Did any of us truly consider staying bearish on natural gas for long?
After seeing prices plunge by over 38% in mid-April, many people were left wondering if and when natural gas would ever return to form in 2012.
Sure, it wasn’t surprising to see price levels recover during the summer months as one of the hottest and deadliest heatwaves on record swept through the Midwest and East Coast.
But even after the heat subsided, natural gas has continued on a steady upward trend – much to the delight of investors who hung in there.
It’s currently trading at its highest price year to date.
What’s more? Winter is coming… (Game of Thrones fans know what I’m talking about.)
Does that mean we’re now out of the woods?
Not just yet…
Energy prices remain volatile given the ongoing economic fragility around the globe – and the natural gas market is no different.
While demand looks to be picking up, you just never know what tomorrow brings.
That said, I do know of a lucrative way to play the natural gas market without needing to worry about the day-to-day price swings.
In fact, no matter which way natural gas prices move, I’ve learned that a highly sought-after commodity used during gas extraction has been consistently raking in huge profits for its producers.
The need for this material is so great that there aren’t enough railcars in the country able to transport it to even keep up with the soaring demand.
Still guessing? Let me tell you…
Thanks to the explosive growth of horizontal drilling and hydraulic fracturing of shale in the US, the demand for frac sand has gone ballistic in the past few years.
But this is not just any sand that you can simply run out to the beach and grab a handful of.
This sand is of the monocrystalline silica variety and there are stringent requirements which they must meet in order to be used in the fracking process.
According to the American Petroleum Institute, fracturing proppant sand is selected based on size fraction, roundness and sphericity, crush resistance and turbidity.
Ideal granules should be nearly pure quartz and have a high compressive strength of between 6,000 lbs and 14,000 lbs per square inch.
Such industrial-grade sand has been produced in America for years, but only recently has this particular type of sand seen that much pent up demand – all thanks to the growing shale oil and gas developments here at home.
As I had mentioned earlier, the biggest challenge for frac sand producers is getting their sand to the fracking wells quick enough when energy companies need them.
Thus the shortage of railcars has created a severe bottleneck – not to mention a premium on the sand itself since there’s not enough to go around.
“There’s been a sand shortage in the U.S.,” says EOG Resources CEO Mark Papa. “And so those who have sand or have access to sand can pretty much charge what they want for that sand.”
What’s more, there’s only a handful frac sand producers in America which supply the entire shale industry.
So unless the natural gas industry was to fall off a cliff, the sand business will remain brisk as a number of producers are backlogged with contracts still waiting to be delivered.
To put things in perspective, the Railway Supply Institute reported a waiting list of over 65,000 railcars on order in 2011.
A single well in the Marcellus Shale reportedly uses 7 million lbs. of sand, or approximately 35 railcars. One analyst predicted that sand consumption for shale oil and gas in 2012 could reach 100 billion lbs.
You can do the math on how many railcars that equates to. It’s enough to make the hair on the back of my neck tingle just thinking about it.
So in short, frac sand companies are making good bank.
But the obvious question is: how can you cash in?
At the present time, there are only two sand producers that are publicly traded – both of whom issued their IPO’s just this year. They are US Silica Holdings (SLCA) and Hi-Crush Partners (HCLP).
With the industry being as hot as it is, others may follow suit in the near future, so definitely keep an eye out for them.
US Silica is over a hundred years old, but they finally became public this past January.
It’s the second largest silica sand producer in North America behind privately-held Unimin.
SLCA is headed by Bryan Shinn who’s been with the Company since 2009. Prior to that he worked for over 25 years in a variety of key management positions with chemical giant E. I. du Pont de Nemours and Company.
Shinn and his executive team are assisted by Jeff Jahn, who is SLCA’s Mine Planning and Development Manager. Jahn has been with the Company since 1993 and obtained 17 years of industrial minerals experience prior to joining SLCA. His ability to oversee all aspects of mine development, exploration, leasing and acquisition has been instrumental in US Silica’s growth as an industry leader that it is today.
According to the USGS, frac sand only accounted for 1.41 million tons or 5% of SLCA’s total production in 2001. A decade later, the numbers have soared to 12.3 million tons or 41%.
In the ground, the American Petroleum Institute estimates that the Company owns over 140 million tons of frac sand reserves, giving them a shelf life of 40 to 45 years based on annual shipments of around 3 million tons.
The Company expects annual revenue to reach $400 million in 2012, up from about $295 million in 2011.
Earlier in the year, SLCA announced that it was partnering with BNSF Railroad to open a transportation facility in San Antonio, Texas to supply sand to the Eagle Ford Shale. To date, it has added eight more transload facilities, with more already planned for the future.
Since hitting a high of $22.14 near the end of March, it’s lost nearly 60% over the summer months when Company insiders sold 45 million shares shortly after the IPO and triggered a sell off.
The price has since risen back to the $14-range from a low of $9.02. With the level of momentum that it’s getting from their $400 million revenue target as well as the expansion of its transportation infrastructure, I feel SLCA is still undervalued and its price could easily shoot higher.
Hi-Crush Partners operates near Wyeville, Wisconsin and began trading on the NYSE in August. It’s a subsidiary of Houston-based Hi-Crush Proppants LLC which owns, operates, acquires and develops sand reserves and related processing and transportation facilities, primarily in Wisconsin.
On the management side, they are highly experienced in the oil and natural gas industries and they collectively own 39% of common shares.
Co-CEO’s Robert Rasmus and James Whipkey previously founded Red Oak Capital Management which primarily partnered with the largest oil services companies in unconventional basins in the US.
Its COO is Jay Alston who is considered one of the frac sand industry’s leading consultants. Alston had designed and managed the construction of numerous frac sand processing facilities throughout the US prior to dissolving his consulting business and joining HCLP.
Their cost structure is low compared to their competitors. Firstly, their sand reserves do not require expensive blasting or crushing as they are surface mined rather than below ground. Second, HCLP is one of the few producers in the upper Midwest region with onsite rail capacity for unit trains. Therefore, with processing and rail loading facilities within arms’ reach, they have efficient and cost-effective product movement.
All of their revenue is generated via long-term contracts and as of June 30, 2012, there are contracts on the books to sell 1.46 million tons of frac sand annually for the next 4.6 years.
It’s estimated that their Wyeville facility contains approximately 48.4 million tons of proven recoverable reserves with an implied reserve life of 33 years based on current production rates.
While the revenue they are on pace to bring in this year would still be a fraction of US Silica’s annual target, HCLP’s first half income of $34 million has already exceeded the $20 million that they generated in all of 2011.
Its shares are currently trading at $22, which is approximately 30% above its initial offering of $17 back in August. But seeing as they have a solid supply of contracts already in place for the next four years and natural gas continues to demonstrate a healthy recovery, HCLP has a very strong upside moving forward.
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