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Trends of Yesterday, Today, and Yes – Tomorrow!

Last week, I was asked to be the opening speaker for the 4th Annual Logistics Conference in San Antonio. There was great information shared by a number of speakers that I hope to share in brief with you later. For now, I thought I would share my talk for those of you, who didn’t make it. Also, I encourage you to put the event on your calendar for next year, October 13th & 14th 2016 in San Antonio. So here is my presentation:

This past year has been quite a bit of a roller coaster ride for many. Some folks may be doing a bit of screaming the way oil prices have dropped. I have been asked to share with you, some of our observations from our trading desk at DownHoleTrader.com and trends we see developing in the market.

We talk with a lot of people and hear varying viewpoints on the future of oil and gas. The question of the day is: “Will Oil Prices Return and When?” Most conversations I have with more seasoned veterans of the field reflect a confidence that oil prices will lift.

They see a big picture not just the free fall that we experienced lately. It is challenging to make predictions given so many influences on oil prices. That said, I believe that oil prices will start to rise sooner than most believe.

If you or your company did not prepare for eventual market saturation then these may be challenging times. But, hopefully your company positioned to be protected from the impact of oversupply and oppressed oil prices.

So, let’s look at the fracking market before and after OPEC’s decision to flood the market. Historically, price increases have been driven by embargoes or production decreases. Price decreases have been driven by new production in the market or recessions. This current downturn is due to an intentional oversupply by OPEC to drive out competition and regain market share.

Prior to oversupply, hydraulic fracking experienced exponential growth. Resource shortages created a hydraulic fracking version of the great land rush. Just about every category was a seller’s market.

As a result, last year, we experienced an infrastructure that was stressed to the max in some categories. We had shortages of everything from frac sand, rail cars, labor, housing, barite, pneumatic trucks and other resources at varying times and for varying reasons. Let’s look at each in more detail.

So, the categories making up the infrastructure supporting hydraulic fracking went into over-drive growth to meet the insatiable appetite of the frackers. Shortages were sometimes regional and caused by limited resources for logistics. And in other cases, they were across the board based on limited supplies.

FRAC SAND

Raw land sites for developing projects in Wisconsin were experiencing bidding wars and selling above asking prices. One of our clients pursued a project that ended up in a bidding war and sold for a million dollars over the asking price. To add to the land rush, regulators were making it more difficult to permit and develop mines in Wisconsin and Minnesota. The further along a well planned site was in the permitting process, the more highly sought after they were.

We received phone calls from companies in the gold and coal mining industries that were looking to purchase reserves just to hold them until they could sell them later for good returns.

We had 4 or 5 companies calling us that were solely in the business of consolidation: Buy it, build it, and sell it. One group had access to $300M to fulfill their plan.

Specific cuts of frac sand were in short supply, such as 20/40 7k, which accelerated the rush for securing permitted raw land and purchasing operating projects.

We also had numerous end users contact us looking to purchase operating mines to establish vertical integration.

On the existing operations, we had numerous mines sold out of their production capacity.

PNEUMATIC TRUCKS were in high demand. Owner operators were coming from the four corners of the country. Shortages appeared to be temporary in most cases.

RAIL CARS were sparse, especially during the harvest season. Rail car manufacturers had backlogs of orders out one year and at one point we heard two years.

HYDROCHLORIC ACID was nowhere to be found on several occasions. Companies were coming into the sector that sold to the steel industry and other applications.

BARITE was in high demand. Miners and distributors were selling it before it reached the U.S. I had one mud company in the Bakken that maintained a one month supply in storage to hedge their risk against shortages. Often, barite was delivered that didn’t meet spec, which left companies in a lurch trying to locate replacements.

We saw a new structure emerge where distributors with storage facilities took on the role of securing barite supplies, testing and verifying the API spec. They would only pay for it once it was landed in the U.S. and verified with testing. The days of barite delivered direct to the well site are gone for new suppliers.

GUAR prices were $1.54/lb this time last year. As demand increased in numerous locations around the world, India which produces a large percentage of the world supplies, increased production. Shortages in guar were minimal. People were growing guar in their backyards and taking it to market. Huge volumes of guar hit the market and there was plenty of supply in warehouses.

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So, that is where we were before the oil price free fall. If oil prices had sustained in the higher ranges, one of two things were going to happen:

1st An imbalance of resources to meet demand, indicated that the infrastructure was showing signs of weakness. The ability of all categories to keep up with the growth rate of drilling was breaking down. It only takes a few resources to shut down a well.

For example:

Last year we had 6 customers with rig crews on site waiting for sand
One company trucked sand from Wisconsin to Montana because they couldn’t get rail cars
Companies sought out HCL alternatives, because supplies were hard to find.
New technology, products and services quickly emerged
Engineers even softened their sand specs and started using lower crush sands. On
several occasions we had buyers just call to find out what was available rather than
tell us what they needed.

The tipping point wasn’t too far out before shortages began to significantly impact production. Ultimately, shortages would have limited growth in some areas until alternatives and solutions were revealed or the supply sources caught up to the demand.

2nd We were warning last year in our newsletters, for companies to prepare for an eventual slowdown due to market saturation. New plays were being discovered all over the world. Production growth was growing from fracking in more areas than just the U.S. We were moving towards a saturated market without OPEC’s help. Oil production growth was exponential.

Prior to the drop in oil prices consolidations began occurring in this sector. Consolidation is a natural trend in the maturation process of any industry. In a quickly growing industry sector, the economies of scale warrant it. Companies purchase their competition and other companies to:

advance market share,
secure access to resources,
acquire advancements in technology, and
vertically integrate to reduce costs by cutting out the middle man.

Also, consolidation was advancing quickly in this sector because of an already well established oil industry. The industry Walmarts are well established.

A YEAR LATER, the picture has significantly changed.

There are bargains of low cost buy outs for pennies on the dollar. Companies prepared for market saturation, who were positioning for consolidation are taking advantage of these bargains based on their end-game strategy and company vision. However, the consolidation activity fell off once it was clear lower prices would be for longer. The new focus has been on sustaining for a long term low price market and thus reserving cash.

In the meantime, we are seeing a good amount of activity from companies who have reduced their production costs and focused on their lower cost reserves. And, we expect to see more as companies have driven down costs and are now able and motivated to start generating new production to help boost revenues.

Further, we are about to see a new wave of loan defaults and sell offs creating more infrastructure fall out, as investors and lenders are existing from the oil and gas sector. This will affect companies across the board, especially if they are struggling through this downturn. Developers, who depended on capital inflows for operating cash due to out spending heir cash flow, are about to pay the piper.

TODAY – Here is what the fracking categories look like from our viewpoint today.

August was our quietest month since the reduction in oil prices. September is much more active.

As for frac sand, most of the projects in development that we know of were stopped in their tracks. We had 23 projects in various stages of development that we were promoting and now we have about 3 left and currently no indications of any being restarted or new start ups.

This is going to be a category to watch, because if demand comes back quickly, frac sand production may struggle to get fired back up. The few projects that have continued to move ahead will be poised for good opportunities.

Also, the majors, who have diversified revenue streams from aggregate and have sales for other sand use, will be well positioned to capture market share. Don’t count them out if they have diversified revenues and are not overburdened with debt.

In terms of existing operations, many of the majors have shut down production plants and there are quite a few smaller companies with plants sitting idle. We have been asked to promote several frac sand processing plants on our website. This sector is truly feeling the ride.

Also, several of the independent processors, who contracted from several Northern white mines to purchase hydrosized product, shipped it to their site, then processed the sand based on market demand, have gone quiet. Several of our buyers shared that with rail and barging costs down, it is cheaper to buy processed sand direct. That may change with winter coming. Plus, rail and barge rates are increasing as the agriculture harvest is starting to put demand on those resources.

Out of over 60 mines that we work with in Wisconsin, Minnesota, Michigan, Tennessee, Utah, Arkansas, Mississippi, Louisiana, and Texas, we currently only have one mine that we know of that has their capacity sold out. However, this may quickly change as southern mines are experiencing higher demand in the Permian and Eagleford. Supplies may diminish quickly.

We are seeing a few one year contracts but we are also seeing the lowest prices in sand we have ever seen. We actually have today an offering of northern white delivered into San Antonio for $79/ton. We anticipate seeing more contracts as oil prices move up or supply shortages kick in and buyers move to lock in good rates.

Trucking services and resources appear to be readily available for immediate need. We just did an article on this category in our newsletter –there seem to be a lot of owner operators looking for work right now. On a large scale, an anticipated shortage in drivers is on the horizon.

Barite – We still receive quite a few barite offerings in ore or 200 mesh form. However, most have not proven delivery capabilities. Our mantra is get 3,000 to 5,000 tons to the U.S. where a customer can test it and check it for themselves and we can get you buyers. Barite has been late to the party but it looks like there are now some more solid and viable options. We have seen rates for delivered 200 mesh into Texas in the $140 range to $160. We have barite offerings from Guatemala, Peru, China, Mexico, and Morocco. Demand is still pretty good for barite.

Guar – prices are way down in India. Fewer distributors are taking the risk of bringing supplies over to the U.S. without a client commitment. Supplies are high in India, but delivered resources to the U.S. seem to be diminishing. International shipping costs will start going up. Market prices in India have hit all time lows in recent weeks. According to our supplier in India, the sowing has been strong this season and the rainfall in the guar belt has been good, particularly in Rajasthan. But, SUPPLIES HAVE gotten as low as 10,000 lbs a day.

Also, there are several guar producers in the U.S., who are well positioned to source the market in less time than product can be brought from India. Check out a few of these guys. They are also selling to the food industry. And, of course, I am an advocate for supporting U.S. farmers, but we still need imports to meet demand. So, we expect US producers to take some market share as supplies diminish or when oil prices return.

Chemical Suppliers are hanging in there as many of them already had diversified industry revenues. Also, they are doing well with alternative products providing lower costs. Companies were too busy making money before and securing resources. Now, it is a “leave no stone un-turned environment,” where companies are willing to look at alternative products to reduce costs.” HCL demand is down and we haven’t seen shortages in some time.

Rail & Barge – Please contact Richard McClure, who hosted the round table for an update: 972-514-9000. We know of several miners with rail cars idle or being used for sand storage. Also, we are coming into the harvest season, which tends to put demand on rail and barge resources and drive up rates.

End Users – We are seeing some smaller end users on shaky ground. We encourage our readers and clients to follow several bankruptcy filing websites.

So, the current state of the market shows that there are plenty of resources to supply current demand for the most part.

Several groups from companies that were bought out prior to the market turn are back in the space actively looking for bargains, especially in the area of new products and technology. We have received a number of calls from experienced frackers looking for buyout opportunities.

At the risk of walking the plank of predictions, I am an avid believer that oil prices will lift somewhat and sooner rather than later. I would like to take a moment and share why.

For starters, don’t listen to Wall Street. Most everything they do is based on quarterly performance because their survival depends on it. They focus on short term market influences.

1ST – U.S. production has pulled back for six straight weeks and is off ~600K bpd from the weekly high set in April 2015. Did anyone notice that the EIA numbers have been significantly adjusted? This trend could put us at upwards of a ~$1M bpd off by the year end. Also, the EIA released this report last week showing demand surpassing supply in Q4-2016. The problem is that it doesn’t reflect the new adjusted numbers. The IEA is forecasting a lower decline in U.S. tight oil at rates that other sources indicate have already occurred. (This data was from 9/24)

2nd – Prices were up 5% last Wednesday after the release of inventory reports, showing a 2.1M barrel drop instead of only a 200k barrel drop.

RIG COUNT vs. PRODUCTION: 3rd – Rigs are producing more today than 6 months ago. We have one trucking service that uses a system that shaved 9 days off a crew production schedule of 30 days. As producers drive down costs, they are more likely to return to generating production at lower prices.

4th – Other countries are showing a pull back in production and there is one in particular that is showing signs of a pull back that is a game changer: Iraq.

Canon Andrew White, who is the Vicar of Baghdad, informed us about Iraq’s financial woes sometime back. Just recently, Oilprice.com writer Nick Cunningham wrote: “On September 6, the Iraqi government outlined the grim circumstances for its oil sector in a letter to oil companies, including ExxonMobil, Royal Dutch Shell, BP, Eni, and LukOil. “Because of the drop in our oil-sales revenues, the Iraqi government has sharply reduced the funds available to the Ministry of Oil,” the letter from the oil ministry read. “This will…reduce the funds available for the reimbursement of petroleum costs to our contractors. ……. The evidence then points to Iraq not living up to the expectations of it making up such a large portion of global supply growth in the coming years. Taking away several million barrels per day of production capacity by 2020 that we had previously expected to come online suggests that the oil markets will tighten significantly in the not so distant future.”

Iraq is not the only country showing potential problems with their production capabilities as their piggy banks begun to run dry. Others are struggling, as well.

5th – World Population Growth is increasing at an increasing rate. To support an argument for oil and gas prices to move up sooner rather than later, is a rising demand in population growth. Here is data that supports the idea.

It took 130 year for the population to grow by 1 billion people between 1800 to 1930
It took 30 years for the population to grow by 1 billion people between 1930 to 1960
It took 15 years for the population to grow by 1 billion people between 1960 and 1975
It took 12 years for the population to grow by 1 billion people between 1975 and 1987
It took 13 years for the population to grow by 1 billion people between 1987 and 2000
It took 8 years for the population to grow by 1 billion people between 2000 and 2008
It took 7 years for the population to grow by 1 billion people between 2008 and 2015
And, from 2015 to?

The magnitude that this could have on world energy demand could be quite significant.

Regardless of what anyone says, OPEC’s strategy did not eliminate the U.S. frackers. We have definitely taken a full front hit but we aren’t out of this match. They underestimated the U.S. oil and gas entrepreneurs, who are some of the greatest in the world.

Our O&G guys took what OPEC intended to shut us down and used it to get faster, leaner and meaner. We can frack wells cheaper today and in less time than ever before.

And, don’t underestimate the speed with which frackers will return to the oilfield and complete the backlog of wells already drilled! There may be contraction in our infrastructure, but be assured that the second time around it will expand faster.

So, I presume you are here because you are still enjoying the ride and like myself, anticipating another climb to higher heights. In the meantime, let me say what isn’t said enough. The O&G industry exists today, because of some of the greatest entrepreneurs in the world. We are, after all, the ones who started the oil & gas industry.

We taught OPEC how to get their oil out of the ground.

We taught the rest of the world how to frac shale.
And, we are not finished.

In spite of little support from Washington,

In spite of the fact that we helped to sustain our country through difficult financial times after 2008 by providing jobs and business opportunities for companies,

In spite of taxation,

In spite of the EPA requiring that we prove that we weren’t killing lizards in West Texas rather than proving it themselves before restricting our businesses,

In spite of restrictions in off shore drilling,

and numerous other obstacles,

WE ARE STILL HERE!

We have invented technology and solutions for cleaning and recycling water that will solve water shortage problems across the world.

We have come up with technology for moving commodities that will change the logistics industry.

We have invented new products that will change and impact everything from turning dirt into 8,000 psi cement to inventing paint that doesn’t allow barnacles to grow and doesn’t have to be repainted for years!

We are thriving, surviving, persevering, improving and will win this oil war. The U.S. will be energy independent one day, because of our oil and gas entrepreneurs.

We are still in this game because you are some of the greatest inventors, problem solvers, geniuses, and entrepreneurs the world has ever known.

And, I think you deserve a round of applause!

Have a great week!
Jen
407-810-3102

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