Oil slump spells uncertainty for fracking, frac sand

The decline in oil and gas prices has clouded the outlook for 2015, particularly for oilfield service providers, including pressure pumping firms, which make most of their revenue from fracturing. 

At the recent institutional investor conference in Toronto held by AltaCorp Capital and ATB Corporate Financial Services, Trican Well Service (TSX: TCW), Calfrac Well Services (TSX: CFW; US-OTC: TOLWF) and Canyon Services Group (TSX: FRC; US-OTC: CYSVF) predict a strong start to 2015, but are cautious about the rest of the year. 

During the Jan. 14 frackers panel discussion, Trican chief financial officer Michael Baldwin said his company had experienced “good levels” of activity in the Western Canadian Sedimentary Basin (WCSB) and in the U.S. in the fourth quarter. He expects that to continue during the first quarter of 2015. Given there’s not much guidance on what customers are planning after spring break-up, Baldwin anticipates service prices will decline, particularly in Canada.

“It is actually our busiest start to the year ever,” Canyon CEO Bradley Fedora, whose firm provides well stimulation services only in Canada, said. “We actually have been — and maybe our competitors have been, too — turning away work pretty steadily almost every day now for almost two months … the irony is that nobody knows anything about the second half of the year, but Q1 is really good. And on the pricing side, the reality is there isn’t room to give big price cuts.”

Pricing levels in Canada troughed in late 2013 and they are up 10% from that level, Fedora said, explaining there isn’t room for the desired 20% drop customers want from service providers. 

Michael McNulty, chief financial officer of international player Calfrac, added that service providers in Canada got a price increase in the fourth quarter of 2014. Since it was so recent, customers could easily grasp that back, he says. Once they do, there’s little margin left for cuts. “This shouldn’t turn into a bloodbath, because if it does then we aren’t going to make any money. And that is not good for anybody.”

Looking at the U.S., McNulty said  there is even less room for reductions there because there hasn’t been any substantial price improvement. Complicating that picture is the fact that there are more competitors in the U.S., willing to do the job for cheaper rates.

Regarding the fracturing equipment market, Fedora noted the Canadian market has doubled from a million horsepower (hp) to 2 million hp since 2009, with most of the growth occurring at the end of 2012. “That market has been fairly stagnant,” he said. “there actually has been a net reduction in hp in Canada in the last 24 months.”

When this market returns, Fedora believes there will be a shortage of equipment. “When you look back at 2010 and 2011, which bounced off the lows of 2009, and I think you are going to see a similar situation. The reason why is because the frac intensity has grown on a well basis, as metres drilled increases in a basin, which is what we look at now instead of well count. The frac intensity per metre has grown.”

Along with that, the sand consumption on a per-well basis has doubled in two years.

He says the current market is “finely balanced,” given that suppliers are operating at capacity.

While Calfrac’s McNulty agrees, he pointed out the U.S. market in certain regions is somewhat oversupplied and could benefit from the sustained downturn.

Given the looming uncertainty with commodity prices, all three of the Calgary-based firms have minimum capital expenditures planned for the year, with most of the capital expenditures going toward equipment maintenance.

“It is going to be a tough year and we have to adjust,” McNulty said, noting that if activity declines, Calfrac will have to reduce personnel. “The cold and hard facts are we are a service company and if we don’t have the activity we will have to cut [workers].”

Commenting on the firm’s use rate year over year, McNulty said it is hard to tell how much it will be off by in 2015. Calfrac has been running different scenarios that have estimated a decline of between 25% and 50%, and believes the most realistic estimate will be 30%.

Trican’s Baldwin said the 30% range “makes sense.” “We know what’s coming down the pipe so we are really focused on cost reductions.” 

Fedora added that the firms could easily implement cost savings. “We as an industry or as a company can react really, really quickly once we have a clear vision of what the second half of the year is going to look like.”

Providing an update on sand and logistics, Fedora said that the sand price has gone up, but this increase is relatively minor compared to the costs associated with moving sand from the northeast U.S. to northwest Canada. By the time sand gets to a location, 85% of its cost is related to logistics, he said.

“When we think about cost control, we are a lot less worried about the price of sand, whether it is $28 per lb. or more. But what we are worried about is what are the rail companies going to do and how we can get more efficient at trans-loading and trucking from many of these trans-loading locations to the site,” Fedora explained.

The biggest cost-saving opportunity for Canyon is around Canadian trucking, he says. The company has looked at investing in sand logistics, but Fedora admits it is a “tough investment case.”

The weakening Canadian dollar has also hurt Canyon’s sand, chemical and equipment costs. The firm gets most of its equipment from the U.S.

Baldwin said that as activity goes down so will sand use, creating price reductions. Trican is talking with its suppliers about providing reductions to bring the sand prices down 5% to 10%, he said. On the trucking side, Trican plans to have less trucks running in 2015. Baldwin agrees with Fedora that over the long run, it will also have to become more efficient with logistics.

McNulty said logistics is a big part of Calfrac’s business and that the firm had invested heavily in logistics in 2014. He believes this gives it a competitive edge, particularly in areas such as the Rockies and in the Marcellus, where it is challenging to get the sand to the well sites.

“They will be a lot of pressure on our suppliers to reduce their costs as well,” McNulty said. “I do think we will see some reductions. That is probably how we will work with our customers and not reduce our prices, but discuss with them about passing on to them cost savings that we are able to get.”

Industry overview 

The WTI oil price has fallen 56% since June to US$47 per bbl, prompting oil producers to slash spending.

As a result, there will be a slowdown in drilling activity, cutting demand for rigs, pressure pumping fleets, and other key equipment and services, research and consultancy group Wood Mackenzie notes.

Analysts expect reduced drilling activity after spring break-up, with rig count dropping in both Canada and the U.S.

First Energy Capital analyst Kevin Lo estimates active rig count will fall by 32% year-over-year to 235 in Canada and 24% to 1,354 in the U.S. He anticipates a Canadian well count of 8,000 this year — a 30% decline from his 2014 estimate. With fewer wells, drilling operating days and metres drilled should fall as well.

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;As a result of these changes, we now expect WCSB industry cash flow to decrease 53% from 2014 to 2015, leaving us with the lowest conventional revenue since 1999,” Lo writes in a Jan. 14 note. He predicts the energy services industry will spend 32% less on a year-over-year basis, and forecasts WCSB drilling use of 29%, down from 43% last year.

Meanwhile, Trican, Calfrac and Canyon will be lowering their own cost structures and spending, while considering staff reductions and wage rollbacks.

The analyst has revised the price targets for the firms in his coverage universe, including for the three pressure pumpers. He has cut his target on Calfrac by $5 to $16, on Canyon by $1 to $10, and on Trican by 50¢ to $8.

On Jan. 21, Calfrac shares closed at $8.27 with a $788-million market cap; Trican finished at $5.15 with a $769 million market cap; and Canyon ended at $7.12 with a $488 million market cap. The shares of all three firms are off between 60% and 70% from their 52-week highs reached mid-2014, when WTI crude was above US$100 per bbl.