.”
Spears & Associates estimates a loaded sand truck heads out to a frack job in the Permian Basin every 13 seconds, amounting to 5,400 truckloads per day, three times more than in 2016. An average well completion now consumes 15 million pounds of sand, equating to 300 truckloads per well.
“So when you commit to drilling a three-well pad, you’re also committing to having 900 truckloads of sand delivered to that well site over about a two-month period,” Spears said. “You try and solve the problem with more and more trucks, and that just ends up in longer traffic jams.”
To alleviate the traffic bottleneck, Spears advocates a change in Texas law that limits the weight of the trucks. “If Texas trucking laws allowed an additional trailer, the very same truck that now holds 50,000 pounds of sand could hold 75,000 pounds. It would alleviate a major part of the trucking issue.”
Fulton emphasized that proactive inventory management will help reduce truck congestion. She points to Hi-Crush’s PropStream service, in which containers of sand are delivered to the wellsite on trucks, as an efficient method to minimize wait time—or demurrage—of trucks sitting idle at well sites or sand terminals. Hi-Crush is also working with trucking companies to lighten the weight of the trucks themselves so they can carry more sand under Texas’ maximum weight regulations. This has enabled them to put 10% more sand per truck, “and 10% more sand per truckload translates to 10% fewer trucks on the road.”
Additionally, Hi-Crush is exploring delivering to well sites at non-peak hours to relieve congestion. “Most truck drivers want to drive on an 8:00 to 5:00 shift, but if they get paid a little more and there’s less traffic from 1 to 4 a.m., that may be a better time to move a lot more sand when you’re not competing with the normal workday traffic.”
Where quality sand deposits exist in-basin, other oil and gas regions are also seeing new mines coming in as well—somewhat.
“It's a phenomenon that’s not just germane to the Permian,” said Bennett. “Help is on the way in the other basins as well. It’s going to be the future in sand sourcing over the next two or three years.”
The Eagle Ford Shale garnered new mine announcements from nine companies over the past several months, albeit at lower nameplate capacities than their Permian counterparts. Black Mountain recently broke ground on a 2.2-million-ton-per-year sand mine in the Eagle Ford due online in the fourth quarter, and another 3-million-ton-per-year facility in Oklahoma’s Scoop/Stack region due online about two months later.
While smaller than the Permian plants, the company is just right-sizing for the markets there, he said.
“We have a lot of conviction that this is the next evolution for sand markets. To the extent a basin has an in-basin sand deposit that’s suitable for fracking, we intend to build a world-class mine over it and supply the industry.”
But not all basins have a ready supply of sand. Beyond the Permian, Spears thinks the wildfire of in-basin mine development will be muted. “I don’t think we have sand that’s appropriate for hydraulic fracturing everywhere. It’s got to go through a selection process to make it a frack-worthy proppant, so I don’t see a willy-nilly approach to opening sand resources in every basin.”
Most basins will continue to be supplied by Midwest mines, he said, while the Permian, South Texas and “a little bit” in Oklahoma will in-basin sourced. “That’s where I imagine things will settle out.”
In addition to the 100 million tons per year announced in the Permian, Eagle Ford miners have announced 25 million tons per year of new in-basin capacity, with 20 million tons per year announced in the Midcontinent and 10 million tons per year in the Haynesville Shale, according to Seaport Global. “So there’s plenty of 100 mesh sand that’s going to be available,” Randhawa said. “We don’t think all of that is going to be built. We believe overall supply and demand is going to stay fairly tight through 2019, because all these local mines have been delayed.”
However, he foresees the 100-mesh market becoming oversupplied by mid-2019, while the 40/70 market becomes undersupplied due to Midwest capacity attrition.
Will sand demand peak anytime soon?
“Nothing grows forever,” said Spears, “but I think we’re on a trend where, for the next three years, the industry continues to ramp up. We’re only about a year-and-a-half into the upturn at this point, and we probably have three more years of upturn.
“So we’re not near the peak.”
Steve Toon can be reached at firstname.lastname@example.org.
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