While oil and water don’t mix, for the fracking industry... the two go hand-in-hand.
You see, while WATER is one of the oil industry’s biggest threats – it's also one of investors’ biggest opportunities.
Consider this: Each horizontal well in North America that uses hydraulic fracturing, or fracking, uses 2-6 MILLION gallons of sweet fresh water. And the entire North American industry will use an estimated 72 BILLION gallons in 2012.
The cost involved in handling that water could be in the billions of dollars within a couple years.
That's why a multi-billion dollar Water Services industry is emerging right now in the oil patch.
It’s a huge opportunity for some great capital gains — but changing regulations, and a very attentive mainstream audience questioning business practises which have been in effect for decades, will make it choppy water for investors.
“In 2008 there were 25 billion barrels of water handled (by the oil and gas industry) in the US—even at 60 cents a barrel it’s a multibillion dollar business,” says Jonathan Hoopes, President of GreenHunter Energy Inc. (GRH-AMEX). “With the big growth in unconventional since then, it’s likely another 5-6 billion barrels.”
GreenHunter is a pure play on the fast growing water market in the oil patch, along with companies like Heckmann Corp (HEK-NYSE), and Ridgeline Energy Services (RLE-TSXv; RGDEF-OTCQX). There are also many private technology companies with new water treatment processes.
Ridgeline is developing a water purification and recycling technology for the oil and gas sector. CEO Tony Ker says the industry is just beginning to put a formal cost structure on their water, and it’s not always easy to see through the mist to a simple business model.
“Customers in the oil and gas industry are finding their way into the water industry,” he told me in a recent interview. “Two years ago customers didn’t know what the water business meant. At some point they knew they would have to clean and re-use it, but didn’t understand how to do it.
“Now we’re watching it form as we speak. Customers are now starting to define what the water business will be. Before, it had no shape or form. Now we’re seeing various companies put cost structure on the business; put costs on storage, treatment, transportation.”
In the Marcellus Shale, they say it costs $3 + per barrel (/bbl) to dispose of water — and $7-$10/bbl to haul it away. If a horizontal well uses 4.2 million gallons of water to frack (that would be a slightly bigger than average well, but it makes my math easy ;-)), then that’s 100,000 barrels (42 gallons=1 barrel).
If you get 30% of that back in the first year, that’s 30,000 barrels x $10+ per barrel hauling and disposal costs=$300,000 in water costs per well. But that’s $300,000 in water REVENUE for the right company. Then there’s another 30% of that water you get back over the life of the well—assuming costs are constant, that’s $600,000 in revenue.
And there are thousands of wells getting drilled in North America each year; more than 80% of them are now horizontal, and most of those require fracking. The dollar value of managing that water multiplies out fast.
GreenHunter is estimating that the 2011 water disposal market in the Marcellus alone was $1.3-$1.7 billion, and in 10 years the market will be $15-22 billion.
In the Eagle Ford shale play in Texas, they’re quoting a disposal fee of $0.80+/bbl and an average $3.00 – $6.00 /bbl hauling fee. And with an estimated 800 new oil & gas wells drilled there in 2011, the market just keeps getting bigger. In 2011 the water disposal market was estimated to be $500-$800 million, and in 10 years they are guesstimating that local market will be worth $6-9 billion.
The Bakken oil formation – they estimate – will be a $10.6 billion market within 20 years.
And there is just storing all that water until it is ready to be used. With the new pad drilling, where producers drill multiple wells that splay out in different directions from one pad, millions of gallons water can be stored in one spot for up to and over one year. Just storing that water has turned into a $150 million + business with incredible profit margins—in just one year. And it continues to have hyperbolic growth.
“I believe in two years you will see moderate sized water facilities of 50,000 to 100,000 barrels a day, that are permanent, that will process water for re-use,” says Dennis Danzik, a director of Ridgeline and the inventor of their water purification technology.
There are other major revenue sources as well. Sourcing water is a revenue business as municipalities and landowners in the western US sometimes sell their water to the industry for fracking.
Hoopes believes that regulation around water will develop to the point where producers and service companies will have to supply “cradle-to-grave” monitoring of water to prove it is either recycled or disposed of properly–which is great news for GreenHunter and Heckmann.
It’s clear to me in speaking with water company executives that their customer base, the producers, truly want to be green—and not just because it’s good for business. But everyone also says it has to make sense economically to recycle and re-use that water.
And when it comes to trucking out water to disposal wells or recycling at the well site, Hoopes says it will come down to simple economics:
“It will be the lowest cost option that wins.”
Ridgeline's Danzik agrees, saying that cost pressures in the US are intense. “Most of the companies entering the water sector have unreasonable pricing expectations.”
I think there will be regulatory and public pressure for producers to recycle more water.
That will potentially be a HUGE market that somebody—or somebodies—is going to fill. But the low cost technology isn’t in the market…yet.
GreenHunter and Heckmann Corp (HEK-NYSE) — another pure play in the fast-growing water market — have more diversified water management systems, vs. more niche lines like Ridgeline. When I look at their financials I see EBITDA margins ranging from 15%-30%. (The niche players have bigger margins.)
But the water treatment business model could be more exciting, as it will likely be based on throughput—customers will get charged so much per litre, gallon or barrel of water put through whatever recycling system is used.
With tens of billions of barrels of water being used, that could be the Holy Grail of the water sub-sector — a per gallon charge.
The reality is, however, that the growth in drilling in the major US shale plays is way ahead of how fast the water recycling/treatment industry can hope to develop. So the simple (but highly regulated) disposal of water through UICs/SWDs will be here for a long time.
Danzik adds that each oil and gas basin in North America has different needs; so solutions will obviously be different.
“Pennsylvania has water but no place to put it; Texas has no water but can dispose of it.”
“In the Marcellus, they’re in trouble, and that will increase as summer gets closer. In the North-east you have a real problem with disposal. The salt water disposal has been moved west; it has to be disposed of in western Ohio and Indiana and Virginia. They’re putting it in pits. They have to do something.”
“They (the producers) will have to pay full price per truckload, as much as $5,000 to $6,000. That will be the disposal charge. That will equal hundreds of millions of dollars.”
Again, that will be music to the ears of one lucky service provider in the new water sector… and their investors.
Longer term, Danzik sees the trucking industry as the most vulnerable to the changes happening in the fast growing water industry, as well-site water treatment increases market share (that’s his business, after all.)
It’s a variable, high-cost service, and local residents don’t like the traffic or the sight of literally hundreds of trucks delivering water tanks and water around their area.
Hauling or recycling water, storing or disposing of it—Hoopes says that the water business is growing so fast that for awhile, everybody in the space should be a winner.
“Everybody’s market share is a small percentage; this is not a winner take all scenario yet.
It’s too early. We’re all taking water management systems to a more mature status. I think there is a lot of potential to grow market share before we start butting heads too hard.”
By. Keith Schaefer
Publisher, the Oil & Gas Investments Bulletin