The Weir Group PLC (LON:WEIR) operates in 2 main divisions. Weir Minerals is a world leader in slurry pumps and valves manufacturing for the mining industry. Weir Oil & Gas provides high pressure pumps and fracking equipment, valves and engineering support for upstream and downstream oil & gas projects. It is worth saying at the outset that Weir Group is not the company it was even three years ago, it has been involved in some transformative acquisitions and the source of earnings are now substantially different – the price chart and previous comparisons are not hugely instructive.
Weir possesses strong market positions in highly engineered and specialised products; they are benefitting from growing installed bases with highly resilient and growing cash generative aftermarket revenues. This is a high quality, secular growth story which is integral in the supply chain for an industry which might provide “the answer” to many of the worlds largest economies economic and political problems. What price would Barack Obama put on an answer to the problems of blue collar unemployment, gasoline prices hurting consumers, energy independence and Middle Eastern political involvement?
Extracting Energy from Shale Rock & Horizontal Drilling
It is not easy to extract natural gas (NYSE:UNG) or oil (NYSE:USO) from shale rock. It is tough and uncompromising, even by the standards of other rocks! The rock traps the gas and oil so tightly that it has never been economically viable to extract. Over the last few years technology has developed which has allowed the rock to be cracked enough to release its valuable cargo. Below is a video from The Weir Group website on the process of horizontal drilling and fracking.
David Yarrow of Clareville Capital described the process of horizontal drilling and hydraulic fracturing very well in his outrageously good write up on Weir in April 2011
So as to tap the thin layers of shale, wells are drilled vertically to intersect the shale formations – often at depths of 10,0000 feet. The well is then deviated to achieve a horizontal wellbore within the shale formation. These horizontal wells can now travel up to 2 miles along the shale seam in parallel with the ground 2 miles above.
The poor permeability of the shale is addressed by hydraulic fracturing. A “perforating” gun is fed down the bore and gives off a string of explosives that blow holes the width of a fine knitting needle 18 inches into the shale.
Then comes the genesis of the SPM story. At least a dozen trucks with pumping equipment generate enough horsepower to blast a mixture of fine sand, water and lubricant chemicals into the bore. The sand blasts into the piercings in the shale and jams open crevices so that the gas can find its way into the bore. As much as 10 million gallons of water and 10 million pounds of sand can be pumped into a single well during the fracturing stage. It is a fluid intensive process…..
The recovery rate in aggressive and unwelcome shale formations will depend less on skill and more on the power and pressure of your pumps. Furthermore the pumps are going to take a hell of a beating in an intensive programme of trying to smash the gas out of the shale. In this underground battle zone, horsepower, precision and durability are key variables.
It is intuitively comfortable to contend that operators will not then compromise on the integrity of the pumps or the quality of the after service. After making the well, there would seem no point in cutting corners in well stimulation in a rock that doesn’t really want to “play ball”. Those that build wine cellars, don’t tend to fill them with too much Bulgarian red.”
Energy Independence in the US
“You can always count on Americans to do the right thing – after they’ve tried everything else.” Winston Churchill
“Energy independence is the best preparation America can make for the future.”
President Ronald Reagan
“Our goal should be, in 10 year’s time, we are free of dependence on Middle Eastern oil. And we can do it. Now, when JFK said we’re going to the Moon in 10 years, nobody was sure how to do it, but we understood that, if the American people make a decision to do something, it gets done. So that would be priority number one.”
President Barack Obama
The US drive for energy independence is ongoing. The Shale energy story is an exciting one because it offers light at the end of the tunnel for potentially hundreds of thousands of American citizens humbled by unemployment and impoverished by high oil prices. If anyone doubts the gravity of the situation I suggest you observe the following….
Shale Oil offers highly attractive break-even levels estimated around $50 per barrel by both insiders and industry consultants, with increasing recovery rates driving significant growth in the industry. This healthy cushion between current spot of north of $100 and these breakevens gives a margin of safety to anyone planning these types of projects.
The US EIA predicts that Shale Oil production growth will be 12% per year out to 2035, a clear indication of the US appetite for self sufficiency. The International Energy Agency forecasts that growth in Shale Oil production in the US of 265% from 2010 to 2016.
The US market accounts for 75% of Weir O&G orders (for now) and in particular unconventional oil sources which are expected to account for 17% of US production by 2016, a 30% CAGR between now and then. The chart below demonstrates the scale of the boom we are currently experiencing, US shale gas production has increased by a factor of 12x of the last decade and now that focus is switching to Shale Oil due to the current pricing differential. Although Weir’s pumps are used in the extraction of both oil and gas the process for oil is more intensive; it requires longer laterals, more frac stages/pumps and increases the service intensity – Halliburton have estimated that this means revenue per well could be 1.4x to 1.8x higher for the service companies that for that of a dry gas well.
Some estimates suggest that just the Baaken in North Dakota could be producing 1m barrels per day by 2020 which is circa 1% of global production from one US state. Even today North Dakota produces more oil than Ecuador which is an OPEC member!
Some have suggested that the Baaken has more crude than Saudi with an estimate of 300 billion barrels of oil. The main reservoir occupies around 200,000 square miles deep underground.
How much of the 300 billion barrels is actually accessible is dependent on the extent to which technology and expertise continue to advance. What was once impossible is now practiced widely, the recoverable percentage is likely to go up and the breakeven on the extraction may well fall. For clarity, in 1995 the recovery rate was estimated at 0.1%, in 2008 it was estimated at 1.5% and now it is gravitating towards 3%. What does seem likely however is that the complexity and intensity of the drilling process will continue to ramp up, it might just become more “normal”.
Horizontal Drilling – The Game Changer?
Horizontal Drilling has been described by former BP CEO Tony Hayward as a “game changer” and by Sir Ian Wood, founder of The Wood Group, as the most significant development in the industry in a generation.
The dynamics of the industry are extremely attractive for Weir. There is growth on top of growth here. Increased expertise and advancements in technology have led to the fracking process becoming increasingly more intensive. More wells being drilled, lateral lengths are increasing, greater horsepower and increasing frac stages per well leads to higher operational intensity and more wear and tear on equipment which flows through to higher servicing requirement and greater parts turnover. Fleets are now operated 24/7 due to the shortages of manpower and equipment, downtime is a luxury that cannot be afforded and utilization rates are increasing.
Operational efficiencies and attempts to maximise returns have led to operators working the equipment harder and longer, this is of course great news for Weir’s pumps. Data from Halliburton shows that service intensity in 2010 was 7x greater than that in 2006 and doubles that of 2008 just 2 years earlier.
Car tyres have a pressure of around 30 pounds per square inch, Weir pumps operate at 15,000 pounds per square inch and therefore are require extreme care when operating. As Yarrow recalls in his report
“Steve Noon told me that he had seen a controlled blow out of a SPM pump in an empty field. One of the iron components which weighed the same as a small child, ended up 250 yards away. Sadly, every year there are deaths adjacent to the pumps in horizontal drilling – it is a tough old game.”
A frac pump previously had a life expectancy of