The increasingly gritty search for shale oil and gas has turned sand into a valuable commodity, as drillers deploy rising volumes of the stuff to prop open rock fractures.

 Suppliers of the silica and other auxiliary hydraulic fracturing services, from compression to saltwater disposal, have been some of the stock market’s biggest winners of late.

This survey will review several of the top plays in this fast-growing niche. But first, some essential background is in order.

The technique of hydraulic fracturing, or “fracking” had been around since the late 1940s and has been used extensively to promote higher production rates from oil and gas wells across traditional production regions like Texas and Oklahoma. Fracking involves pumping water, chemicals and a proppant down an oil or gas well under high pressure to break open channels (fractures) in the reservoir rock trapping the deposit. The proppant is a solid material designed to hold those channels open, allowing the oil (or natural gas) to flow to the well bore. Some common proppants include sand, ceramics, glass beads — even walnut shells have been utilized.

Like fracking, horizontal drilling was invented decades ago and had been widely utilized in the oil and gas industry since the 1980s. As its name implies, horizontal drilling involves drilling down to an oil or gas deposit and then turning the drill horizontal to the formation to access a greater fraction of the deposit. These horizontal “laterals” can be 5,000 to 10,000 feet in length:

Source: ProPublica

 The hydraulic fracturing revolution in the US has created many new opportunities in the oil and gas space. The “midstream” partnerships that transport the oil and gas have long made up the single biggest category of MLPs, and are represented by such giants as Enterprise Products Partners (NYSE: EPD) and Plains All American Pipeline (NYSE: PAA).

Less obvious may be those involved in support services for oil and gas operators involved in hydraulic fracturing. The graphic above hints at some of those peripheral opportunities. Water has to be supplied to the drilling site, as well as proppant and other chemicals. Storage tanks are needed along with the infrastructure that moves the oil and gas to market. 

Hi-Crush Partners (NYSE: HCLP) is a pure-play domestic producer and supplier of premium monocrystalline sand used as proppant. The MLP’s reserves consist of Northern White sand, predominantly found in Wisconsin and elsewhere in the upper Midwest. Hi-Crush Partners produces a range of frac sand sizes for use in all major US shale basins and has onsite rail capacity for unit trains.  Substantially all frac sand production is sold to pressure pumping service providers under long-term, take-or-pay contracts that require customers to pay a specified price for a specified volume of frac sand each month.

In hindsight, it’s hard to believe that HCLP had a tepid opening when it went public on August 16, 2012 at a price of $17 per unit. This was well below the anticipated IPO range of $19 to $21. But in 2013 Hi-Crush Partners was the year’s best-performing energy MLP with a gain of 142 percent.

For the first quarter of 2014 HCLP reported earnings before interest, taxes and depreciation and amortization (EBITDA) of $19.2 million on revenues of $55.8 million. The Partnership’s distributable cash flow (DCF) for the first quarter of 2014 was $17.4 million, corresponding to distribution coverage of 1.0x. The first quarter cash distribution of $0.5250 per unit, or $2.10 on an annualized basis, translates into an annualized yield of 5.1 percent based on the recent closing price of $41.48 per unit.

HCLP recently raised guidance for sales volumes, EBITDA and DCF for 2014. Guidance for sales was increased from a range of 2.3 million to 2.7 million tons of sand to a new range of 3.6 million to 4.3 million tons, EBITDA guidance was increased from a range of $80 million to $90 million up to $115 million to $135 million, and the guidance for DCF was increased from a range of $75 million to $85 million up to a new range of $100 million to $130 million. For 2015, the Partnership projects sales, EBITDA, and DCF to grow to 5.4 to 6 million tons, $140 million to $185 million, and $125 million to $170 million, respectively.

Emerge Energy Services (NYSE: EMES) has a lot in common with Hi-Crush Partners. The partnership produces sand for hydraulic fracturing through its Sand Production division, although it also has a Fuel Processing and Distribution division. Like HCLP, units of EMS had a weak IPO on May 9, 2013 but in late May the partnership began a meteoric climb that now has the unit price up by 411 percent[1]  since the IPO. 

Unlike HCLP, Emerge Energy Services is a variable distribution MLP. Such MLPs have no minimum quarterly distribution and no implied promise to keep the payout steady or growing. The distributions vary with the cash flow of the MLP.

In the first quarter of 2014, EMES reported reported net income of $18.5 million, adjusted EBITDA of $28 million and DCF of $25.1 million.  Net income and adjusted EBITDA for the first quarter of 2013 were $9.9 million and $17.3 million, respectively. For the full year 2014 the Partnership projects net income of $58.5 million to $63.5 million, adjusted EBITDA of $98.5 million to $102.5 million, and DCF of $90 million to $95 million.

For the last three quarters, the distributions were $0.86, $1, and $1.13 per unit. (The first distribution after the IPO was prorated). At the recent closing price of $84.61, the past 3 distributions project to an annual yield of 4.7 percent[2] . (Based on just the most recent distribution, the annualized yield would be 5.3 percent.)

USA Compression Partners (NYSE: USAC) was the first MLP IPO of 2013, debuting on Jan. 15 and advancing 54 percent for the year. USAC provides compression services for the oil and gas industry. Natural gas producers contract with USAC on a long-term fixed-fee basis to compress the natural gas so that it can be delivered via pipeline to customers. USAC installs compression equipment to move the gas from the well to its destination. Its customer base is scattered across the important natural gas-bearing shales like the Barnett and the Marcellus. At the current price, units yield 7.2 percent.

 For the first quarter of 2014 USAC reported that revenue rose 54 percent year-over-year to $50.2 million. Adjusted EBITDA rose 44.4 percent to $25.2 million and adjusted DCF increased 44.9 percent to $16.8 million versus Q1 2013. Adjusted DCF coverage for the first quarter of 2014 was 0.88x. The Partnership recently confirmed full year 2014 guidance of adjusted EBITDA of $109 million to $115 million and DCF in the range of $75 million to $81 million.

 The first MLP IPO of 2014 was Cypress Energy Partners (NYSE: CELP), a partnership that is also in the business of providing hydraulic fracturing support services. Cypress is a growth-oriented MLP providing saltwater disposal and other water and environmental services to US onshore oil and natural gas producers and trucking companies in North Dakota and West Texas. The Partnership has seven saltwater disposal facilities in the Bakken and two in the Permian Basin. The facilities receive a fee for each barrel of saltwater (fracking wastewater) that is disposed, and derive additional revenue from sales of the residual oil recovered in the process.

The partnership also has a Pipeline Inspection and Integrity Services division that assists pipeline operators with documentation and project oversight of their asset integrity programs and related construction, inspection, maintenance and repair activities. Cypress was the first IPO specializing in  water and environmental services and pipeline inspection and integrity services.

For 2014, the partnership is projecting a ~20 percent advance in margins and an increase of more than 30 percent in adjusted EBITDA[3] . The partnership agreement calls for a minimum quarterly distribution of $0.3875 per unit for each whole quarter, or $1.55 per unit on an annualized basis. At the recent closing price of $23.72, that would translate into an annualized yield of 6.5 percent.

Key Statistics for the Fracking Support MLPs