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Take Me Higher: Driven by inflating input and restart costs, frac pricing to improve in 2017

25 May 2017 Caldwell Bailey

The hydraulic fracturing services industry, after two years in the doldrums, is on pace for significant improvement during the remainder of 2017. Capacity utilization of all existing frac horsepower (raw utilization) is forecast to average 56% in 2017, up from an average of 36% in 2016. When adjusted for utilization of ready-to-work horsepower, utilization is forecast to average 79% in 2017 - a level just below our threshold for a shift in market power. Things seem to be looking up for services firms, and, as a consequence of the tightening, we also forecast a 26% increase in overall US Land frac services pricing in 2017 - with further increases in 2018 and beyond.

Figure 1: US Land Frac Price Index

Our forecast pricing increase will be driven by many factors, as frac services companies operating at-or-below breakeven levels during the downturn had cut all expense categories as far as possible. Costs for sand, chemicals and labor have already begun inflating, and we believe they will continue to rise if oil & gas prices remain at or above current levels. We believe frac sand prices will increase 20-25% at the wellsite in 2017. Notable as well, the availability of hirable and retainable labor is consistently cited by oilfield service firms as the single biggest bottleneck to more rapid expansion of their operations, a fact which could lead to swifter increases in that cost category as services firms compete to put crews back into the field.

While there have also been significant increases in equipment reactivations and associated costs since the fourth quarter of 2016, we believe a driver of increasing prices there has significantly more running room. To-date reactivations have been relatively low-cost - firms generally cite $5MM or less to put a fleet back to work, with some reports as high as $8MM. With 3MM HHP already repaired to "ready-to-work" status, we believe the low-cost reactivations are largely over. Going forward, and should activity support it, frac firms will be faced with decisions to reactivate fleets from the "back of the yard", costing north of $15-$20MM to repair, driving up the need for cost recovery and pricing increases to operators.

Figure 2: Quarterly reactivations vs newbuilds

At the same time, we have seen some firms already purchasing new build equipment, generally in the range of $1MM per pumping unit, suggesting some pricing has already increased to levels justifying greater investments. Over the course of 2017 our analysis indicates over 900k HHP of new build units will enter the market - and all indications are that they will not do so at a discount. While not helping to balance an equipment market that remains nearly 50% oversupplied and has experienced very little reduction in the fleet, the new builds should assist in justifying rising frac services pricing as E&Ps demand increased service quality and efficiency. Despite recent commodity price swoons, we do not forecast much if any of these orders to be pushed into 2018 due to impending Tier IV Final Emissions regulations and increased costs for equipment delivered beyond 2017.

We believe that if activity continue to increase, frac pricing will rise significantly. As equipment reactivations become more costly, as input demand and logistics costs rise, and as more and more quality manpower is needed to run equipment, frac pricing will take these facts into account, and from our conversations, operators have largely acknowledged this reality. Of course, all of this is predicated on rising, or stabilizing, commodity prices. If the price increase or stability happens, it appears frac could be on the road to recovery.

Where should you invest next? Learn more about our consulting capabilities in upstream cost and operating performance.

Caldwell Bailey is a Senior Consultant in Onshore Services & Materials at IHS Markit.
Posted 25 May 2017

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