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 Demand has jumped for the sand used in hydraulic fracturing, which
blasts it, along with water, chemicals, into wells to crack rock and
release crude oil and natural gas.
The increasing practice of "superfracking" requires much more sand,
and investors have taken notice.
Emerge Energy Services LP, a master limited partnership that
produces sand for use in hydraulic fracturing, began trading a
little more than one year ago at $17 per unit. Today the units trade
at about $109.
Shares of two other sand miners, U.S. Silica Holdings Inc and Hi
Crush Partners LP, have more than doubled in the past year.
And Fairmount Minerals Ltd, one of the largest providers of sand to
the oil and gas industry, is considering a $1 billion initial public
offering, according to sources familiar with the situation.
Still, investing in these companies carries risks.
A drop in crude prices would slow drilling. And the market for sand
itself is opaque, requiring investors to make a leap of faith as
contract terms, prices and supply and demand are not fully
disclosed.
Also, some oil and gas companies, such as EOG Resources Inc, are
cutting out the middleman by buying their own sand mines.
At the same time, RBC Capital Markets says U.S. demand for raw frack
sand will climb 30 percent from 2013 to 2015.
Houston oil and gas company Rice Energy Inc, which operates wells in
the eastern United States, says it has benefited from using at least
7 percent more sand than its competitors.
"It's something that we've found really effective to help stimulate
the well" to produce more oil and gas, said Julie Danvers, director
of investor relations.
MILK MONEY
Demand for sand is expected to outpace the number of rigs drilling
new wells for the foreseeable future, but valuations for the sand
miners are rich. Their enterprise value – market capitalization plus
debt – is about 10 times expected earnings before interest, taxes,
depreciation and amortization.
An investor looking for a way to profit indirectly from the fracking
boom could buy shares of Martin Marietta Materials Inc, which
provides gravel to build roads at frack sites and whose enterprise
value is 11.7 times EBITDA.
Analysts at Baird Equity Research say Emerge has a good growth
outlook but rate its units "speculative."
"If you buy (Emerge Energy) here, do not do it with the milk money,"
Baird cautioned in a June 5 note to clients.
Not every oil and gas producer is convinced that super-sized sand
fracks are needed. Chesapeake Energy Corp Chief Executive Officer
Doug Lawler said that while the company was tinkering with the
amount of sand it used in some areas, greater quantities do not work
on all wells.
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"With every shale, the reservoir is different," Lawler told a
shareholder who asked about sand at the company's annual meeting on
Friday.
Sand miners also face the risk of an energy glut and corresponding
drop in oil and gas prices, which could reduce drilling.
While crude prices have gotten a substantial lift from worries over
violence in Iraq, there is lingering concern that producing oil from
shale will leave the domestic market oversupplied.
In 2013, U.S. crude production climbed to a 24-year high and is
forecast to grow more this year with the help of oil pumped from
shale, according to government data.
MURKY MARKET
Investors in sand miners must also accept the lack of information
available to them.
Thomas Dolley, a mineral commodity specialist at the U.S. Geological
Survey who tracks the sand market, said the industry was fragmented,
and participation in the government's supply and demand surveys was
not mandatory, resulting in what may be incomplete data for
investors.
Because most sand companies are privately held, Dolley tracks sand
mine openings through industry contacts and the media, he said.
"I would say we could use a little more transparency," he said.
The U.S. Bureau of Labor Statistics' latest producer price index
shows frack sand prices in May reached their highest level in more
than two years, according to a report from Cowen and Co.
But Cowen called the government's data for short-term trends
"unreliable" because some prices in the sample include
transportation costs and others do not.
(Reporting by Anna Driver; Editing by Terry Wade and Lisa Von Ahn)
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