DEP Updates: The DEP team continues to grow! We are pleased to announce longtime friend and client, Geoff Jay, has joined Daniel Energy Partners. Geoff will focus on E&P and Refining commentary in order to complement our work on the U.S. onshore oil service market. As many of you know, Geoff was a buy-side energy analyst for more than 20 years having worked at Janus Capital Management, Citadel Investments, and the Berger Funds. During this time, Geoff covered nearly every subsector in energy and developed strong relationships with both company management teams and his institutional investor peers. He is a graduate of Northwestern University and is smarter than the existing DEP research team.
DEP Field Tours & Other Housekeeping Items: We hope to be in Midland this Thursday/Friday and then off to Denver the following Monday/Tuesday. Lining up meetings now, but you can make our life easier by letting us know if you are free those days. Finally, we blasted out the registration link for the THRIVE Energy Conference last week. The link went to clients and sponsors. If for some reason you didn’t get it, let us know and we will resend. Really important that you register beforehand otherwise you might not get in. Date of the conference is February 23-24th at Minute Maid Park.
BKR U.S. Land Rig Count: Nice jump with a +11-rig w/w gain to 581 rigs. The Eagle Ford was the big mover +6 rigs while the Haynesville added +3 rigs.
E-Frac Continues to Grow: Not surprising and expected as Evolution Well Services announced a new contract which will require the construction of its 8th fleet. The new fleet will work under a multi-year contract for an E&P in the Permian and will be deployed later this year. Terms of the agreement were not disclosed, neither was the customer, but safe to assume it is one of the larger operators. In addition to the contract, Evolution also announced surpassing over 40,000 frac stages. Our take: the latter announcement is a reminder to potential customers about the company’s longer history with electric frac relative to most other frac providers. As the electrification shift unfolds, one would assume some E&P companies might opt for experience and/or an established solution, particularly if a multi-year contract framework is required.
One further point to consider, the U.S. frac market remains in an expansionary mode as new fleets are on order; new companies are emerging, and older equipment is being upgraded. A central question and eventually a potential concern will be the destination of the new fleets. Specifically, for both the E&P customer and the frac provider, will these fleets be expansionary, or will they replace legacy equipment? We would submit for most E&P companies; the answer would be replacement which means the displaced legacy crew hits the spot market. Now before we ruffle feathers, this is a very fair question given the industry’s past history of overbuilding. With companies such as Evolution, U.S. Well Services and BJ Energy Solutions, the new orders will most likely be expansionary. So too will be the redeployments of fleets by start-ups such as Pure-Frac, Grappler Pressure Pumping, Straitline, Express, Acquire, Integrity, Regiment, among others. Therefore, as we enter Q4 earnings season, commentary by public companies regarding their newbuild/upgrade prospects takes on greater interest to DEP.
We’ll dig into this theme in more detail next Sunday as we wrap up our U.S. Pressure Pumping Market update, but simplistically, we see the active U.S. frac fleet at ~241 fleets today with potential growth of ~15-20 fleets this year. Two things to remember on our tally. First, we are still updating with companies this week, so our active count could change slightly. Second, our ~241 tally is active fleets, not necessarily working fleets. That’s a big distinction. For example, we had two sub-10 fleet companies specifically share both their active vs. working fleets. There was a combined two-crew difference between the active and working totals. NexTier, meanwhile, noted in its Q4 pre-release two weeks ago that it averaged 30 deployed fleets in Q4 while its fully-utilized fleet count averaged 29 fleets. The delta with all three of these companies likely reflects a myriad of possibilities such as downtime, weather, maintenance cycle, etc. This means if we were to show a working fleet tally, it would be less than 241 fleets. We point this out as some industry analysts continue to report 250+ working, not active, fleets. This, in our view, is wrong. Now, as for newbuilds, we believe there are as many as ~20 in the pipeline. Not all will come in 2022, of course, but the issue is a U.S. market which is likely up ~5% or so which is also seeing a +5% growth in new/upgraded capacity along with reactivations of legacy equipment by private start-ups could see some loosening, particularly in the Tier 2 market later this year. Again, we’ll address this is a more thoughtful manner next week, but it’s something to start thinking about.
Fluid End Observations: We kicked off the data gathering process for our 1H’22 Perspectives on the Pressure Pumping market with round one update calls made to friends in the fluid end industry. As noted earlier, we’ll publish our frac report next Sunday, but takeaways from the fluid end market are highly relevant as these companies offer good visibility into the directional trend of U.S. frac activity for two reasons. First, fleet reactivations/rebuilds almost always require new fluid ends as pumps cannibalized during the downturn need to be refreshed before deployment. Second, companies who foresee stable-to-growing demand are likely to increase orders of fluid ends while true visionaries who can foresee a downturn quickly pull the plug on new capital equipment orders. The good news today is most fluid end manufacturers are witnessing rising orders, a sign activity is poised to move higher. However, in all our discussions, the most optimistic view on frac activity is a +5-10% increase in crew counts from here. Most fluid end contacts hover around an expectation of +5%. Meanwhile, as with all things these days, supply chain constraints and inflationary costs are forcing fluid end companies to seek higher pricing. Notably, forging costs and particularly freight costs are on the rise.
Fluid End Suppliers: Many years ago, when we kicked off our quest to understand the U.S. frac market, we developed a comprehensive fluid end supplier list through discussions with forging companies, fluid end OEMs and frac providers. At one point we had a tally of 27 suppliers. Times have changed, a consequence of the downturn and M&A within both the fluid end OEMs as well as frac providers. Consequently, the list of relevant fluid end OEMs is diminished. We emphasize “relevant” as companies who previously manufactured fluid ends, in theory, still could do so if they chose as we believe the capital equipment necessary to mill/produce the fluid ends still exists. However, based on discussions with numerous fluid end players, we believe a much-compressed list of companies actively compete today. In fact, we submit the true list of active fluid end OEMs is now roughly 13 companies. We cross-checked our estimates with a leading OFS OEM and their tally aligns well. In the go-go days, this company tracked 28 qualified fluid end suppliers, but today, the company sees this number closer to 12. The ~12-13 fluid end competitors include those owned by frac companies.
Fluid End Supply & Demand. The reason diminished capacity matters is because demand is growing. Quantifying this into a formal supply/demand model is a challenge as several companies will not share actual production rates, notwithstanding our history of maintaining confidentiality. Therefore, understanding true productive capacity is hard. What we do know from speaking to most fluid end players is the level of inventories today are reduced; priority of current production goes to existing customers; and the time required to ramp is characterized by several contacts as 2-3 months, not weeks. Furthermore, many companies still have production rates well below pre-COVID levels. In the case of three players who shared their monthly production capacity, the declines remain deep. For anonymity’s sake, we will describe three players and index their monthly production to 100 units. For player A, the company saw monthly production fall from our index of 100 pre-COVID to ~7 units at the 2020 trough, but production is back to 50 today. A second company went from 100 to 15, which is the level today. A third remains about 30% below its pre-COVID levels. Admittedly, this isn’t the easiest way to grasp the relative declines, but suffice it to say, monthly production for those willing to answer the question remains well below pre-COVID levels. Importantly, this reduced capacity is occurring despite the withdrawal of several competitors from the fluid end manufacturing business.
The key reasons for the lower production capacity are simple. First, the U.S. working frac fleet remains well below pre-COVID levels. Second, fluid end companies believe new generation fluid ends have longer lives – the average range is characterized as 1,400 to 1,800 hours, but we picked up leading edge anecdotes of fluid end life well in excess of 2,500 hours. One key consideration with useful life is the quality and frequency of maintenance on the fluid end. In other words, are the crews regularly changing the valves and seats at the required intervals. Also, a few frac companies perform rebuild work on fluid ends with at least one frac company claiming it can extend the life of a fluid end by up to 500 hours with its repairs. Most fluid end OEMs, however, claim this practice is not widespread. Of note, one fluid end OEM reports a reduction in useful lives in recent months, a potential sign the crews are not properly performing regular maintenance or not performing it correctly, a possible reflection of inexperienced crews. Nevertheless, both frac companies and fluid end OEMs report much greater emphasis is placed on studying the life of the equipment today vs. in prior years and this, some believe, helps explain why equipment is lasting longer vs. years ago.
Fluid End Pricing. Moving up, as expected, but nuances exist as not all fluid ends are created equally. Some fluid ends have lower quality metallurgy and thus are priced lower. Others are considered higher end quality fluid ends and/or manufactured from larger forging blocks, thus priced higher. Providing an exact price is, therefore, tough as the comparisons are sometimes apples-to-oranges. That said, as we pin down our fluid end friends, most agree the current pricing for quality 2,500HP fluid ends is in the mid-to-high $50’s, up from what some describe trough pricing as the low $40’s. In the case of one frac company, it reports paying $52k per fluid end today, up from $46k a few quarters ago. The fluid end it uses would not be consider to be “high” end – we were told the design and several fluid end companies threw this design in the lower-quality metallurgy category, but the rate of change in price, however, is notable. We try to avoid the fire sale price comparisons as doing so is also a bit of apples-to-oranges as context matters. Several fluid end manufacturers will acknowledge the downturn led to flash pricing where companies significantly discounted price in order to move inventory. In fact, two fluid end OEMs confide this strategy was employed as the companies sought to exit non-core product lines. There are a few fluid end players who acknowledge pricing for their products remain in the high $40’s / low-to-mid 50’s but will move higher in the coming months. One just announced a 10-15% price increase, but more will follow. Here’s why. Fluid end OEMs are facing inflationary pressures just like all other industries. Some acknowledge pricing for today’s fluid ends is based to some degree on costs incurred 3-6 months ago. Now, as input costs are rising, so too is the need for higher prices. Therefore, multiple fluid end OEMs foresee another round of increased pricing this summer – those willing to quantify see fluid end prices on high-end fluid ends reaching the low-to-mid $60’s. This potential change is supported by other less active OEMs who claim pricing will need to move higher by 15-20% to incentivize a ramp in their productive capacity. One player, as an example, has other product segments and is therefore not dependent on fluid ends sales to drive the business. Consequently, it is showing restraint, but this same player has the installed capacity to drastically increase its production should the right market conditions exist.
Other Fluid End Tidbits. Interesting observations from frac companies on preferred vendors as there is essentially no consistency with feedback. One frac provider had used a well-known provider for years. It was then attracted to lower prices and switched to another provider, but due to technical issues with fluid end, it moved back to the original provider. Another frac company with whom we chatted sees it differently. It is a huge fan of the fluid end OEM that the first frac company argued had a too technical product. Meanwhile, a third frac provider can’t stand frac company #1’s fluid end provider and has opted to use another player. Yet, a fourth frac player likes to test new designs, but has otherwise opted to standardize on 1-2 different fluid end makers product. We suspect as we chat with more frac companies this week, we’ll hear similar feedback. Now, is this a major revelation? Not really, but it tells us that just as the E&P companies want choice with their frac providers, so too do the frac providers want choice with their fluid end vendors.
In another discussion, we updated with a forging company who sees better margins and demand from non-energy businesses, such as marine and aerospace. Company would rather win more work in those segments and is therefore reluctant to increase oilfield directed activity to the extent the other options remain viable. The ramp in infrastructure spending could potentially be a headwind for oil and gas should forging / steel capacity shift other directions (at least as it relates to this forging contact).
With respect to forgings, all fluid end companies report increases of at least 25% for forging prices. The biggest quoted increase is near 60%, a percent change which most fluid end contacts claimed was a tad high. Right now, forgings are being sold in the mid-$20,000 range, up from the low $20,000’s a couple years ago. Several fluid end contacts believe forging prices will go up further. One opportunity under consideration by several contacts is to change the metallurgy to minimize the use of nickel. According to contacts, the price of nickel is up nearly 100% since early 2020. Reducing and/or eliminating nickel content could lower costs – question is whether or not this change will impact the forging quality. At least one contact does not believe it will impact quality.
Several fluid end contacts gave ranges with respect to current profitability margins. Generally, most see gross margins in the 10-20% range today. This compares to gross margins of 30-40% pre-COVID. Frequent comment: “never worked so hard to make less”. Margins impacted by lower volumes, lower pricing, higher forging costs and higher freight costs. On the latter point, companies who import forgings from overseas report freight costs are up nearly 3-4x vs. pre-COVID. Buyers of domestic forgings say freight is up over 2x for sure. Further, multiple fluid end OEMs claim they have to invest more in working capital as supply chain issues mean the companies need to carry more inventory to keep in WIP.