A new paradigm in fracing requires a new method of analysis

25 April 2018 David Vaucher

US onshore shale players have ramped up 2018-19 capital spending intentions and production targets across the board, from the smallest independents to the Global International Oil Companies. This raises the prospect of 2018 being the year when the "fallacy of composition" takes hold in the unconventional asset space.

A "fallacy of composition" situation would mean services and infrastructure are more than adequate to support each individual company's development plans, though prove incapable of supporting the cumulative activity levels being planned for the unconventional resource plays. A consequence being higher-than-anticipated upward pressures on capital and operating costs, challenging the ability of operators to retain the cost improvements accrued over the past 36 months.

As part of the continued push to face these challenges and conserve cost reductions, more and more North American operators are directly sourcing their own water, proppant, and chemicals. Consequently, pressure pumping companies have begun to look less like oilfield service providers, and more like traditional utilities in that they are reduced to offering what is essentially commoditized power.

If one accepts this suggestion, then one might also be prepared to accept that there could be a more illustrative way of assessing North America's frac fleets than simply looking at hydraulic horsepower (HHP).

One of the first math lessons we learn in school is that of "apples and oranges", to illustrate the importance of units for performing correct analyses. As we become more experienced, units take on a more nuanced significance: they become a way not only to check for correctness within an operation, but also a tool to look at an analysis in a different, more insightful way.

For instance, we purchase a vehicle to transport us over a distance, so "miles" is an important unit to consider. Indeed, that quantity is utilized heavily for lease calculations as well as purchase decisions.

But would anyone argue that how far the car is driven in between fill-ups is perhaps of secondary importance to how it was driven: would one rather buy a car with 100,000 miles that was gently driven at legal speeds on the highway, or 50,000 miles by a 16-year-old with a heavy foot who loves the smell of burnt rubber?

Put another way, we should look at the units of "miles" by themselves as well as miles:

Per hour, to represent "wear and tear"
Per year (or month, day, etc) to estimate remaining useful life

Tying this back to the North American upstream industry, I use this preamble to propose the following hypothesis:

By focusing solely on HHP to calculate utilization and more generally assess North America's frac fleets, service companies and operators may be missing a significant piece of the whole story.

Indeed, there is some attention on fleet turnover (i.e. per year) as described by the second bullet point, but in our view not as much on the first (i.e. per hour). Speaking of available HHP within a region does have some meaning, but HHP represents the capacity to produce power, not how that power is delivered.

This is a subtle but key distinction, and it's the reason that our electricity bills are calculated based on kW/hr rather than kW: a power plant has the capacity to deliver a certain power load, but from the utility's point of view, 500 kW/hr looks very different if it's 5 kW for 100 hours than 500kW for one hour.

This relevance of rate is crucial for power providers to keep in mind because each outcome represents a very different service capacity and maintenance schedule.

If those two terms (capacity, schedule) sound as if they apply to fracing, well, they do -- and increasingly so as operators source more water, proppant and chemicals themselves.

In accepting this paradigm - rate of capacity delivery is just as important as the capacity itself - a slew of analogies lends itself to analyzing and truly understanding the frac market: the aforementioned utilities, transportation industries and manufacturing.

The common threads amongst these industries are the constraints imposed by the all-important dimension of time; it is this dimension that we at IHS Markit have begun working into our analyses of the onshore frac market.

We remain at the earliest stages of implementing this change in our approach to research and forecasting. Rather than make this a purely academic study, the intention is to take advantage of the team's deep experience and make the analysis as operationally accurate as possible. With that in mind we have begun to factor in the following: