positioning proppant capacity for market shifts

Positioning proppant capacity for market shifts: logistics, storage and risk managementAlex Fleming, Senior Manager, Ernst & Young LLP

Positioning proppant capacity for market shifts: logistics, storage and risk management

Why

Performance forces

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Volatility

What

Performance issues

Optimize

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Innovate

How

Performance path

Leadership

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Technology PeopleMetrics

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EY’s performance agenda is a framework for driving issues-based conversations leading to strategic decisions and approaches

Proppant market paradigm


The North American proppant market has several fundamental inefficiencies that drive current behavior

VisibilityVelo

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Volatility

Supply-side stickiness (sand mines do not open and shut instantaneously)

In-transit inventory (two to three weeks of supply) captured

Reaction time for demand changes related to mine capacity

Local and regional variability of demand

Uncertainty and regional transfer issues

Information asymmetry between partners

Limited buyers and sellers with high market power

Take-or-pay contracts

Varying markets for proppant types (sand, resin-coated, ceramics)

Variants (coarse, fine, brown, white)

Agency problems of proppant logistics vs. OFS providers

Diagram of perfectly efficient market and clearance price/quantity

Price

P’

Quant.Q’

D’

QTOP

PTOP

Demand SupplyD

S

S

SD


8%-9% CAGR

14%-17% CAGR

Fundamental demand variability will continue to exist and vary widely between regions and within plays

VisibilityVelo

city

Volatility

Regional transload facilities (controlled by OFS/proppant

logistics)(30/50 and 40/60 silos)

Mine/proppant producer

Source: "Proppants in North America," Freedonia Group, 2013; EY analysis. Demand refers to projected regional usage based on macroeconomic factors, oil and gas production, and supply capacity. Southern Region includes the Eagle Ford, Haynesville, and Permian plays. Western Region includes Niobrara and parts of the Bakken. Midwestern includes parts of the Bakken, Utica, Marcellus. Eastern includes remainder of Marcellus and Utica.

Pad

Scenarios become more difficult when different sand grades come into play (coarse vs. fine and brown vs. white)

Interregional and regional variability is extreme relative to total demand, even when only considering sand proppants.

Individual wellheads

16/30 in unit train on sidings

16/3030/5040/60 white20/40

30/50 Customer changes plan to switch to 30/50 after Stage 3.

Two weeks of 30/50, 40/60 and 16/30 in

transit

This all leads to misallocation and “stranded” supply across regions at various parts of delivery:- 5%-10% due to in-transit leakage (about 2

billion pounds in transit at any one time)- Up to 20% due to variability and last-

minute changes (early in field development)

- Up to 10% leftovers unable to be restocked

There is no mechanism for adjusting to demand inside of lead time and clearing surplus outside of an individual owner.

The average of regional variability represents US$900m in 2022 value of

proppant in a single region.


Value chain partners and demand signals

The uncertainty in the proppant market is still carried largely by oilfield services companies, which face challenges optimizing across other players

Optimize

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Trucking Co.

Source/mineOperator Oilfield services provider

Major proppant providers and mines are moving toward vertical integration. Railroads are entering collaborative contracts.

OFS

Total demand

59 billion pounds in 2012; 1 billion exported

Proppant supply and imports

60 billion pounds in 2012(112 b is US industrial sand and silica production capacity)

Proppant logistics providers

RailroadsTerminals

Field plans and well designs

OFS companies driving terminal and railcar ownership are integrating backward to protect their competitive position.

Operators and OFS companies have limited and sometimes selected planning collaboration.

Source: "Proppants in North America," Freedonia Group, 2013; USGS Minerals Yearbook, 2012. Projected by EY analysis. Total in category is US production only; 2012 proppant exports total about 1 billion pounds.

OFS companies faced punishing take-or-pay contract situations in 2011 and are still bearing the brunt of variability due to ownership from the mine and inability to clear surplus externally.


Players have attempted solutions in three basic areas, with rail providers as the key value chain facilitator, but without fundamental innovation

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Innovate

► Hi-Crush and Baker Hughes contractual dispute and resolution► CARBO and Northern Frac Proppants► Pioneer acquisition and rebranding of Premier Silica► Superior Silica and Canadian National Railway, BNSF and US

Silica

Protection► Contract protection and

right-of-way assurance► Take-or-pay terms► M&A for control

► Shift to predominance of unit train loading and construction of unit train terminals

► Major OFS terminal developments, facility automation and mobility tracking

► Lean Six Sigma and Kaizen application to transloading

► Application of network logistics optimization software to sand and rail fleets for day-to-day scheduling

► Postponement of milling and barge transport (Mississippian)► Bakken inbound and outbound capacity increases (example:

Dakota Plains, Unimin, CP – Pioneer Terminal collaboration)

Tactical optimization► Terminal flows and design► Trucking optimization and

TMS► Railcar management

Network optimization► Long-term lease and

purchase of rail capacity► Mine purchase► Optimization tools

Source: EY survey and synthesis of published news reports. EY interviews with industry experts.

None of these actions show signs of fundamentally changing the market dynamics, only pursuing step changes to current chokepoints and limitations.

Changing the equation


Rail providers could be an incubator or the effective facilitator of a viable secondary market or trading platform for proppant

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Physical or virtual trading in transit

► Physical trade Owner in transit: logistics providerHolding: ladder railyard DCOwnership Transfer: intermediate railyardLogistics Costs: Negotiated pre-DC during sale► Virtual trade Owner in transit: 3rd party entity or final recipientTransfer: Immediate and effective at time of virtual tradeLogistics Costs: owner upon arrival at terminal► Rail network swaps Owner in transit: 3rd party or recipientOffer: swaps or forward contracts in a facilitated market for similar loads on other rail networks

Pooled demand and just-in-time purchase and routing

► Local operators join a “sanitized demand pool” that aggregates forecasts anonymously across a basin.

► Third-party proppant logistics provider and trucking company maintain enough capacity in trucks to have those types of proppant on the road for just-in-time callout the morning of demand (or during previous stage).

Unit train and silo availability for buying/selling

► Proppant logistics providers maintain ownership through the terminal and then offer loads to a subscription pool of providers. The pricing per load varies depending on subscription members’ adherence to their own demand plans.

► Unit train yards at transload – railroads maintain ownership of loaded trains and cars and offer them for sale upon arrival.

► Buyers purchase “call” right to buy a unit train of a certain grade in any transload in a certain basin 30, 60 and 90 days in advance.

Loaded in-truckRailroads and rail yards Terminal silos or sidings


There are several challenges to setting up innovative secondary markets, but it may be the only way to overcome the market failures

Regulatory Physical/information Capabilities

► Transload and clean air regulation could become more complicated with multiple owners of proppant in a silo. Railcar fleets would be marginalized.

► Financial anti-trust concerns could arise based on entities involved in transactions.

► Investments to build this capacity may require JV between players, which will immediately cast doubt on the competitiveness of the market mechanism.

► Trading requires mobile monitoring and exact location across owners and rail networks.*

► Source quality controls will have to be certified for product entering any pooled trading situation.

► Information infrastructure for trading and players needs to be hosted by a third party but available to all participants in the value chain.

► Organizations are reluctant to enter trading situations due to fears of speculation and abuse.

► Planning information is not formalized or stable enough to allow staff to make good decisions.

► Modeling and trading skill sets have been drawn down in parts of the energy industry and would require cultivation and investment to draw talent.

Capabilities to develop► Planning analytics and S&OP

with wellhead integration► Mobile data capture and

network integration with value chain partners

► Predictive analytics and trading

The first player to “crack the nut” profitably and transparently will change the way that the proppant market exists for North America and the world.

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*Rail providers currently lead in mobile tracking and information


Proppant is also on the other side of the inbound/outbound problem as the market continues to develop, which provides more potential innovations

Upstream operations Downstream operationsMidstream operations

Exploration and production

Offshore fields

Collection terminal

Primary distribution terminal

Secondary distributionterminal

Consumer retail

Bulk export to foreign markets

Denotes flow of petroleum products

Refineries/petrochemical plants

Exploration and production

Onshore fields (e.g., tar sands, shale plays)

Foreign imports Processing

plants Liquefaction

Regional transload facility

Industrial wholesale

Markets

Pipeline networks

Pipeline, rail, road

Tanker, pipeline, rail

Tanker, pipeline

Tanker, pipeline, rail

LNG tanker

Pipeline


Road


Tank

er,

pipe

line,

rail

Pip

elin

e

Regasification

Pipeline networks

Pipeline

Pipeline

Rail

Proppant inbound

Mine/proppant producer

Rail

Road

Innovative collaboration across the value chain is the only way to maximize the limited network capacity beyond current efforts. Building sustained competitive advantage requires a step outside paradigms.

Two-way shipper contracts, half-half train with proppant hoppers and crude tanker cars with incentives for both shippers

Rail network swaps for proppant, coal, LNG and crude facilitated by railroads

Combined unit train terminals for proppant delivery and crude loading, optimized for cycle time


In conclusion

Why

Performance forces

VisibilityVelo

city

Volatility

What

Performance issues

Optimize

ProtectGrow

Innovate

How

Performance path

Leadership

Execution


ProcessesOrganization

Alignm

ent

Ado

ptio

n

Vision and strategy

► Proppant market players are taking incremental steps to grow, protect and optimize execution, but no fundamental innovation has occurred.

► The proppant market shifts may become less intense, but the core variability of the market will continue to exist as demand grows in the next 10 years.

► Misallocation and inability to clear proppant surpluses after origin are hobbling the market, and a secondary market may be a viable way to change the equation. The financial impact of providing this clearing mechanism could be sizable.


EY Advisory’s Oil & Gas practice is actively working with our clients to innovate and address long-term competitive advantage in the proppant market

For more information, please reach out to:

Alex Fleming – [email protected] Franks – [email protected] Perrine – [email protected]

EY | Assurance | Tax | Transactions | Advisory

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positioning proppant capacity for market shifts

Economy & Finance

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