This article was originally published by TheStreet on October 24, 2014
NEW YORK (TheStreet) -- Oil prices have tanked this month to multi-year lows, but if they bounce back, Emerge Energy Services (EMES) could be one of the master limited partnerships that would offer "the largest price appreciation," wrote Citigroup in an Oct. 15 research report led by Faisel Khan.
Emerge Energy runs two unrelated businesses: fracking sand production and fuel processing and distribution. The fracking sand is used as a proppant to keep hydraulic fracture open in shale oil and gas wells to ensure continuous flow of hydrocarbons. Besides Emerge Energy, this sand is also produced by U.S. Silica (SLCA) and Hi-Crush Partners (HCLP) .
Although Emerge Energy generates three times as much revenue from fuel processing and distribution as sand production, the latter has got investors excited. That is because the sand business is around 10 times more profitable than the fuels business in terms of operating margins. Further, triple-digit revenue growth in the sand business has dwarfed the 48% increase in revenue from the fuel business in the first six months of this year.
Emerge Energy's units have more than doubled since the beginning of the year on the back of strong demand of fracking sand, settling at $90.28 when the markets closed on Wednesday, despite the 20% drop over the last three months.
This demand for fracking sand, Citi's analysts noted, is "heavily dependent" on oil production, making Emerge Energy highly exposed to oil prices. Brent and West Texas Intermediate oil futures dropped by around 21% over the last three months, threatening to disrupt oil production and causing the pullback in Emerge Energy's units.
With Brent and WTI trading in the low $80s a barrel, the demand for fracking sand is still strong and there have been no indications of weakness in the future, said the spokesperson of a leading fracking sand producer in an email to TheStreet who has asked not to be identified, in accordance with the company policy.
Emerge Energy's projects the demand for proppants, which mainly includes fracking sand, will grow from around 60 million tons to less than 100 million tons for the four years ending 2016. Additionally, its peer U.S. Silica sees the demand tripling from the current levels through 2019, driven by increasing consumption of fracking sand for each well as drillers experiment with new techniques.
If WTI oil prices were to drop to $75 a barrel, and stay there for an extended period, then that could create problems for Emerge Energy. In another Oct. 14 report, Citigroup's head of commodities research Edward Morse, said such a drop could translate into "meaningful pullbacks" in shale oil and gas production. This can have a negative impact on the demand of fracking sand.
But on a positive note, Citi's Khan, Genco and Bhardwaj wrote that a bounce in oil prices, meaning Brent climbing to $95 a barrel, "is possible after we get through the refining maintenance season." The U.S. refineries usually scale back their operations in September and October for maintenance after the end of the summer driving season. This usually causes a drop in oil demand which weighs on oil prices.
The refineries gradually become fully operational to meet the increasing winter demand for heating oil, Citi noted, which can reflect positively on oil demand, lifting the commodity's prices.
Citi's Khan has also said that in addition to Emerge Energy that BreitBurn Energy (BBEP) ,KNOT Offshore (KNOP) , Legacy Reserves (LGCY) , Linn Energy (LINE) , LRR Energy (LRE) and QR Energy (QRE) could rise as the price of crude recovers.
