A trainload of sand, enough to fill 50 or more rail cars, can disappear down a single bore hole when drillers frack oil and gas wells in eastern Utah&#;s Uinta Basin.
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They mix the sand with the fluids and chemicals injected underground to fracture rock formations and unlock the hydrocarbons they contain. Industry has discovered that more sand results in higher yields. Getting the sand is not easy or cheap, but relief might be on the horizon.
Utah energy developers must acquire their &#;frac sand&#; from Wisconsin quarries, which hold an abundance of clean silica grains of the right size, shape and hardness, a material known as &#;northern white.&#; But now alternative sources are under exploration in southern Utah&#;s Kane County, potentially opening the West&#;s first major quarries of sand needed for fracking operations.
A 12,000-acre area in Kane County could yield enough to meet the needs for Utah energy developers for 40 to 50 years, according to energy industry representatives speaking last month at Gov. Gary Herbert&#;s Energy Summit in Salt Lake City.
&#;We have some of the best frac sand in the country,&#; J.T. Martin, president of Salt Lake City-based Integrated Energy Cos., told conference attendees. &#;We are calling this &#;Utah pink Champagne.&#; The Wisconsins have nothing on us.&#;
Martin&#;s firms provide oil-field, transportation and marketing services to Utah&#;s oil and gas industry. He said one, Integrated Sands LLC, controls claims and leases for sand on 12,000 acres of state trust and federal lands in Kane County, which it hopes to develop.
Officials with the School and Institutional Trust Lands Administration, or SITLA, are pleased with the prospect of producing such sand from its holdings, which in turn would support oil and gas production from its mineral holdings in the Uinta Basin.
&#;I am thrilled Utah is finally looking at home for frac sand. It&#;s our job to get these things in production,&#; said Tom Faddies, who oversees mineral production for the state agency that manages land to raise money for schools.
Hydraulic fracturing, or fracking, has become a controversial drilling method over concerns it imperils groundwater, but it is credited with spurring a surge in domestic oil and gas production. The industry&#;s use of sand has soared, prompting drillers to accept greater variation in the sand used, according to Faddies.
The Great Lakes region produces 70 percent of the nation&#;s sand for fracking, with Wisconsin accounting for half the total. Transportation represents more than half the sand&#;s cost at the wellhead.
Locally sourced frac sand could not only save industry millions in transportation costs, but also bring economic benefits to another corner of rural Utah.
&#;It will create a lot of jobs and generate a lot of money,&#; Rep. Mike Noel, R-Kanab, said at a legislative interim meeting this month.
Sand plays a vital role in the fluids that are injected under intense pressure into bore holes drilled horizontally through oil and gas deposits. Once the formation fractures, the chemical cocktails are sucked out, leaving behind the sand as &#;proppant&#; that keeps the cracks open so the hydrocarbons can flow up the well.
Industry&#;s use of sand doubled to 61.5 million tons between and but dropped off with the collapse in oil prices. Demand is expected to exceed 100 million tons this year as drill rigs return to work in response to rebounding prices, putting an intense crimp on supplies that could delay the coming drilling boom.
The need for sand is also expected to grow as fracturing technologies improve, extending the reach of cracks that need to be propped, according to the U.S. Geological Survey. Now exceeding 2 miles, horizontal wells reach ever greater distances, also increasing the amount of sand needed per well.
The best sand for fracking comes in rounded, spherical grains, about 0.5 to 1 millimeter in diameter. They must withstand the powerful forces associated with fracking, a property known as &#;crush resistance.&#; Facets and impurities can render sand useless if the grains collapse.
In a study commissioned by SITLA, the Utah Geological Survey analyzed sand from 60 sites around the state and found promising sources in southwest Utah&#;s eolian sand dunes.
&#;We specifically looked at roundness and sphericity, grain size and chemistry,&#; said UGS geologist Andrew Rupke. &#;It has to be relatively pure quartz sand. You don&#;t want a bunch of other material in there because then [the grains] tend to be weak, or might react with the drilling fluids and plug up the pores.&#;
Utah grains tend to be smaller than optimal, but faced with a supply crunch, industry has lowered its standards, Rupke said. Unconsolidated deposits and friable sandstone like those found in Utah are preferred sources because they require less processing to produce usable sand.
The SITLA report did not analyze crush resistance because those tests cost $3,000 each.
&#;We will lease the lands,&#; Faddies said, &#;and let the lessee do the tests.&#;
Martin&#;s firm has conducted some of these costly tests, and the results have shown the grains to be suitable, he said, if not ideal for fracking.
Two Kane County locations, around Coral Pink Sand Dunes west of Kanab and the sand hills outside Big Water, hold vast deposits of potentially acceptable sand, but they are still about a 350-mile haul to Utah&#;s oil patch.
Faddies believes SITLA&#;s sand deposits closer to or even in the Uinta Basin would offer more economical sources for industry.
Smart Sand ($SND) is one of the largest suppliers of high quality frac sand called Northern White (NWS), inefficiently priced at ~50% of liquidation value and 30% book, with pristine balance sheet and rapidly growing revenue and earnings. It&#;s a low risk, high uncertainty idea on improving frac sand market conditions and, at the same time, 25% of my portfolio.
First, let&#;s see some numbers:
I&#;d say the calculations are quite conservative, but feel free to modify the discounts as needed. It&#;s still going to be cheap in my view.
In the middle of the previous decade, there was a frac sand boom, as selling sand was quite profitable due to supply constraints and fairly high demand. A few years of excess cash flowing to the companies selling frac sand, combined with unintelligent risk taking drove the industry from a boom, to a bust. Due to a sudden oversupply, sand prices dropped drastically. Costs had to be cut to save money, and Northern White (NWS), previously the most widely used type of sand due to its high quality, was replaced by in-basin sand (IBS) &#; worse in almost every way, but cheaper in the short term.
Around -, as the situation had worsened to quite dramatic levels many of the drillers had already stopped buying the more expensive NWS, and started using solely this locally sourced in-basin sand. Two years later, the pandemic hit, and many of the highly levered frac sand suppliers went broke, as the lasting oversupply drove the margins down significantly.
This is the moment when Smart Sand started shining. Although the losses were quite severe, due to some wise past decisions the balance sheet remained in a great shape, and thus the company had a lot of opportunities to seize in buying cheap assets from their desperate competitors. For example, they bought a deactivated mine in Blair, Wisconsin from Hi-Crush for $6.5 million, which was first purchased by Hi-Crush for $75 million just 6 years prior.
Nonetheless, the industry itself was in shambles.
Around two years later, little sprouts of recovery started coming out, and that&#;s when I realized that Smart Sand might not be just an asset play, a cheap cigar butt that should be sold after a temporary price bump. That was the moment when everything started stabilizing and improving rapidly. Just look at the numbers:
kind thanks to
macrotrends.net
So, the rapid expansion and the pillaging of the discounted assets in this hopeless industry started paying off (at least revenue-wise).
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Mid- I remember noticing that, hey, this quarter wasn&#;t that bad! And indeed, from then on, the results have only gotten better. It turned out that Smart Sand quickly became the second biggest provider of Northern White sand:
In the second quarter of , the company opened its new Blair facility, and with access to Canadian National rail line could start expanding into the land of maple syrup and ice hockey which is, undoubtedly, a large market to penetrate. Again, the mine began processing sand in Q2 , so we have not yet seen the full impact of the expansion.
Additionally, in February they bought back 11.3% of its shares from a large private equity investor that was with the company since the beginning, Clearlake Capital, at an average price of $1.71 per share
I could sum up Smart Sand&#;s past few years as growing and getting ready. Although the share price went pretty much nowhere since those few years ago, (apart from a few temporary price bumps, which I took advantage of), the intrinsic value and the company&#;s potential have been very much growing.
Before we go deeper, it&#;s important to know how frac sand is used in the process of getting oil and gas from the ground.
To put it as simply as possible: &#;it's a process by which water, sand, and chemicals are injected underground at very high pressures to crack open rock layers and release the oil or gas trapped inside.&#;
Then the sand keeps those cracks in the rock you just dug into open for you to extract all the goodies you want. That&#;s why the quality of different types of frac sand matters here &#; if you use crappy proppants, you get less from your wells, as sand is slowly being crushed into smaller and smaller particles which clog the wells, continuously decreasing the volume of goodies available for extraction. What matters here is the size of the grains, the shape, the &#;roundness&#;, crush resistance and so on.
The problem remaining is the market&#;s perception on which type of proppant is the one that should be used today. Back when the industry started using IBS more than NWS, the costs started visibly dropping, obviously. Today, many customers still think it is the right idea to use cheaper IBS over the more expensive NWS, so the latter lost its position as the proppant leader. Fortunately for us, there is lots of evidence that tell a different story. For one, consider the most important evidence out of all, the report made by Rystad Energy
If you want to get more details on the methodology, geographic placement of the &#;test subjects&#; etc. I advise you to read the full report. My TL;DR to you would be that Northern White is superior to in-basin sand in the majority of cases, and allows drillers to get more oil and gas from the ground at lower costs in the long run, even considering the higher base price
Here is probably even better &#;TL;DR&#; than mine, so before you go further take a look at this article.
In Q3 earnings call, the management said
As well as:
So, sales at least 10% higher than , and continued buybacks.
More buybacks would definitely be more than welcome, and looking at the available $9.3M of cash, it&#;s more than possible that the management will continue to reward shareholders this way, buying back shares at 30% of book. It&#;s even more plausible when you consider the fact that the CEO owns almost 7 million shares, or approx. 16.3% of the total shares outstanding, with additional 5.85 million shares (or 14.2%) held in his LLC, Keystone Cranberry, where he has sole voting and investment power. In total, he controls over 30% of the company.
Additionally, it&#;s worth mentioning that, apart from revolving credit facility and operating leases, Smart Sand has very little debt.
On top of that, Q3 was one of the best quarters in the past few years, with net income totalling $6.7M, or around $0.18 per share. This was the first profitable year in a while for the company, and the market did not even acknowledge that, as the share price today still sits stagnantly below $2 per share. The turnaround is very much here, but the stock is still trading as if the company were to lose almost half of its value.
Also, due to the weather implications, the best quarters are typically the sunniest ones. During winter months production is limited, and producers must rely on the reserves gathered during warmer times, so that is why you can see that the best results are usually mid-year, or Q2 and Q3.
Apart from that, Smart Sand also pays annual bonuses at the year&#;s end, so that should also impact the upcoming quarter&#;s results (Q4, which should come out in a matter of a few days).
One more important thing would be that I have noticed that the management focuses a lot on driving down the costs of their product which, as we know, is a very important factor for the customers here. I found it difficult to compare just how large the cost differences are in comparison with Smart Sand&#;s competitors, so you could say this is where my analysis could be improved. One thing I will mention though is that from reading a lot of reports and transcripts of earnings calls, they seem very much aware of the power of being a low-cost producer and actively try to improve in this matter wherever possible.
In my view the biggest risk here is opportunity cost. The value in the company and its product is definitely there. The question is when this value is going to come out of the shares into the pockets of the investors.
My thesis here is not that Smart Sand is going to be a 100 bagger, but rather that it is a low risk, high potential opportunity. The downside is protected by the asset value and the sheer size of the current operations (which will undoubtedly be appreciated by the market when the current industry trends reverse, bringing great returns to the shareholders). It would also not take much for the share price rerating to happen &#; just some more good news as seen lately, and a little more eyes on the company. Seriously, there is surprisingly very little coverage of this industry. Even Bloomberg Terminal was of pretty much no use here. No wonder investors are so few and far between.
I&#;ve heard people say, &#;But Stonks, the rig count is dropping, how can the future bring better results for Smart Sand?&#;
Well, while it is true that rig count is indeed dropping&#;
&#;the oil and natural gas production is increasing
Which suggests that, with this in mind, companies have probably started paying more attention to well efficiency, rather than just the amount of them active at a given moment, which may actually be a good thing for Smart Sand. After all, if you want to increase the efficiency of your wells, why not switch to a better proppant?
Additionally, if you focus on making the wells &#;bigger&#; (increase the drilled lateral length) to maximize the extractable amounts of oil and gas, you will most definitely have to use more proppant.
It is also worth mentioning some other possible risks, such as the possibility of a sudden decline in the energy industry, which would undoubtedly hurt Smart Sand. This topic is as wide as can be, and every investor has a different view on the future of the energy market, so I will not try to convince anyone that we are either in a &#;commodity supercycle&#;, nor that the world will stop using fossil fuels entirely in the coming years, as I do not feel competent enough to have an intelligent opinion here.
Apart from that, we might also see some regulations and political moves when it comes to fracking that could do some damage to the industry. Again, nothing concrete.
To sum things up, I see Smart Sand as a low-risk opportunity, with a potential for high returns. The management is shareholder friendly and has skin in the game. The company trades for ~50% of liquidation value and 30% of book value, so we have a tangible margin of safety here, and practically no debt. The revenue increased from $127M in to $256M in and will probably reach around $300M for FY. The management predicts that &#;s sand sales will increase at least 10%, as compared to this year:
I&#;ll be extremely happy to talk to you regarding this investment. I&#;d also highly appreciate any constructive critique, no matter how devastating to my huge ego.
Thanks a lot for reading! That was my first ever public writeup, so if you liked it, be sure to let me know and maaaaybe there&#;ll be more to come soon :)
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