Select Energy Services, an oil-field service provider that specializes in pre- and post-fracturing water logistics, went public on April 20 and stands out as the lone pure play on this critical business. This lack of comparable publicly traded companies makes the stock a show-me story, much like Solaris Oilfield Infrastructure.
Last year, Select Energy Services’ water solutions accounted for almost 80 percent of the company’s revenue, with the remainder coming from oil-field accommodations and equipment rentals (9 percent) and well-completion and -construction services (11 percent). After completing the acquisition of Gregory Rock House Ranch and affiliated entities and assets in March 2017, the proportion of Select Energy Services’ revenue that comes from water logistics likely will increase.
Unlike Sell-rated Cypress Energy Partners LP (NYSE: CELP), which generates the bulk of its wastewater management revenue from disposal wells, about 76 percent of Select Energy Services’ 2016 water solutions revenue came from pre-fracturing services—mostly water delivery via truck or temporary and permanent pipelines. Services related to flowback and produced water accounted for the remaining 24 percent.
Select Energy Services has amassed an impressive inventory of water sources, securing permits or long-term rights to approximately 1.5 billion barrels of water annually from more than 350 sources.
This strategy has enabled the company to build an industry-leading position in the Bakken Shale, where the firm has governmental permits to withdraw up to 100 million barrels of fresh water per annum from the Missouri River and Lake Sakakawea. Select Energy Services operates two underground pipelines that can deliver up to 62 million barrels a year to producers in McKenzie County and plans to build a third pipe serving operators in Williams County and western Mountrail County. Long-term contracts support the development of the latter pipeline.
Select Energy Services also boasts a competitive advantage at its operations in the Eagle Ford Shale, thanks to the company’s superior inventory of water permits and rights.
Near-term results stand to benefit from the trend toward longer laterals that require larger volumes of water and stepped-up drilling and completion activity throughout the US onshore market.
This volumetric upside, coupled with a bit of a pricing recovery—management estimates that the company accepted discounts of 30 to 35 percent across its service lines relative to the 2014 peak—should set the stage for a rebound in operating cash flow, especially after aggressive cost-cutting during the down-cycle.
In addition to building a third pipeline in the Bakken Shale, management has also identified expansion projects in the revivified Haynesville Shale and the emerging SCOOP play in central Oklahoma.
But Select Energy Services still generates a significant chunk of its revenue and operating earnings from the Bakken Shale and Eagle Ford Shale—areas where activity levels could prove more sensitive to commodity prices and competition from plays that offer superior economics. The company also generates its best margins in the Bakken Shale and Eagle Ford Shale because of its exclusive supply agreements.
Meanwhile, the recently closed acquisition of Gregory Rock House Ranch and affiliated assets expanded Select Energy Services’ presence in the red-hot Permian Basin. This transaction gives the company the rights to an array of water sources and 900 miles of temporary and permanent pipeline infrastructure in the northern Delaware Basin.
This deal increases Select Energy Services’ leverage to accelerating drilling and completion activity in this area, though profit margins tend to be weaker because of the intense competition in this highly fractured market. Our trip to the DUG Permian Basin conference also underscored the extent to which water recycling could emerge as a critical solution in the region; Select Energy Services may need to build capabilities in this business over the long haul.
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Elliott and Roger on May. 25, 2022
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