The U.S. energy Renaissance came about because of a combination of high oil prices, hydraulic fracturing, horizontal drilling, and shale. From a big picture perspective, it sounds so simple. On the ground, however, it's far more complex, and there are a lot of moving parts. One of the important components of fracking, as the shale drilling technique is called, is sand. And with oil prices falling, so too are the shares of frac sand suppliers like Hi-Crush Partners LP (HCRS.Q) and U.S Silica Holdings (SLCA -1.84%).
What goes up
Up until the middle of 2014, oil prices seemed like they could defy gravity since the United States seemed to be cranking out more and more of the stuff. That was too good to be true, of course, and oil eventually succumbed to concerns about a global oversupply of the fuel. The drop has been nothing short of spectacular, with oil plummeting from over $100 a barrel to less than $50.
The big problem in this for oil drillers is that it costs money to pull black gold out of the ground. That's particularly true in shale regions, where drilling tends to be more complicated and, thus, more expensive. In fact, with oil so low, drillers are starting to pull back. For example, energy service providers Halliburton Co. (HAL -1.65%) and Baker Hughes (BHI), which have agreed to merge, are looking to shed 4,000 or more jobs between them as they prepare for a slowdown in demand. Schlumberger Limited (SLB -0.93%), the largest player in the space, is looking to cut 9,000 positions.
But that's not the only tap-on effect from falling oil prices. Although drilling equipment and the humans who work it are vital to the fracking industry, so, too, is frac sand. That's the stuff that gets shoved down wells with water and chemicals to break up shale formations and release oil and natural gas. If there are fewer wells being drilled, there's going to be less demand for the sand that Hi-Crush and U.S. Silica sell. It's no wonder their share prices have plummeted along with oil.
How bad could it get?
Rick Shearer, CEO of Emerge Energy Services LP (NYSE: EMES), another frac sand supplier, recently explained to The Cap City Times that, "We certainly expect things will be softer in 2015 than they were last year." But he added that, "The good news is that those who are still drilling are using more sand per well." The CEO of U.S. Silica has echoed that positive view, as well.
So, there's a counterbalance, but the frac sand market is fairly new to the boom and bust cycle of the drilling industry. Indeed, demand for the product only recently started to take off with the growth of fracking and has, thus, only really experienced oil prices moving generally higher. It seems odd that the giant drillers and service providers are cutting back quickly at the same time Emerge is talking about possibly adding new jobs.
There's a disconnect there worth keeping a close eye on. In fact, you have to wonder if the sand providers are hoping that oil prices rise just as quickly as they fell. If that happened, the impact wouldn't be too bad. But the actions being taken by longtime industry survivors Halliburton, Baker Hughes, and Schlumberger don't seem to suggest that will be the case.
A buying opportunity?
With the price of sand providers falling with oil, it's an area you may want to watch for good deals. The fact is, fracking isn't likely a fad, so there will be demand for sand. The questions are how much, and has the steep fall experienced by frac sand stocks so far gone past a rational level? That, unfortunately, is hard to tell until oil prices stabilize.
If you are the type of investor who likes to buy when everyone else is selling, Emerge, U.S. Silica, and Hi-Crush should all be on your watchlist. But it may be a little too soon to call a bottom, even if the shares of this trio are starting to stabilize. And you should take a broader look at the drilling space before accepting the outlook provided during this sand trio's fourth-quarter conference calls -- especially if they appear at odds with longtime industry players.
