A weekly look at what occurred in the oil markets of the U.S. and the world this past week and what’s ahead.
A recent report by Moody’s on the health of the frac sand industry has significant implications for the transportation sector that moves the material around.
The report in general was extremely bearish on the future of the companies that mine the sand used in fracking. One of the companies, Emerge Energy Services, has had such a tough time that it recently restructured debt with its lenders. While it avoided a Chapter 11 filing, its was an act that speaks to the problems in its market.
The issue that it and other companies face is that the areas that traditionally had produced much of the frac sand is a long way away from many of the oil- and gas-producing fields that need that sand to complete fracking operations. Wisconsin had been a strong area to produce what is known as Northern White Sand (NWS). This sand had long been considered the gold standard to be used as a “proppant,” the term for sand that gets blasted into drilled holes, along with massive amounts of water, with the proppants creating the small fissures in the well’s rock to unlock the hydrocarbon deposits inside.
That wasn’t a problem in the past. But what’s happened now is that new frac sand mines have been opening closer to the Permian Basin in the Texas/New Mexico region. The sand isn’t as high quality as that found in areas like Wisconsin, but when the lower transportation costs are factored in, it’s become more than competitive and is gaining market share.
“Without much transportation needed, the in-basin sand is priced at more than a 60 percent discount to NWS (when all shipping costs are factored in), making it economically compelling despite any potential differences in quality,” Moody’s said in its recent report on the health of the frac sand industry. “We expect the oversupply from in-basin sand production to keep current prices range-bound, limiting upward profitability in particular at a time when demand is constrained.”
What this has meant to the rail industry, which hauled frac sand out of the Wisconsin and other areas in the northern U.S., can probably be partly inferred from the weekly Association of American Railroads statistical report. In its most recent report, the category of rail shipments of Nonmetallic Minerals, which includes sand, was down 6.1 percent from the corresponding week a year earlier and was down 5.3 percent year-to-date. It can’t be known whether that is all attributable to a decline in the long haul of frac sand; the total U.S. rig count year-to-year is down more than 7 percent, according to Baker Hughes, so that could be the cause as well.
But regardless, it is clear from the report that the qualities in the northern sand are good, but not necessarily good enough. Taylor Robinson, the president of PLG Consulting, wrote several months ago in an analysis on the internet that the advantages of the higher quality sand disappear fairly quickly. Reporting from a conference on the subject, he wrote about what analysts at the conference said: “We are not seeing substantial evidence of producers sticking with NWS for 100 mesh in the Permian Basin nor changing back due to quality concerns.” That can be interpreted as suggesting that the north-south rail movement that was needed to take frac sand to the producing basins may not be coming back.
The quality of the northern sand was a major barrier to entry in the past, according to Moody’s, making it tough for other companies without those sorts of reserves to match the quality of the entrenched miners. “Today, however, with increased dependence on in-basin sand, transportation is less of a constraint, lowering the probability of sustained price recovery,” the Moody’s report said.
The report further stated that the close correlation between the price of frac sand and the price of WTI has broken down. The price of frac sand is somewhat opaque. But in its earnings call for the first quarter, officials with Hi-Crush Partners (NYSE: HCLP) said its realized price had dropped to $48/ton in the first quarter of 2019 from $58 in the fourth quarter of 2018. HCLP’s stock is down more than 86 percent from its 52-week high.
It could be that after weeks if not months of being the “runt of the litter,” diesel prices are about to break out to the upside.
The weekly inventory reports this past week by both the Energy Information Administration and the American Petroleum Institute showed million barrel-plus draws in distillate stocks. The S&P Global Platts estimate was that there would be a minor draw of just 225,000 barrels. The inventory figures for crude and other products in the reports were mostly bearish and sent those prices careening lower Thursday, with declines of more than 3 percent for WTI crude, Brent crude and RBOB gasoline. But ultra low sulfur diesel (ULSD) dropped just 2.67 percent.
A day later, with the overall market getting hammered by the reaction to the first stirrings of a Mexico-U.S. trade war, ULSD dropped less than WTI and RBOB gasoline though it declined more than global crude benchmark Brent.
While a trucker may only be concerned with the end price at the pump, diesel also needs to be viewed in terms of how it’s doing relative to the rest of the barrel: the crude that it comes from and the gasoline that at the margin competes with it for some refinery assets. The price of diesel relative to other key petroleum benchmarks can also be viewed as an indicator of demand for the trucking capacity that is the base demand for diesel consumption.
A brief glance at some of the key spreads shows that diesel has been the laggard among the oil complex not only for months but recently as well. For example, Brent to ULSD in cents per gallon had dropped to 32.29 cents/gallon at the Thursday settlement; it had been 39.42 cents just two weeks earlier. The spread between ULSD and RBOB gasoline had been narrowing before the Thursday moves for several weeks, jumping up to 3.64 cents/gallon after the Thursday close, up about 1.4 cents from the prior day. At the start of the year it was 42 cents, as gasoline has been the biggest climber this year and diesel the laggard.
Ultimately, the price of diesel is mostly going to be dependent on the price of crude. But once you get past that truism, there’s a lot of room to maneuver in predictive analytics, whether they are done on the back of an envelope or through a complex formula. The current market may be reflecting the fact that U.S. inventories reported this past week of 124.8 million barrels are almost 8 million barrels less than the five-year average.
The oil market as a whole may not be pointing higher, but the diesel portion of it is starting to show some signs of strengthening.