Oil price falls crush frac sand demand

By William Clarke
Published: Monday, 08 June 2020

The global Covid-19 pandemic has plunged the oil market into an unprecedented slump, threatening a complete reshaping of the oilfield mineral market. One of the hardest hit industries is likely to be frac sand mining.

Frac sand, which is added to fracking fluid in order to prop open cracks in the rock formation, has seen one of the most remarkable boom-and-bust cycles of any industrial minerals over the past ten years. 

Demand for frac sand has risen from under 30 million short tons per year in 2010 to over 100 million short tons in 2019. But the price of this commodity has been very volatile over the same period; the grade and size of sand favored varied wildly, supply boomed, and the prospects of the fracking industry fluctuated with every development in the oil market. 

Now frac sand miners are reporting quickly diminishing prospects, and laying off employees at a rapid pace, as the entire industry faces an uncertain future.

Oil prices started to tumble in February, while the Covid-19 shutdown slowed activity in China, and the world adjusted to the possibility that the outbreak could become a pandemic. The fall was accelerated in March by the breakdown of an agreement between Organization of the Petroleum Exporting Countries (Opec) members and other oil producers, particularly Russia. This informal grouping of oil exporting countries had cooperated on cuts to production since 2016.

But the news that Russia would not support further supply cuts caused a breakdown in supply discipline, leading Saudi Arabia to announce heavy price reductions and planned increases in output. Brent crude oil, the most widely used benchmark, fell from over $65 a barrel at the start of 2020 to a low of less than $16 a barrel in April, the lowest level in over 20 years. 

Further talks in April allowed the two countries to reverse direction, with mutual cuts agreed, but this did little to lift prices out of their depression. At the time of writing, prices were still below $35 a barrel. 

This fall in oil prices significantly disincentives new drilling activity, the key driver of oilfield demand. 

Drilling rates have slumped

Drilling rate drop
On May 1 oilfield services company Baker Hughes reported its monthly estimate of global drilling rates in April. The number of active drilling rigs in the world excluding North America plunged to 915, down from 1,059 a month earlier. This was the lowest rate of drilling activity since 2006. 

This drop in oil drilling is also cutting demand for barite, which is used as a weighting agent in drilling fluid. 

Barite, a natural form of barium sulphate, is used in drilling fluid due to its high weight, low cost and non-magnetic nature. The weight of the barite slurry helps drilling fluid to sink to the bottom of well holes, carrying away rock cuttings, and to maintain the pressure of the hydrocarbon formation.

Offshore drilling, which is more technically difficult than conventional onshore drilling, is particularly hard hit by lower oil prices. Offshore drillers are the main buyers of high-grade barite, using material of specific gravity 4.2 or higher, meaning that it is at least 4.2 times heavier than water. 

But if the outlook is poor for barite demand, the picture for frac sand is even more uncertain, as the US onshore market takes a hammering. Although conventional onshore drilling is usually cheaper than offshore, fracking is more expensive, leaving it especially vulnerable to low prices. 

Into this vulnerability the Covid-19 generated shutdown added an unusually large spread between US inland oil prices and international markets. On April 20 the US oil market saw the unprecedented occurrence of negative prices, thanks to a "perfect storm" of oversupply, falling demand and glutted storage capacity.

This negative price was preceded by a long-term shortage of oil offtake capacity due to the increase in production in Texas and elsewhere. With oil pipelines running at capacity, there has been no way to move oil out of the region, leading to low prices close to wellheads. 

A number of large pipeline projects are currently under construction, but offtake capacity is struggling to meet supply. And while the US economy shut down to slow the spread of the Covid-19 pandemic domestic oil demand plummeted, reducing the rate of offtake from domestic fuel refiners. 

This glut across the oil network finally hit Cushing, Oklahoma, which is the main hub of the US oil industry, and the point at which West Texas Intermediate oil futures must be delivered when they expire. 

The result was that the tanks at Cushing finally filled up, just as the May futures contract neared its expiry date, leaving traders scrambling to avoid being left to take ownership of oil when there was no capacity to store it. This game of hot potato saw the expiring May contract collapse from $18 per barrel to -$38 per barrel in the final few hours of trading. The price has bounced back since then, but remains at just under $32 a barrel, compared with over $60 a barrel at the start of the year.

Fracking markets rocked
The negative WTI price rocked fracking markets. The breakeven price for fracking, which means the price at which it is profitable to produce oil, varies widely from region to region. But in the Permian Basin in Texas, the center of US fracking, it is usually thought to be around $50 a barrel. 

As a result, the downturn in US oil prices is stalling fracking activity. According to the consultancy Rystad Energy, the total number of wells being fracked in major oil basins fell to 162 in April, compared with 550 in March and 807 in February.

In a note to investors in March, the broker Raymond James warned that the downturn in fracking activity will be "far more drastic than in previous down cycles" due to the high levels of debt held by companies in the sector, who are still struggling with loans taken out after the 2015 oil price crash. The US rig count could fall by as much as 70% in six months, Raymond James said. 

In fact, low oil prices and such financial circumstances for fracking are already weighing on the drilling rates. The latest weekly figures for US drilling, released by Baker Hughes on May 15, showed active US drilling rigs at a record low of just 329, compared with 792 two months ago. The fastest drop has been seen in the Permian Basin, where the total number of active rigs has fallen to 175, compared with 418 two months earlier. 

Oilfield service companies are painting a gloomy picture for the rest of 2020. In a conference call with investors in April, Halliburton chief executive Jeff Miller said that North American oil-patch spending could halve year on year in 2020. "The market in North America is experiencing the most dramatic and rapid activity decline in recent history," he said. 

"Since mid-March US land rig count has fallen 34% and is expected to continue declining from here. With prices at the wellhead near cash breakeven levels, we expect activity in North America land to further deteriorate during the second quarter and remain depressed through year-end impacting all basins," he added. 

Olivier Le Peuch, chief executive of the world's largest oilfield service company, Schlumberger, was similarly downbeat. "We anticipate both rig activity and frac completion activity to continue to decline sharply during the second quarter, to reach a sequential decline of 40% to 60%, which matches the full-year budget adjustment guidance shared by most operators in North America," Le Peuch told investors during a conference call in April.

"This would represent the most severe decline in drilling and completion activity in a single quarter in several decades," he added.
For frac sand producers, the blow to demand comes on the heels of a protracted supply glut, which meant profits were down when volumes were booming. 

Frac sand markets have been moribund since 2018, when a long-term boom was ended by rising supply. 

Demand for frac sand has jumped since 2016, and for some time the main beneficiaries were miners based in Wisconsin and Minnesota.

But the high cost of transporting sand, as well as a shift in approach that led frackers to favor using higher volumes of lower grade sand, led to a sand rush in West Texas and other regions closer to the fracking sites. 

On March 10 the miner Covia, formed in 2018 by a merger between Unimin and Fairmont Santrol, and now one of the largest frac sand sellers, reported sales of 3.3 million short tons for the last quarter of 2019, down by 21% on the previous three-month period. In a conference call with investors on March 10, Covia chief executive Richard Navarre warned that the effects of the recent slump in oil prices was likely to weigh further on results.

US Silica, another major frac sand seller, reported a sharp drop in sales in the first three months of 2020. Total sales volumes in the company’s proppants segments fell by 17% year on year in the first quarter of 2020, at 3.2 million short tons. US Silica also reported frac sand prices sharply down at $48.63 per tonne, compared with $67.41 in the first quarter of 2019. 

"These decreases are a result of the shift to in-basin sand, overall decrease in demand due to current environmental conditions related to the Covid-19 pandemic, as well as overall supply being greater than demand," US Silica said. 

"During the first quarter of 2020, there was an unprecedented drop in global demand combined with the breakdown of the Opec+ agreement to restrict oil production that led to one of the largest annual crude oil inventory builds in history," US Silica said. "This led to sharp reductions in global crude oil prices." 

"Containment measures and other economic, travel, and business disruptions caused by Covid-19 also affected refinery activity and future demand for crude oil, and consequently, the services and products of our oil and gas proppants segment," the company added.

Smart Sand, meanwhile, announced first-quarter sales of 757,000 short tons. This was an increase from sales of 648,000 short tons in the first quarter of 2019, but revenues fell by 8% over the same period due to a sharp drop in prices. "[The] Covid-19 coronavirus pandemic has caused a global decrease in all means of travel, the closure of borders between countries and a general slowing of economic activity worldwide which has decreased the demand for oil," Smart Sand said. 

This drop in revenues has already triggered a slew of redundancies. US Silica has already sharply cut capacity over the last year, with seven facilities idled and capacity reduced at six more. In April the company laid off another 105 people. Fort Worth, Texas-based Black Mountain Sand has laid off 167 people, in Oklahoma and Texas, while Covia has laid off 82 people in Texas. 

Fastmarkets’ price assessment for frac sand, northern white,100 mesh, API, exw Wisconsin, was $25-30 per short ton on April 23, down from $27-32 a month earlier.