The U.S. shale business has been in recovery mode since May 2016. Key to this business is hydraulic fracturing, or “fracing,” as it appears in industry short-hand.
Fracing is a capital-intensive part of the U.S. shale growth story. A single “spread” (unit) of frac equipment is comprised of truck mounted pumps, blenders, tanks and valves. The capital outlay for these units is in the $40-$60M range depending on size and specification.
Estimates of market size vary, but we believe there are roughly 350 frac units in operation today, up from about 175 units at work at the cyclical bottom of 2016. At the peak of the market back in 2014, there were about 450 frac units working in the U.S.
Re-deployments of idle capacity has been the primary growth driver as the supply base responded to the new demand shown above. However, we are reaching the end of the bench. In other words, the industry is running out of equipment to reactivate. Deferred maintenance and changing equipment requirements limit the idle capacity that can now return effectively to market.
So this begs the question: when will the industry undertake the next new construction cycle? Some contractors are sold out or close to it. So will they build new equipment soon to take market share as supply tightens?
A handful of expansion newbuild orders have indeed recently been placed. But not enough for us to call the start of a real industry-wide newbuild cycle in frac yet. For many insiders, it feels like the industry is on the verge of a big new wave of equipment orders. Investors in the stocks of frac service companies are increasingly nervous that a flood of new orders could cause pricing to collapse. Take a look at the 30-50% short interests on frac service companies like RPC, Inc. ($RES) and Keane Group, Inc. ($FRAC) for evidence of the fear.
The fracing industry could decide to order en masse at any moment, so paying attention to shifts in management’s tone regarding their appetite for newbuilds is critical. That means listening carefully to investor relations presentations, as well as earnings calls.
Barclay’s holds a large energy investor conferences in the first week of September each year . The conference presentation transcripts are available on AlphaSense, as are transcripts from quite a few important events beyond just the standard earnings calls.
Limiting our search in AlphaSense by industry, and searching just for conference transcripts in the past month, we quickly isolated all the talking points from this key industry event. The AlphaSense platform made it easy to search the entire conference transcript for indications of frac newbuild appetite.
Key Takeaways from AlphaSense Search
RPC, Inc. ordered two new units …
At the investor conference, RPC said they decided to order 100,000 hydraulic horsepower (HHP) to be deployed across two spreads. One spread is essentially a replacement spread for older equipment (which will be used on smaller vertical jobs after its replaced), and the other spread is legitimate new fleet expansion.
Some of the equipment will begin to deliver by year-end, and they’ll deploy the new fleet in 1Q18. Also, RPC has started talking to customers about take-or-pay contracts for the first time since 2013 / 2014, but nothing firm to report there yet.
Basic Energy Services said the market is short capacity, just not short enough yet …
Basic Energy Services ($BAS) pointed out that the market falls short on frac spreads. If the rig count climbs from here, then more horsepower will be needed to address shale demand. As evidence of how tight the frac market is, Basic Energy said that i) customer frac delays aren’t causing downtime for them (they go right to work for another customer, if there are delays on a job), ii) they are getting nonstop inbound calls from operators asking for available windows on their spreads, iii) they have fired customers to take better pricing opportunities in the market and iv) they aren’t interested in signing long-term contracts yet.
At the same time, the company said that historical build cycles have required a cash-on-cash payback approaching three years. Margins aren’t there for that yet, and they are simply not rich enough to justify industry wide expansion yet. So Basic Energy is happy with the current size of their fleet.
Patterson-UTI says utilization & pricing aren’t high enough to build …
Most frac service providers that aren’t building simply say that pricing isn’t high enough yet to meet construction return hurdles. Most of these same companies say that the market is short, and utilization is virtually full. In Patterson-UTI’s ($PTEN) case, they need to see utilization increase, too.
Patterson’s CEO, Andy Hendricks, said, “We have 1.1 million horsepower active, but we have 1.5 million in horsepower total. We’re just not there, where in terms of utilization or pricing, to call it a newbuild cycle. And we certainly don’t see it, that it’s necessary to invest in new equipment right now.”
When asked how much higher prices need to go, Hendricks put it this way, “Pricing from the peak of 2014 dropped about 70%. Anecdotally, from various companies, various reports, you’re hearing from the bottom, we’re up 40%, or we’re up 50%, or we’re up 60%. But that’s not back to where we were in 2014, right? We have to be up well over 100% to get anywhere close to that newbuild cycle that we were in, in 2014. So, we’re just not there.”
Superior Energy Services warns that construction is needed for replacement before expansion …
Superior Energy Services ($SPN) CEO, David Dunlap, said that pressure pumping is undersupplied by 1.5 – 2M HHP and attrition is poised to tighten the market further in 2018 / 2019. He downplayed new construction with the following argument:
“A lot of the equipment that we have seen companies reactivate over the course of the last 9 months is equipment that I don’t believe has much more than 25% or 30% useful life. And the life of a frac fleet today, before rebuild, is somewhere between 4 and 5 years. So, the way my easy math works on this, if there’s 13 million-horsepower working out there today, then we ought to have about 3.5 million-horsepower being replaced this year. And I know some of you have heard some numbers from component manufacturers and assemblers that there’s horsepower under construction, we need to be constructing horsepower. We need to be replacing horsepower. This stuff does not have an unlimited life, and we’re not replacing it as an industry fast enough. That leads me to believe the market stays tight in 2018. And I think by the time people get orders in and prices have migrated to a point that companies — fracturing companies feel comfortable placing the orders, we’re 2 years away from seeing the impact of that capacity. I think it’s a tight market in hydraulic fracturing in ’18 and in ’19. Everything that we have reactivated during 2016 and ’17, in addition to the capital rebuild that we’re going through in the second half of the year, is equipment going out into the field with a new engine on it. That’s 100% remaining useful life. So, of our 750,000-horsepower, 450,000 of that horsepower had 100% useful life when it went into the field. We feel really good about where we are from a fleet life standpoint. And I think that’s important, because I think there will be a lot of companies that are trying to replace major components in 2018 and ’19, and we’re going to be running at full capacity throughout that time.”
With just a few key strokes in AlphaSense, I was able to parse through many hours of talk time and thousands of paragraphs of text to see what the key players had to say about building new equipment – turning hours of research time into minutes.
What I learned is that although some isolated frac newbuilding has begun, expansion construction is mostly limited to a handful of small, aggressive companies building just a couple fleets each at this point. Some are building to validate promised IPO growth trajectories, while others are trying to take market share.
Joseph Triepke is the founder of InfillThinking.com, an independent oil and gas business research firm. Prior to launching Infill Thinking, Joseph was an equity research analyst covering the energy industry for large buy-side and sell-side institutions.
1. Side note: The mainstream press has popularized the spelling “fracking,” which most energy industry insiders find offensive, because it resembles another four-letter word and is believed by many in the industry to have been initially coined by environmental opposition to the fossil fuel industry.
2. InfillThinking.com estimate
3. Baker Hughes GE rig count trend line combined with InfillThinking.com frac demand factor and adjustments
4. $RES short interest on Yahoo Finance; $FRAC short interest on Yahoo Finance
Editors note: Smart SynonymsTM, AlphaSense proprietary, AI-powered technology, instantly expands your keyword searches while filtering out false positives. The term “fracing” can be found under the AlphaSense Smart Synonym for “fracking,” along with other related terms.