There's Not Enough Sand To Satisfy America's Insatiable Fracking Demand (SLCA, CRR)

Rob Wile

American oil and gas companies are running out of sand. 

In a new note, Morgan Stanley's Ole Slorer, Benjamin Swomley, and Connor Lynagh write that exploration and production (E&P) companies have discovered that if they use more sand when they frack unconventional shale plays, they are able to increase the amount of reserves they can extract from the ground. The sand helps prop open the rock, allowing the hydrocarbons to flow more freely. 

MS forecasts sand demand growth 0f 96% in 2016 from 2013, compared with just 76% of sand capacity growth.

Here's the chart:

"As E&P operators seek to optimize well results, they are using significantly more frac sand per well and experimenting with different types of proppants," they write. "In particular, the trend toward higher frac sand volume completions has accelerated frac sand demand YTD, and we believe the industry now sits on the verge of a prolonged frac sand supply shortage."    

The market will further be constrained by the lack of rail available to transport sand from places like Wisconsin, Minnesota, and Pennsylvania; and by potentially longer lead times as local opposition mounts to opening new mines. 

"Sand could become stranded thousands of miles away from O&G basins," they write.

Sand prices could increase as much as 50%, though what that means for crude contract prices isn't discussed directly — MS says well costs could increase by 20% on average, but that estimated ultimate recovery (EUR) could increase by 40-60%.

They do suggest oil and gas companies' profitability per ton of sand used will likely increase thanks to the aforementioned output gains. And they are raising their price target for U.S. Silica Holdings to $80 from $59, with a 17.2x price-to-earnings ratio.  

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