Got Sand?

Jim Brown
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20 years ago a pile of sand would have been nearly worthless. If you owned a few million tons of sand today you would be set for life.

When a shale well is fractured under very high pressure millions of pounds of sand are forced into those fractures to keep the rocks from slamming shut when the pressure is released.

This creative use of sand has caused a new business to boom with sand mines and long trains of cars filled with sand heading to the shale fields.

Unfortunately the drilling boom has progressed to the point where we are heading for a sand shortage. Technology has reduced the time needed to drill a well and that allows rigs to drill more wells in a shorter time than ever before. The number of active rigs in North America has increased to 1,925 and a multiyear high.

Baker Hughes said there were 9,394 onshore wells drilled in Q2. That is up from 8,853 in Q1. We could come very close to 10,000 wells in Q3. The vast majority of those wells are horizontal wells and will utilize high pressure fracking and vast amounts of sand.

Morgan Stanley is forecasting demand for sand to increase +96% from 2013 to 2016. Unfortunately sand supply growth is only expected to rise +76%.

The problem for suppliers is that drillers have discovered the more sand they use in fracking a well the more that well produces. After several years of trial and error the leading edge drillers have found that using 86% more sand in a well increases the rate of return by 40% on average. They have also found that longer laterals on the wells can produce more oil long term and offset the extra cost of the well. Longer laterals require more frac stages and more sand. Everything requires more sand.

MS says the top 10 sand users pump approximately two times more sand than their competitors on average and 3-4 times more sand in their leading edge wells. As the slow to evolve drillers catch on to the new facts of life they will also begin to pump more sand into each well and demand is going to rocket higher.

This is not your ordinary beach sand. This is super fine sand with few impurities and it is mined rather than just scraped off a beach. The sand is filtered to remove rocks and impurities and then loaded onto rail cars for the trip to the shale fields.

Another challenge is the lack of enough rail cars and the lack of rail capacity, which is currently being taken over by the shipment of oil around the country. Ten years ago there were 10,000 rail car loads of oil per year. In 2014 there will be more than 400,000 cars of oil making their way across the country. Not only do the cars have to travel to the coast to unload their oil but the empty cars have to make their way back through the rail system to the shale fields to be refilled.

Along the way they compete with the coal trains and now the sand trains for track capacity. When this year's record harvest of corn, wheat and soybeans hits the rails the traffic jams will be horrendous. Already Berkshire's Burlington Northern is being blamed for monster traffic jams in the Midwest and it is only going to get worse. Multiple companies warned or blamed with their Q2 earnings that rail bottlenecks and a lack of capacity was reducing their earnings.

Sand delays are already delaying the fracking of hundreds of wells. This is a goldmine for the sand suppliers. The major suppliers are U.S. Slica, Emerge Energy Services and Hi-Crush Partners. Another major winner is Carbo Ceramics. They manufacture ceramic proppants, which are a high quality replacement for sand. The smooth surface of the ceramic balls allows the oil to flow smoothly through the proppant once in the fractures. They are also suffering from high demand and lack of supply although they have several new plants coming online this year. As sand prices rise Carbo will be a major beneficiary because their high priced proppants will no longer be high priced but compatible with the regular frac sand that is in short supply.

With sand costs rising the cost of a well is expected to rise 20% or more. While that sounds like a crisis the actual benefit from using more sand could be a 40-60% increase in the ultimate recovery of oil from the well. Drillers would take that trade off every day.

With Morgan Stanley predicting a frac sand shortage until 2017 it would seem the sand suppliers have nowhere to go but up.

Oil Inventories

Crude inventories declined -900,000 barrels last week and the ninth loss in the last ten weeks. This is normal for this time of year. U.S. production was flat at 8.63 mbpd and imports rose a minimal +42,000 bpd to 7.68 mbpd. Refinery demand declined slightly by -114,000 bpd.

Inventories at Cushing declined by -400,000 barrels to 20.3 million. Refinery utilization also declined slightly from an unseasonably high of 93.5% to 93.3%. Utilization has been over 93% for the last three weeks. That is about 2% over normal and should be dropping to less than 90% in the weeks ahead.

Crude oil in inventory should begin climbing over the next couple of weeks.

Gasoline inventories declined -2.3 million barrels and the biggest drop in four weeks. This report was for the week that ended on Labor Day weekend so the numbers for next week should also be low with inventories rising after that. Gasoline demand rose +380,000 bpd but that was offset by a +353,000 bpd rise in imports. Production was up slightly by +58,000 bpd.

Distillate inventories rose by +600,000 barrels despite an increase in demand of 302,000 bpd. Production rose +133,000 bpd and imports rose +76,000 bpd. In the distillate chart below the red line is slowly creeping back up towards the five-year average but inventories are still -4.8% below year ago levels.

The demand for oil at the refiner level is more than 2% over year ago levels. Refined product output was 19.96 mbpd last week and the second highest level this year. Despite the weak jobs report there is a rising demand for oil products. If job gains were to continue to grow the demand for gasoline would grow with them.

In the graphic below green represents a recent high and yellow a recent low.

Propane inventories rose 1.41 million barrels to 76.124 million. That is 11.5 million barrels more than the same period in 2013. It is also the highest level since October 1998. The inventory rebound from the four-year lows on March 21st has been amazing. The propane shortage of last winter is not likely to be repeated this year unless we have a very cold winter.

Demand rose from 985,000 bpd to 1,017,000 bpd. If you need propane for the winter now is the time to buy it. I filled up on Friday for $1.64 per gallon. The weather forecasters are predicting a colder than normal winter.

Natural gas inventories rose +79 Bcf to 2,709 bcf. This continues to be the fastest build in 11 years. They are still -15.4% below the five year average at 3,204 Bcf. There are only 8 weeks left in the injection season and at the current rate we could reach 3,500 Bcf. That is still about 400 Bcf below where we need to be going into the heating season.

The blue line in the chart below shows the current inventory relative to the five year average.

The EIA posted a chart this week showing that refinery utilization is at or near record levels at 93.3%. (Red line in the chart below) This is due to continuously rising exports of refined products. Exports last week averaged 3.7 mbpd of things like gasoline, distillates, jet fuel, petroleum coke and gas liquids. "Gulf Coast distillate production is exported almost exclusively into the Atlantic Basin market, with about 50% going to Central America and South America, 35% to Europe, and 12% to North America, primarily Mexico" according to the EIA.

This clearly shows we do not need to export oil. We are better off exporting refined products for higher prices than the raw oil. This provides jobs for U.S. workers and keeps our refineries running at peak performance.


The equity markets had a tough week but they did not suffer any material declines. The gap higher at the open on Wednesday and Thursday followed by strong selloffs in the afternoon were classic distribution patterns. Friday reversed that with a morning dip and strong rebound in the afternoon with the S&P closing at a new high.

Assuming there are no dramatic headlines from overseas this could be a positive week. The S&P futures opened slightly lower on Sunday night but are holding at the 2,005 level.

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Jim Brown

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