The proppant market is not as bearish as many have portrayed it. In fact, market fundamentals have remained stable with some unexpected volatility and depression, yet market balance and stability are improving. In this episode of Upstream in Perspective, Brandon Savisky, a research analyst on the proppant market, joins us to discuss North American market demand and supply, as well as preview future changes.

Jessica Nelson:

The U.S. proppant market spent much of 2018 in a state of oversupply. In fact, I think I read that you guys said this is an interesting and challenging landscape. How do you explain the imbalance?

Brandon Savisky:

Great question, Jessica and a popular one, as well. It is complicated and challenging. As complicated of a market that it may seem, it boils down to the basic fundamentals of supply and demand. To offer some background, ever since the downturn in late 2014 and through the bottom of 2016 now riding the state of recovery a bit into 2017 and 2018, the market not only continued to grow almost exponentially year-over-year in 2016, 2017, and 2018, but it also set a course to cut cost and optimize operations. All toward maximizing capital efficiency. So, with that in mind and particularly looking at cutting cost, operators been focusing on optimizing operations. Which in turn often increased completion design intensities. By that I mean, adding a lot more proppant and typically a lot more water as well. While at the same time operators began to focus on reducing cost around every corner, wherever it made sense of course, they continued to look for low price alternatives. One of the major drivers of the oversupply predicament was when they started looking for these alternatives in the hunt for low-cost proppant alternatives.

This is where the Permian Basin regional supply oversupply began to take center stage, as operators began to utilize and initiate tests as to whether or not the cost trade off of the lower quality, yet closer proximity (in respect to the Permian) versus their traditional premium northern white sand (which is located in the north) would result in similar or better well performance and most of all greater Mbds, and all while boosting capital efficiency. With this strategic shift, especially in the Permian, it didn't take long for sand suppliers and other capital investors to notice this supply opportunity and to quick act. In fact, from the fourth quarter in 2017 to the second half of 2018, we saw a demand increase of about 48 percent of sand and that lead to a six-fold increase in sand supply for the same period. So, that equates to about a 498 percent increase in local sand supply for a 48 percent increase in demand. Now that's quite over stripped.

These actions lead to a rapid spur of sand proppant greenfield development as well as many upgraded brownfield projects, and a race for strategic location scattered across Southwest Texas. With a high value placed on location among the acreage conditions that many operators had in general. So, I mentioned location because it's another interesting topic. We've estimated that about roughly 60- 65 percent of the cost of proppant is made up of purely logistics. The proximity of the local regional supply was a huge factor; therefore, you can see why location is so valuable. Bringing it all together, it was a perfect storm of operators acceptance to the lower quality sand as a substitute for northern white, and the vast amount of capital waiting on the sidelines for an opportunity like this to be presented.

In turn, this produced a large glut of supply that operators required, however at the same time the second half of 2018 a timeliness issue became the problem. That was the final piece of the supply glut. The sand supply continued, but E&P operations began to slow down due to capacity and constraints, and that resulted in what we are currently wading through which is the oversupply in sand.

Jessica Nelson:

Speaking of supply and demand, I know late 2018 you guys said you expect to see a slight decrease in demand in the first part of 2019 with potentially an aggressive recovery by the end of the year. How does that look to you now? I know you made that little bit of a prediction at the end of the year. What do you think of that prediction at this point?

Brandon Savisky:

That's absolutely correct. As I briefly touched on the capacity issue, we are anticipating an aggressive recovery at the back end of the year and that is tied to the relinquishment of capacity to help the operators take away issues. We absolutely have seen a moderation in activity coming out of 2018 and leading into the first half of 2019 in these first two months. It has been by design and according to the plan of the operators, yet it has been much to the dismay of oilfield companies and suppliers. We projected the moderation dating back to the second half of 2018 so it shouldn't come as too much of a surprise to many of those who may have been informed or appropriately planned. With that said, this particular moderation has manifested itself in a one and half percent decrease heading out of 2018, from the third quarter of 2018 to year-end 2018 and continued at a 2.2 percent decrease from that same third quarter through what we expect at the end of 2019 in total proppant and sand. So, our prediction absolutely demonstrated what you mentioned, moderate decline in proppant activity. Unfortunately, it's had a larger impact with oil field companies and oil field equipment product suppliers who may have been caught off guard or a bit ill prepared.

How is the oversupply impacting operator cash flows? Listen to the full podcast to hear Brandon explain the impact.

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Posted 26 March 2019

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.