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This article was originally published on August 14, 2011 by Natural Gas Americas. The original can be found here.

This article is the second in a series of three articles on recent trends in the North American pressure pumping market and their implications for both North American and international operators.  The author, Alexander Robart, is a Principal with PacWest Consulting Partners, a boutique strategy consulting firm based in Houston that works with oil and gas operators and suppliers to better understand and develop innovative solutions to strategic and supply chain issues.

The North American land market has seen a major increase in drilling and completion activity, along with a shift from gas to liquids-rich unconventional formations, which require different products and services from the supply market.  These trends have led to shortages in pressure pumping equipment, proppant, logistics and storage infrastructure, chemicals, and labor.

Pressure pumping equipment manufacturers are currently experiencing order backlogs of up to one year for key components of the pressure pumping fleet, particularly pumps, transmissions, power ends, and fluid ends.  Pumping unit manufacturers who outsource most of their component manufacturing have experienced major challenges obtaining key components, leaving those who have retained all or most of their equipment manufacturing and integration capabilities in-house at a competitive advantage.

The rapid expansion of hydraulic fracturing across unconventional plays has increased the demand for proppant to unprecedented levels.  Worldwide proppant sales in 2010 were nearly double the previous demand peak in 2008 and proppant producers have struggled to keep up with demand.  Many of the largest domestic producers were completely sold out of product in 2010.

Several key unconventional plays, particularly the Bakken, have seen shortages in products due to limited logistics infrastructure.  Fracing a typical well in the Bakken currently requires an average of 2-4 million pounds of proppant, the equivalent of 15 railcars per frac, on average.  The existing rail infrastructure is simply not adequate to transport this much cargo into the region.  Many suppliers have experienced temporary shortages of key fracing chemicals, particularly guar-based chemicals, which are used as gelling agents in linear and crosslinked gel fracs.

In response to increased demand, suppliers are increasing capacity for all related products and services.  The unprecedented market demand for proppant has created opportunities for new entrants in the market, in both the US and Canada, with several entrants attempting to market “non-traditional” sources of proppant, such as sand dredged from rivers.  There have been several new entrants to the raw sand market in the US and many foreign entrants into the ceramics market, particularly from Russia and China.  Some operators have begun using sand that does not meet API standards, rather than leave wells uncompleted due to lack of API-grade sand proppant.

New investments into transportation infrastructure have started to add transport capacity.  Several new firms have recently opened new transload facilities and additional firms have announced plans to develop and operate multi-user rail terminals designed specifically with the needs of the oil & gas industry in mind. In response to shortages of guar-based chemicals, pressure pumping companies have occasionally encouraged operators to switch to pricier substitute products.

Most importantly, pressure pumpers have also been expanding new capacity, building new pressure pumping fleets.  However, in an unprecedented change from recent upmarket cycles, the vast majority of pressure pumpers are now only committing to fleet newbuild programs under dedicated, long-term arrangements with operators that include minimum volume commitments.

Historically, North American operators have typically contracted for pressure pumping services on the spot market.  This offered them tremendous flexibility to satisfy pressure pumping requirements while bearing little to no financial risk themselves.  However, over the last two years, the market has shifted, and the majority of pressure pumping fleets are being contracted under long-term arrangements with operators.  Increasingly, these arrangements include minimum monthly volume commitments, requiring operators to share some of the financial risk with pressure pumpers.

The capacity demands for a new pressure pumping fleet are far higher than in the past, with recent fleets averaging 15-25K horsepower, depending on the play in which the fleet is designed to service.  The cost of a new fleet averages between $20 and $30 million, a major capital outlay and a driving reason for suppliers to be more cautious about committing to newbuild programs without some sort of customer commitments to mitigate financial risks.  The pressure pumping market seems to be evolving to more closely resemble the land rig market, with long-term commitments the norm.

This new supplier caution has meant that capacity has increased more slowly than it would have otherwise if suppliers were simply building new fleets destined for the spot market.  Some experts believe the rig count is now being held back by a lack of pressure pumping capacity, an unprecedented change in market dynamic.

Inherent in all these market changes, is a shift in the relationship between operators and pumpers.  Pressure pumpers now exercise more power over operators and are forcing operators to share more risk.

The third and final article in this series will address the implications of recent changes in the nature of the North American pressure pumping market for international operators and suppliers.  If you have questions regarding any of the contents of this article, please feel free to reach out to the author at arobart@pacwestcp.com.

This article was originally published on August 14, 2011 by Natural Gas Americas. The original can be found here.

Recent trends in the North American D&C market, with particular focus on the pressure pumping market, operator and supplier responses, and implications for domestic and international unconventional operators and suppliers

Part I

This article is the first in a series of three articles on recent trends in the North American pressure pumping market and their implications for both North American and international operators.  The author, Alexander Robart, is a Principal with PacWest Consulting Partners, a boutique strategy consulting firm based in Houston that works with oil and gas operators and suppliers to better understand and develop innovative solutions to strategic and supply chain issues.

The last year has seen two major trends in the North American land market:

1. A general increase in drilling and completion activity
2. A shift in activity to so-called liquids-rich unconventional plays that contain high proportions of oil and natural gas liquids

Drilling activity has increased significantly from its nadir in 2008 and 2009: the US land rig count has steadily increased from roughly 900 rigs in early May 2009 to 1,800 rigs in early May 2011.  Although the rate of increase is expected to slow over the next few years, the rig count is expected to continue to grow.  Macquarie forecasts an average US land rig count of 2,089 in 2014, a 24% increase from the expected average 2011 US land rig count of 1,680.  As a result of this increase in drilling activity and the increased prominence in the North American land market of unconventional resource plays that demand hydraulic fracturing services, the market for pressure pumping services has seen unprecedented growth.

Over the last 12-18 months, the depressed price of natural gas and the relatively high price of oil have driven operators to dramatically shift capital outlays and drilling and completion activity from assets that produce primarily dry gas to oil and natural gas liquids-producing assets in an effort to improve economics. Perhaps the most extreme example of this trend is Chesapeake Energy, which has dramatically pivoted from investing only 10% of capital in liquids assets in 2009 to a forecast 75% in 2012.  The oil rig count finally overtook the gas rig count in early April 2011, up from a relative oil/gas rig count of 20%/80% as recently as May 2009.  Natural gas prices are expected to remain depressed for the immediate future therefore drilling activity is expected to focus on oil and liquids-rich plays.

The dominance of oil-focused drilling and completion activity has significant implications for the North American oil and gas supply chain as drilling, completion, and export methods for producing hydrocarbons differ significantly for oil versus natural gas.  Different products and services are required to differing degrees to drill and complete oil wells.  This shift has occurred within a relatively short time frame, providing little time for the North American supply chain to keep up with both the increase and shift in the nature of demand.

These conditions of high demand and tight supply are rippling through the supply chain, causing supply shortages and price inflation, particularly in completions.  So far, supply has been unable to keep up with the demand for new pressure pumping capacity.  Additionally, there is a considerable backlog of wells that have been drilling but are still waiting for completion.  Halliburton’s CEO estimated the total number of uncompleted US land wells to be 3,500 during the company’s recent 2011 Q1 earnings call.  Forecast 2011 US land well completions imply demand for pressure pumping capacity that is well above the average expected pressure pumping capacity.  In an analysis recently undertaken by PacWest, we estimated that the theoretical pressure pumping capacity utilization during 2011 would be 131%, indicating a significant undersupply of pressure pumping capacity in the market.  When the current completions backlog was taken into account, the picture became even bleaker, with theoretical capacity utilization estimated to be 140%.  This indicates that operators will continue to face a tight market for pressure pumping services across the country and escalating prices, with no immediate relief in sight.

In key liquids markets, particularly the Bakken and Eagle Ford, arguably the two hottest markets in North America, supply chain constraints are exacerbating the market and holding back completion activity; shortages in pressure pumping equipment, proppant, logistics and storage infrastructure, chemicals, and labor are key challenges.  These delays have major implications for operators and suppliers.

The next article in this series will address how North American operators and suppliers are responding to the evolving market and how the relationship between operators and pressure pumpers is shifting. If you have questions regarding any of the contents of this article, please feel free to reach out to the author at arobart@pacwestcp.com.