Despite appearances, we are running out of sand. While that might seem farfetched&#;sand is seemingly everywhere&#;there is not only a thriving international trade in the commodity, but it&#;s the second-most heavily exploited natural resource after water and, by volume, the most heavily extracted solid material in the world.
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Like any commodity, sand requires uniformity. Uniform sand, or "aggregate," includes gravel, crushed stone and concrete, each of which has unique applications. Specialty sands, with a high concentration of silica and oxygen, also exist for industries such as golf, volleyball, sports fields, and playgrounds, as well as retail and technical services. Each has unique shape, size, hardness and color specifications.
Key Takeaways
- Sand is the second most-heavily exploited natural resource in the world after water, subject to broad international demand and a thriving global trade.
- Uniform, or aggregate sand&#;that includes gravel, crushed stone and concrete&#;is used for building roads, parking lots, homes, buildings and landscapes.
- Specialty sand is used for golf, volleyball, sports fields, playgrounds, and other surfaces. Large quantities of sand are used in hydraulic fracturing as well.
- However, the commodity's supply is dwindling, as it is being extracted much faster than it can possibly be renewed, creating the risk of a global shortage.
- For a savvy investor, the scarcity translates to price appreciation, which could make it a good buy, depending on how it's approached.
- Investors can't buy or sell sand futures, like they can with other commodities, but they can invest in companies that are connected with sand production.
From Playgrounds to Fracking Wells
Sand is formed by erosive processes over thousands of years and, according to a UN Environmental Program (UNEP) report, is being extracted far more quickly than it can be renewed. According to the United States Geological Survey, the U.S. imports only about 0.5% of the total sand that it uses. However, countries like China (13.1%) and Canada (9.42%) import significantly larger quantities of the world's sand imports. Sand's scarcity translates to price appreciation, which makes investing in sand compelling.
The U.S. Geological Survey reports that the price of sand and gravel has increased dramatically in the United States, from $3.96 per ton in to $9.90 in . Specialty sands generate even higher prices: frac sand is used in the process of extracting oil through hydraulic fracturing. According to Rytsad Energy, costs in have skyrocketed nearly 185% higher than the previous year, between $40&#;$45 per tonne, due to import constraints on Russia because of the war in Ukraine.
But investing in sand is challenging. Sand&#;s weight relative to its value makes it expensive and challenging to move and store. Investors are also unable to buy or sell futures contracts tied to sand, as they would with other commodities, such as soybeans or oil. As a result, investors interested in deepening their exposure to sand need to look to equity in companies associated with sand production.
Fueling Construction Growth
Conservative estimates in place world sand consumption in excess of 50 billion tonnes a year, according to UNEP. That number is twice that of the annual amount of sediment carried by all of the rivers of the world, which means that mankind is the largest transforming agent in the world with respect to aggregates. Demand is asymmetric: increasing demand is predominantly tied to urban growth in Asia, though it is worth noting that information on global sand consumption, particularly in emerging and frontier markets, is scarce.
Aggregate is the main constituent of both concrete and asphalt. It is also the primary foundation for building roads, parking lots and runways, homes, buildings and landscapes. For each cubic meter of cement used, the construction industry needs about 150 liters of water, 250kg of cement, and 1,900kg or sand and gravel.
In , according to the Global Cement and Concrete Association, China produces 52% of the world's cement, followed by India (6.2%) and the European Union (5.3%). Global cement production is expected to increase from 5.17 BMT in to 6.08 BMT by .
Frac Sand Boom and Bust
Energy Exploration and Production (E&P) also consumes vast quantities of sand, mostly due to its use as a primary proppant in hydraulic fracturing. Proppants are mixed with a liquid to keep fracking wells open and facilitate the removal of oil and natural gas. For scale, individual fracking wells often use seven million pounds of sand, with some requiring up to three times as much. Wells have grown longer and wider since modern-day hydraulic fracking came about in the s.
Frac sand suppliers are highly fragmented, with some 50 producers globally. In addition to energy producers themselves, frac sand suppliers were among the hardest hit by the shale oil bust beginning mid-, as drilling activity plummeted. Major oil and gas producers saw their market halve, but the carnage among sand suppliers was worse. With the steep decline in rig counts, sand suppliers like Emerge Energy Services (EMES) and Hi-Crush Partners (HCLP) saw their stock prices depreciate drastically from their highs.
But by , the U.S. frac sand market heated up, even as oil prices remained depressed, due to the increasing size of wells. Producers also increased the number of fractured stages per well, which fueled a boom in the amount of sand used to drill. As U.S. crude continues to recover in price, coupled with high demand for U.S. natural gas, frac sand demand should continue to surge.
Among those producers that are publicly traded, is U.S. Silica Holdings (SLCA) the largest pure-play fracking sand provider. Bison Merger Sub I (FMSA) also has a significant business for mining and quarrying nonmetallic minerals. Hi-Crush Partners and Emerge Energy Services are structured as master limited partnerships. EOG Resources (EOG) is a large producer but uses all of the sand it mines in its own wells.
The barriers to entry for frac sand producers are high. Not only does it take time, expertise and capital to build a new mine, but it&#;s also difficult to time the market exactly. Furthermore, there can be supply limitations due to infrastructure or shipping constraints.
Environmental issues are also a concern. Sand extraction lowers water tables and decreases sediment supply, resulting in the destruction of ecosystems like fisheries. Sand extraction has also been linked to inland and coastal land loss, water contamination, and river embankment and coastal infrastructure damage.
Limits on Infrastructure Development
Furthermore, the planned expansion of infrastructure in many parts of the world is more ambitious than had previously been estimated. India's current more than $52 billion building boom making has placed sand in such high demand that illegal mining has engendered a sand mafia. In October , Saudi Arabia, which already made headlines for importing sand despite its desert locale, announced a plan to build Neom, a $500 billion mega-city spanning 10,230 square miles.
Sand mining and dredging have been largely ignored by policymakers. But as climate change's ramifications on coastal cities become more evident, this too will likely change. Today, in the U.S., the fastest-growing use of sand includes fortifying shorelines eroded from rising sea levels and increasingly powerful ocean storms, particularly after recent powerful hurricanes. Inland uses include temporary sand dams and sandbag installations to protect residents and property from surging lakes and rivers, as well as mudslides, like those that impacted California in .
While sand substitutes exist, they are expensive. Increasingly, producers have begun to turn to recycled asphalt and cement, although comparative usage is quite small.
In addition to producers, investors looking to make a play on sand could look into dredging companies and dredging/blasting equipment manufacturers, given recent advancements in robotic crushing technologies. For investors concerned about the long-term effects of a sand shortage, glassmakers (windows, glassware and cell screens), water filtration, septic systems, swimming pools, solar panels, and wind turbine manufacturers all rely on the material. Sand is used in the railroad industry, as well as for molds in foundries that make everything from airplane and cruise missile parts to artificial hips.
Fracking is all the rage, and this special sand makes it happen -- but investors need to know what they're getting into before buying in.
Oh, the wonders of sand -- making glass, getting stuck in your unmentionables at the beach, and making fracking possible. In this episode of Industry Focus: Energy, host Nick Sciple and Motley Fool contributor Jason Hall focus on that last feat sand can do, and what investors need to know about the industry. Frack sand isn't just any old sand -- it needs to be able to stand up to the pressures of fracking. So, sand producers and distributors can command a pretty penny...when the stars align.
Tune in to learn how the industry works, a couple of companies that investors might want to check out, the most significant risks you should know before buying any frack sand producer, the biggest industry trends to watch, and more.
A full transcript follows the video.
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This video was recorded on Sept. 13, .
Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, September 13th. We're discussing the frac sand industry. I'm your host, Nick Sciple, and I'm joined by fool.com contributor Jason Hall via Skype ID. How are you doing, Jason?
Jason Hall: I'm wonderful! I'm doing great! I'm really looking forward to doing lots and lots of Industry Focus podcasts with you. Even though you are a University of Alabama graduate.
Sciple: [laughs] For anybody who doesn't know, Jason is a graduate from the University of Georgia. There's a little bit of a grudge going back to January, when my Alabama Crimson Tide had a nice performance in the national championship game, which was, I'm sure, disappointing to Jason.
Hall: No, no, no! They had a good second half. Let's be clear, they had a good second half!
Sciple: That's right. And you're ready for college football this weekend. I was talking to you earlier today. You're going to have an early morning out there on the West Coast for the game on Saturday.
Hall: Yeah. For people that haven't heard me on the show or follow my writing, I live in Southern California now. That can make for some tough Saturday college football. With the storm coming in, they just moved up the Georgia kickoff to noon Eastern time. That's 09:00 am for me. On Saturdays, 09:00 am gets me up little sooner than I want it to. I'll be OK. I've got a 19-month-old. He'll have me up early. We'll go to his swim class, and then it's time to watch the game.
Sciple: You got an appointment with the couch. Alright, Jason, before we dive into some companies operating in the frac sand space, let's talk about a little bit about what frac sand is and what role it plays in the fracking process. Can you talk a little bit about that for our listeners?
Hall: I think a good place to start is why it even exists. The short version is, shale. People that follow the oil and gas industry hear the word shale, you talk about shale plays like the Permian, and before that, the Bakken, and the Eagle Ford plays. You've got all these shale plays, all this oil and natural gas that's trapped in really hard rock formations. Here's the thing: the industry has known about these formations since the 50s. They've known for literally decades that this huge amount of oil and natural gas has been there. But there hasn't been any way, until really over the past decade to really efficiently get it out.
That's where hydraulic fracturing comes into play. High pressure water and other fluids crack the rock. That's only part of it, because you have to keep the rock open to actually extract to the oil and the gas. This is where frac sand comes into play. I know you've done a ton of research into looking at frac sand and what's necessary. Do you want to talk a little bit about some of the characteristics that are important?
Sciple: Sure. Like you said, frac sand is pumped into rocks, cracks open the shale rock and holds it up. What's really important when you're looking at a frac sand is, it needs to be able to withstand very high pressures without breaking. You want to keep that crack in the rock open. What's really important is, it needs to be very durable. You want it to be a similar size, a very consistent size, across all the supply of sand so you can get a consistent result for when they pump that sand in.
Typically, the sand traditionally has been northern white sand, which is sourced out of Wisconsin. It's highly quartz-rich, very consistent in size, very resistant to pressure. It really gets into those fractured cracks in the rock and stays in there.
The issue that has been an issue over the long-term with using this frac sand is, it's all based out of Wisconsin. As we'll discuss later on, the largest shale plays in the country today, and what will continue to be so looking into the future, is the Permian. That's out in West Texas. It's a really high-quality sand, but it's in Wisconsin, so there's going to be a significant expense in bringing it out down to the southwest.
So, there's been a little bit of a transition recently in the sourcing of sand. There's still some being sourced out of Wisconsin and transported down there. But, there's been more of a push to using regional sand. It's known as regional brown sand, which is actually based out of the Permian. The big advantage of that is, it's based in the Permian, so your logistical expense is significantly lower. But, it isn't quite as ideal for fracking sand use. It's not quite as crush-resistant, not quite as consistent in size. But, it's a huge savings for producers in that they don't have to ship it all the way across the country.
Long-term, we're going to see what the result is of switching to that sand, how it's going to result in outputs from these shale wells over the long-term. But that's the big trend now coming out of the Permian.
Are you interested in learning more about sourcing frac sand proppant factories? Contact us today to secure an expert consultation!
Another thing that's important to think about when you're talking about frac sand is, it's a commodity market, just like oil or gold or any other thing you pull out of the ground and sell. Frac sand is a commodity market. Jason, do you want to talk a little bit about how that market has broken down over time, how that supply and demand balance has played out?
Hall: Actually, in the days leading up to the show, we were doing a little bit of prep work. One of the things that I did is took a long-term look, not super long-term -- if you go back to around late , that's when there was the first iteration of a producer price index for hydraulic fracturing sands. I took that, which basically shows what the cost is, starting at a baseline of 100. And then, over time, how that price changes, the producer price changes. I overlaid that with WTI crude, which is West Texas intermediate crude. It's kind of the main benchmark for North American crude. There are other regional benchmarks, but this is the big one that you hear about when it comes to North American crude oil.
I overlaid those two things, and I guess the best way to describe it is that, the price of oil has been a leading indicator of what's going to happen with frac sand prices. In general, that's because, if you think about what happened with oil prices in , you're pushing triple digits consistently. Then, mid-, prices started falling sharply. Then, bottoming in in the mid high 20s for West Texas crude. Within weeks, you started seeing sand prices fall because drillers were backing down on their production. That increases competition between the suppliers. That drives down the price for sand. Then, you also have this issue with oversupply. There's this massive oversupply. You have all the suppliers further fighting for whatever business they can get, for whatever revenue they can generate. And then, as oil prices started to level, and then have started to come back up, really since late , early , sand prices have started to really recover.
What that ties to is the Permian. You're going to hear us talk a lot about the Permian. A tremendous amount of drilling started happening in that region. As costs came down, the oil producers have really done a good job of driving down their development costs for shale. It's become, on a cash basis, really competitive.
There's a lot of demand for sand. It's looking like demand is going to continue to be pretty good. But at the end of the day, as a supplier to these oil producers, the commodity price of oil is going to have a big impact on the sand prices that any of the sand producers can command.
Sciple: Right, exactly. When you look at these drilling locations in West Texas, if the oil price gets down low enough where they're below break even, they can idle those wells and wait for the market to bounce back. I think another important thing to think about, going back from to today, is that the volume of sand use has really risen. As there's been more of a push into horizontal fracturing, and really pushing out the length of these wells, the usage of sand has really skyrocketed. It's because there's a direct relationship between how much sand is used in the fracturing process and how productive a well is. There's really a big return on investment. There was a report that came out from IHS Markit at the end of June that said , what was the previous peak for frac sand use, as you talked about, the very high oil prices and that sort of thing, as of June , proppant demand -- proppant is what frac sand is, it props open the cracks in the shale --was 42% higher than it was at the peak in . And, it's continuing to grow. You're seeing oil prices bounce back a little bit. That's going to add a little bit of demand to frac sand. Then, you look at the procedures that these producers are using, they're more geared toward using a higher volume of sand to get a greater volume of oil.
Again, you mentioned that the Permian is a significant source of demand for frac sand. That's about 37% of demand in the United States. This really is the big story when you're talking about the oil industry in general, but particularly the fracturing industry, which is where the sand operates. Through , IHS Markit, again, is expecting a 12-13% cumulative growth rate. We're expecting to see demand continues to grow. Of course, that is going to depend on what global commodity prices are for oil. But, this is something that's not going away any time soon.
Another thing that's impacting this, let's go back to the Permian a little bit, it may impact the oil sand prices over the long term, is the infrastructure present in the Permian. Can you talk a little bit about how that is affecting oil production and decisions that are being made by drillers there, and how that may impact these sand producers and the sand industry?
Hall: The Permian is actually a pretty old oil play, that region, that part of Texas. They've been producing oil there for decades -- pretty close to a century, actually. Most of the prior production, obviously, was from traditional vertical wells, aiming at traditional, regular oil reservoirs. The point is, there has been a lot of pipeline capacity in that region for a long time. You compare that to other places where we've seen shale explode over the past 10 years or so, like the Bakken, Pennsylvania. Those are places where there hasn't really ever been infrastructure.
So far, the Permian has actually had a relatively easy time getting the oil out relatively cheaply because there's been capacity and pipelines. But that's coming to an end. I mean, it's really coming to an end. A lot of the pipeline companies are building infrastructure right now, but really, over the next 20 months, this region is going to be stretched to its limits to really add any more additional take-off of volume. It's just maxed, it's just about the max right now.
The concern for a lot of oilfield supply companies -- and definitely, if you're following any of the Permian producers, any of the independent producers where this is their bread and butter -- the ability to grow production is probably going to be relatively limited in that region. For the suppliers, if there's not going to be this continued accelerated development of new oil wells, it's going to potentially limit some of the opportunity. When there's a lull in demand, when things slow down, it's the suppliers that tend to get to hit the fastest and tend to get hit the hardest.
There's some concern over the next 18 to 20 months, that suppliers -- this includes the frac sand guys -- could feel a little bit of a pinch. But, I think there's a caveat there that you have to consider, too. One of the things that makes these shale plays very different, and that historically has made them really expensive, and they've gotten better about bringing the cost down, is something called the decline curve. The decline curve is, you start your oil production or natural gas production at X. Over time, the production goes down. These traditional wells lose a few percent a year. But these fracked wells in the shale plays lose a substantial amount of output in the first year or so. And then they find more of a natural decline curve that's still a little bit steeper. What that means is, simply to maintain a certain level of production requires a much higher level of drilling activity than traditional oil and gas output.
What that means is that for the frac sand guys, there's still going to be a certain amount of built in demand simply to maintain output. That's a positive thing, even during weaker demand periods.
Sciple: This is a story that, like you said, is going to play out over the next 18 months. I think this has really given us a good picture of the industry.
OK, Jason. Now that we've laid out what frac sand is, let's talk a little bit about the companies operating in the space. First, like you mentioned, these companies don't necessarily trade one-for-one with the oil market. We looked back over the past two years. We've got oil up about 35%. The two stocks we're talking about today haven't really come along for the ride with that. Over that period, Hi-Crush Partners LP (HCRS.Q) has fallen 22% and U.S. Silica Holdings (SLCA), which is another company we're going to talk about, has dropped about 51%. I guess the question I have for you is, what gives?
Hall: I think the short version is, again, let's talk about the Permian. You go back to oil prices bottoming and then bouncing back in the second half of . That was about the same time that a lot of development activity in the Permian really started kicking off. It was like, "It's one of the biggest plays in the world, a century of oil, it's cheap to produce, the producers are getting consistent results from it. They're going to need a ton of sand." The market went hard and heavy after Hi-Crush Limited Partnership, ticker HCLP, and U.S. Silica, ticker SLCA. Those are the two dominant, kind of the first movers, in terms of having tons of scale. There was a ton of speculation that these are going to be huge winning stocks. I think the market just got ahead of itself, is really what's happened.
At the time, the companies were burning a lot of cash flows. They had some structural issues. Again, think about Wisconsin to West Texas, that's a long way. 1,500 miles to move that sand. It's expensive. Even though there was growing demand, at the time, oil producers were still squeezing suppliers as hard as they can to make money, to have breakeven cash costs on these wells. I think that's the short version. The market was speculating on this great opportunity, but the businesses weren't really producing the positive results to support it. And you had a crash. You look at mid-, stock prices really cratered. Over the past year, I think the stock prices are a lot more in line with the performance of the other companies.
Sciple: Sure. That makes total sense. Again, we're talking about suppliers in an industry. There's a correlation, but it's not going to be a direct correlation. There are a lot of factors that will go into that.
Jason, let's go ahead and swing in and get real deep into Hi-Crush Limited Partnership to start out. The first thing that pops out to me looking at this company is the valuation metrics. This is a company with a $1.1 billion market cap. It's got a price to earnings below 6X. Its price to tangible book is 1.3X, and it's yielding over 20%, one of the highest-yielding stocks on the market. Can you talk a little bit about what's going on with that yield, what investors should look out for, why are these traditional valuation metrics so low? What's the story there?
Hall: Hi-Crush Limited Partners is an interesting story. I think the first thing is, we'll talk about the dividend. Why is the yield so high? What's going on there? Here's the deal. Hi-Crush is a limited partnership. This is different from your typical C Corp, traditional stocks, traditional structured company. Master limited partnerships don't pay corporate income taxes. It's what they call a pass-through entity. There's some advantages, in terms of it being able to generate cash flows and pass them along to investors in the form of dividends, which they call a distribution. That's what it's called for MLPs.
But, there are some things on the other end of it that can make it less of an attractive investment for you and me, for your retail investor. It has a general partner, which is essentially the controlling entity. In High Crush's case, the controlling entity is Hi-Crush LLC, which is a privately held, separate company that has several major investors, including some private equity groups, including the co-founder and current CEO, Robert Rasmus, which I think is good for investors. He has a stake, and that helps align it. But, in essence, what happens is, when you have a master limited partnership, and you have the general partner that runs things, there's something called IDR. It's incentive distribution rights. Essentially, what happens is, the distribution goes up. The way IDR is structured is that the general partner gets a larger and larger portion of the rewards. The key is that at that $0.725 per unit distribution, it pushes it all the way up to where it's 50/50, where an outsized portion of the proceeds goes back to the general partner.
In short, by paying out this $0.75 per unit distribution for four consecutive quarters, the idea is that it will create a situation where those IDRs are reset, and the company can convert to a C Corp. Now, there are other aspects of that are going to happen that can affect this. There'll probably be some dilution. Basically, to buy out the general partner, the company will have to issue shares that will become common units. There's some potential tax consequences for investors that hold shares of the company now.
It's kind of muddied. The other thing is, if you bought shares today, you'd capture three more of those $0.75 per unit distributions, which works out to about 18% of today's market price. But then, it's almost guaranteed that the distribution is going to get cut. It just doesn't make sense to continue to pay it out at a high level.
The long story short is, don't buy it because you're going to get a 19% yield. That's a payout over the next nine months that'll happen to get to that one year. Then, everything is going to get reset if management makes a decision to convert to a C Corp. Everything's going to change. That's what's going on there.
The bigger implications, essentially the company's using debt to pay that distribution right now. It recently issued $450 million in senior unsecured debt at 9.5% interest. That's a very high rate to pay. It has good credit, but it's considered junk. This is not an investment-grade company. It also entered into a new revolver to replace its old tread facility. It has debt that it's issued, basically to support this high level of dividend to get to that point. So, it's kind of a leveraged buyout, almost, in a way.
The other thing, too, is that this is a time when the company needs cash flows to really continue to grow and to be strong. It's occurring right when the offtake issues in the Permian are starting to become a reality. Worst-case scenario, if there's any kind of global oil demand crisis, and there are so many uncontrollables out there that could affect what happens in the Permian, that could affect its demand for sand... there's kind of a worst-case scenario that makes me concerned because the company's taking on much leverage to try to get to the point to change its corporate structure.
In the long term, I think it's a good idea to make this change. But in the short-term, as an investor, it's what's keeping me on the sidelines, is the best way to put it.
Sciple: Yeah, that makes a lot of sense. If you look back at the company's history, they've had a similar thing happen to them in , where they started raising their distribution. Then, at the same time, they started making some significant capital expenditures. And it just ended up being a dangerous cocktail, with the oil prices coming down, you're upping your distribution, you're putting in significant capex. It really put them in a dangerous situation, which they have since recovered from to this point. But it's a little bit scary to see, the way the market's playing out, that the story could happen once again.
Hall: It could. I think if you've got a really good tolerance for risk, I can see, maybe, making a small investment and watching closely. Even if things do go sideways, I think long-term there's really good prospects. But, if things don't go perfectly over the next year, I think you'll be able to get a much better value point. Things could get a little bit scary if it doesn't go perfectly.
Sciple: Yeah, that's right, Jason. As a shareholder of Hi-Crush myself, it was a little bit concerning to see all this stuff come out. The other interesting thing, we mentioned the capex, that really makes Hi-Crush stand apart. We mentioned in-basin frac sand earlier in the first half of the show. They were really the first frac sand provider to really get into the Permian and have a location physically there. They have a mine located in Kermit, Texas, which opened in July . It has 105 million tons of sand. It spans 75 miles and 1,500 different permitted well sites, and can serve 95% of all proppant consumption in that area. That's really been a huge advantage for them. They converted an old ATV park, believe it or not, to build that sand mine, which has had some big advantages. We'll talk a little bit later with U.S. Silica. It's had some struggles in the Permian building out their in-basin production.
The big advantage for Hi-Crush was, this place, as a converted ATV park, already had utility infrastructure in place, roads to get in, all those sorts of things. That's an advantage that Hi-Crush has. They were able to smoothly bring that mine online. Other producers in the area have struggled with it. It's been a huge advantage for them to be the first mover, and among the big suppliers to have an in-basin sand mine, to be able to provide that and cut out those logistical expenses.
That's also letting them repurpose their Wisconsin production to other shale plays across the country. We talked about the Utica, we talked about the Marcellus Shale in Pennsylvania. We've talked a little bit about the Bakken up in the northern part of the United States, in the Dakotas. Really being able to take advantage of that Permian presence with their current mine, but then also repurpose some of their other assets to service other parts of the country.
Hall: Yeah, I think it's smart. One thing you and I talked about, too, that's important to bring up is some of the last mile things that they're putting in place that are beneficial to producers, in terms of helping producers lower costs. But, it should also lead to better margins. That's a big advantage Hi-Crush has, maybe to a little bit lesser extent in the Permian that was coming on base that U.S. Silica has. Do you want to talk a little bit about what's happened there for Hi-Crush?
Sciple: Their PropStream last mile logistics platform is really their calling card in this area. They actually made a recent acquisition. They acquired FB Industries, which is another frac sand management company. They acquired that company for $60 million a couple of months ago. That's a big move for them, to push hard from the logistics perspective. They offer two different solutions. They have a container-based solution, where they will fill up at their different distribution centers, a container that can be loaded onto a truck and taken directly to the well site and just dropped right into the well. That's a very convenient solution for E&P operators in this space.
And then, with this acquisition of FB Industries, they added a silo-based management system, which is more of a legacy system, but for other producers or customers that may prefer a system like that, they're able to supply the full gamut of what a producer may want.
Really, at the end of the day, logistics are the name of the game in this frac sand space. It's really, can you get me a product that meets specifications? Can you get it on time? Can you get me exactly how much I need? That's a real advantage of these big players like Hi-Crush and U.S. Silica. They can really, not only have the supply online, but manage, top to bottom, the logistical aspects of bringing the product to the well site. It's a really important thing for producers, and they're in a position to supply that in a compelling way.
Hall: Yeah, absolutely.
Sciple: Let's talk a little bit about U.S. Silica Holdings, ticker SLCA. This is another company, you look at it, it's got a P/E of 10X. From a valuation perspective, it looks relatively reasonably valued. I will point out a difference between U.S. Silica and Hi-Crush -- Hi-Crush is a pure-play frac sand provider. They have one segment. It's frac sand sales. By contrast, U.S. Silica is a more diversified business.
80% of their revenue is oil and gas proppants, that is their frac sand. That's about 77% of their contribution margin, which is kind of a net income or adjusted income metric. They do get about a fifth of their revenue from industrial and specialty products, which is different types of sand. They provide sand for golf courses, beach volleyball courses, for use in glass, building products, chemicals, filtration materials. That gives them a little bit of diversification. They recently made an acquisition to push in that direction even more so. Do you want to talk about that, Jason?
Hall: If you look at their balance sheet, you'll see in May that U.S. Silica's debt exploded. That's when their acquisition of EP Minerals closed. That was a big acquisition that primarily was aimed at helping to further diversify the business away from oil and gas. Going forward, if the company's income from oil and gas grows, it's because all prices are up, production's up, things are hitting well.
But, over the next year, we're probably going to see it generate more income from its other sectors. We've already seen that so far this year. If you look at the company's earnings, its industry and specialty chemicals contribution margin pretty much doubled sequentially from around $21 million in the first quarter of the year to $41.3 million in the second quarter. A significant amount of that was because of the EP acquisition. That's one of the things I like. It gives it a little bit of strength, it can help it with the cyclicality of oil and gas. It can help smooth out its business and its cash flows, which can be really, really important.
It also has around $300 million in cash and equivalents on its balance sheet. It has some ability to ride things out. It has capacity to continue to invest in capital expansion and improving its business. I really like those things about its business. Even though, if you look at just the straight price to earnings ratio, it's technically 40% more expensive than Hi-Crush, there's a hell of a lot less to be concerned about. Its liquidity is better. It's investing in growth vs. taking on debt to support a dividend to give it the ability to make changes in its corporate structure. Again, for the long-term, I think it's good for Hi-Crush. But in the short-term I'm not sure about it.
If I were going to buy one of these two today, I would certainly be more inclined to buy U.S. Silica. The business is more secure. I think there's a little bit more predictability. You know what you're getting a little bit better than you do with Hi-Crush because of the uncertainty with its corporate structure.
Sciple: Right, for sure. You don't have those corporate structure concerns, you have some other areas that, if we do see a little bit of a cyclical downturn in oil price, they can be generating cash flow from the other parts of the business to really secure when there is a bounce back in oil price, which will come sooner or later. They will be in a position to, during the downturn, make significant investments using their other cash flows.
They're really making a big commitment here. This EP Minerals acquisition was $750 million. Maybe that doesn't sound like a lot, but for a business that is only $1.63 billion, that's a little less than half of your overall market cap. It's a big push into this diversification for them.
I will say, another thing to mention, a comparative with Hi-Crush, U.S. Silica is also trying to bring some production online in-basin in the Permian. They've mentioned in their recent earnings report conference call that they've had a little bit of an issue getting that online. Unlike the Hi-Crush mine in Kermit, they're going from a greenfield situation. They don't have quite the infrastructure in place. They've had a little bit of struggle there. But, as they can take these cash flows from other parts of the business and invest in building these things out, over the long-term, they're going to be in a really good position.
Another thing to think about, we mentioned Hi-Crush's logistical operations with their PropStream service. U.S. Silica has a similar service called SandBox. A little bit of difference, like we mentioned, Hi-Crush has both the silo-based solution and the containerized solution. The SandBox solution is only a containerized solution. But, those are all the big, major trends in the frac sand industry. We're moving more toward focusing on logistics and we're moving more toward; how can we get production closer to these E&Ps in the Permian? That's something that both businesses are investing in and something that really is going to be a differentiator for these businesses going forward.
Hall: Yeah. One thing, too, that U.S. Silica announced earlier this week that was unique, and I'm wondering if we might see more of these, Pioneer Natural Resources, which is a big oil and gas producer in that region, reached an agreement with U.S. Silica to basically buy a stake in U.S. Silica's Lamesa, Texas sand mine in exchange for a 15-year supply of sand. Anybody that follows the gold mining business may have heard of a gold streamer. These are companies that basically front money to gold miners in exchange for a discounted price to be able to purchase gold over time. I'm wondering. I like the move because I think it can give them capital that they can use to invest without having to take on more debt, without having to dip into their existing capital resources. I like this move, and I'm interested to see if we don't see more of these happen in the coming years in these big plays.
Sciple: Yeah, it makes a lot of sense. Another thing to think about from that perspective, too, is that it locks up a long-term contract for them. If we see a little bit of a downturn in the oil market, they still have this contract in place to continue supplying that customer.
We've talked a lot about the frac sand industry. For investors who might be interested in this space, what are the two or three important points, things that they should watch over the coming, as you mentioned, 18 to 20 months? what are the things investors should look at -- if you see this happen, maybe think about stepping into the space; if you're in the space already and you see this happen, maybe you should step away. What are the important things investors should be watching?
Hall: The first thing to remember is that if you are investing in either of these companies, you're making a bullish bet that oil prices will remain at least high enough that development in these big shale plays is going to continue to occur. You have to count on that, No. 1. If you're not bullish over the long-term for that, that's probably not a space you should necessarily consider investing in.
You have to acknowledge that, because of the nature of oilfield suppliers, when things do get a little bit squirrely, they're the first ones that investors run from. They're the first ones that take a little bit of a hit. These are going to be very volatile investments. What you have to do is, you can't get too caught up in watching the daily movement of oil prices, because that's going to drive the wheel from a daily price movement perspective. You have to focus on what's actually going on in the industry. If oil goes up or down 0.5% or 1%, and it moves these oil stocks, figure out what's going on. Why is that happening? Think about the longer-term themes. If there continues to be investment in the area, they're developing wells, the pipelines are continuing to be developed, then the underlying thesis behind the company remains strong.
You also have to look at their cost advantages. As long as these continue to be the big players and key suppliers, I don't think you really have to worry about small mom and pops undercutting their business, because of the scale that these companies have.
Really, it's a long-term bet on continued development of these big shale plays. That's really what it boils down to.
Sciple: Exactly, Jason. If the Permian turns out to be what it's been promised to be, if it's going to make the United States the largest oil producer in world, these frac sand providers are going to be a significant part of the growth of that industry. Something for investors to watch.
I really enjoyed talking to you today, Jason! I'm looking forward to having you on the show later on this year!
Hall: You too! Sounds great! It was a lot of fun! Let's do it 100X more!
Sciple: Let's do it! As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Today's show was produced by Austin Morgan. For Jason Hall, I'm Nick Sciple. Thanks for listening and Fool on!
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