How real is the rail frac sand recovery?

By Tony Hatch

How real is the rail frac sand recovery? The feedback I got during the first-quarter railroad earnings process — from energy exploration and production (E&P) analysts, railroads, trade associations, rail-car leasing companies, etc. — leaned toward bullish, but not completely so.

I also have been compiling interviews, reports and data on frac sand. Railway analysts typically aren't experts on mining or shale drilling; even the experts are not of one mind. Nothing, for example, is more in dispute than the nature of the shale comeback. And we've seen reports with headlines suggesting a "Bakken boomlet." But according to the most recent North Dakota Pipeline Authority data, crude by rail (CBR) represented 22 percent of the Bakken output. Compare that with the 65 percent that CBR represented in 2013-14.

While I would lean toward thinking that the return to growth of Midwest-based, high-quality white sand (and therefore sand-on-rails) is a secular trend, there seems to be no clear consensus/no "final answer" yet. But we can infer that:
 
1. CBR is a fringe opportunity.
2. And at least anecdotally, sand looks to be a solid, ongoing opportunity.

The sand ramp-up

Sand began ramping back up in the second half of 2016. In first-quarter 2017, Class Is' originated volumes were up 10 percent (note: frac sand represents about two-thirds of the Association of American Railroads' line item “Industrial Sand”), and they accelerated in March and April. Canadian totals were even higher off a lower base: Q1 was up 92 percent and April was up 99 percent! Overall, U.S./Canadian crushed stone totals were up 18 percent in Q1 and 24 percent in March alone. Meanwhile, petroleum products (i.e., CBR, which is roughly one-third of that line item) continue to decline compared with a low level a year ago.

A few more numbers to consider:

• Union Pacific was up 59 percent in frac sand in Q1 — and up 100 percent to the Permian — and UP officials think growth is sustainable. BNSF, meanwhile, was up 29 percent in Q1 (although CBR was down 10 percent).

• Overall, frac sand in 2016 was roughly half of the peak in 2014 (despite the whole “more sand per well” thesis), but the Q1 total was the third-highest quarter ever at about 120K carloads (peak was 130K in Q4 2014), according to AAR data.

• Wisconsin and Illinois white sand makes up over two-thirds of that market — the former, at 50 percent share levels at the peak, was 43 percent last year; the latter runs 25 percent to 30 percent. Their share reached a peak of 76 percent in Q1 — of course, that is share of the rail market, versus locally sourced brown sand (aka “dirt”!) that has a much higher (undetermined) truck share.

'Quality of the proppant'

On the whole white vs. brown sand (aka “the quality of the proppant”), there is huge debate. Many have told me that local sand will win due to the huge quantities needed, permitting issues and, of course, cost. But Wisconsin-Illinois sand was up 50 percent through May, which is remarkable, and most parked sand hoppers are said to be in service. During the boom, shippers were resorting to using non-sand cars to carry sand — that is not happening at present.

Says Tudor, Pickering, Holt & Co.: Exploration and production companies (E&Ps) are struggling to find finer sands and are resigned to "'price creep." Further, the energy investment banking firm is “more confident than ever that a healthy portion of the shift to regional sand in the downturn was counter-cyclical behavior driven by the necessity to cut costs in a declining crude oil price environment" — to which their clients said “Duh!” But quality will still win out: Low-crush strength regional sands create “real issues downhole,” so customers are already shifting back to higher quality white sands and this “counter cyclical behavior will unwind helped by higher truck prices," they note.

Consensus in the leasing community (and E&P research) doesn’t exist, but the compromise position is that some mixture of brown and white will win the day (lower costs without sacrificing quality — haha — said one leasing CEO: “E&Ps will use lower grade brown sand first due to lower cost and sometimes mix it with Northern White ... but now, ironically, Texas brown could be becoming in short supply.”) But most have said that the 10,000 stored small hoppers are out working, and even that there are rumors that the sand car backlog — long thought to be more “hope” than real — is actually being pressed forward in some cases.

Analysts seem to be bullish on the supply/demand outlook (“tight into 2018”) for sand mining stocks, with logistics footprint a key factor in valuations. To quote Tudor, Pickering: “Increased well intensity continues to grow, (so) we believe (that) logistics will become more important and the last mile will remain an issue driven by the quality of the sand pumped into individual wells.” One company mentioned — “Smartsand” — is seen as needing to improve its "midstream/downstream logistical footprint” (opportunity?). Wells being pumped today require 500 to 1,000 truckloads — given demand expectations, logistics bottlenecks are the biggest worry.

Other considerations:

• Some incremental mines that are being contemplated have cost/quality issues, with one such issue being called by analysts the problem of being “beholden to trucking.”

• Expected demand, in order, comes from by basin (TP): Midland, Delaware, "Other," Eagle Ford, Marcellus, STACK, SCOOP, Utica. Total proppant demand is expected to be about 98mmt in 2017 and 147mmt in 2018 — these demand numbers assumed over $50 (and truth be told, it's below that now as of this writing).

• The Permian has some new sand mines opening this year, but experts see low capacity utilization (60 percent to 70 percent) of the relatively poor quality local sand, leaving plenty of opportunity for railed white sand.

The bottom line is that Rule #1 with energy markets is that volatility is the order of the day; and with pipeline development, CBR has a rather limited future. Sand transportation is booming again today and this appears to have sustainability. But always remember Energy Rule #1.

Tony Hatch is an independent transportation analyst and consultant, and a program consultant for Progressive Railroading’s RailTrends® conference. Email him at abh18@mindspring.com.