Aris Water Solutions: Pioneering Sustainable Water Management In The Oil And Gas Industry

seekingalpha05-02

Aris Water Solutions is a leader in water management for oil and gas operators in the Permian Basin, offering full-cycle water handling and recycling solutions.The fracking process used in the oil ...

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Management In The Oil And Gas Industry\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-05-02 18:13 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4688388-aris-water-solutions-pioneering-sustainable-water-management-in-the-oil-and-gas-industry><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Aris Water Solutions is a leader in water management for oil and gas operators in the Permian Basin, offering full-cycle water handling and recycling solutions.The fracking process used in the oil ...</p>\n\n<a href=\"https://seekingalpha.com/article/4688388-aris-water-solutions-pioneering-sustainable-water-management-in-the-oil-and-gas-industry\">Source 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amount of water, and Aris helps reduce the industry's carbon footprint by managing and recycling water.ARIS has a unique infrastructure and strategic location in the Permian Basin, with long-term contracts and innovative approaches to water recycling, positioning the company as a leader in sustainable energy operations.We initiate with a Buy rating and a TP of $17.5 representing a 26% potential upside.Abstract Aerial Art/DigitalVision via Getty Images We recently initiated coverage on Atlas Energy Solutions (AESI), a leading proppant producer, with a BUY rating. AESI products play a key role in the energy industry by facilitating the extraction of oil and gas through the fracking process. In this article, we explore another company closely tied to AESI's operations: Aris Water Solutions (NYSE:ARIS). Company Presentation Founded in 2015 and headquartered in Houston, Texas, ARIS is the leader in water management for oil & gas operators within the Permian Basin. With its infrastructure, the group has one goal: to help its customers to reduce their carbon footprints. Focused on sustainability, ARIS is offering full-cycle water handling and recycling solutions. To fulfill its mission, the company has important infrastructures with integrated pipelines producing, recycling, and supplying water. The Water Recycling Challenge for the Oil Industry The Oil & Natural Gas production boom in the U.S. is linked to the use of a process called hydraulic fracturing, also known as \"Fracking\". According to the Independent Petroleum Association of America: More than 1.7 million U.S. wells have been completed using the fracking process. We already explained this process in our article on AESI, and we invite you to have a look at it. Just a little reminder, fracking is an oil & gas extraction technique involving the fracturing of rock below the surface through the injection of high-pressure fluids. The fluids are mainly made of water and sand. However, despite its efficiency, this technique implies the use of a very large amount of water. According to the American Geoscience Institute: Water use per well can be anywhere from about 1.5 million gallons to about 16 million gallons. As U.S. energy dominance continues to expand, more and more water is needed. As shown in this particularly interesting article from the New York Times Magazine, since 2012, water consumption per frack has been multiplied by 7. This implies more than 15 million gallons of water per frack in the U.S. FracFocus Water has become one of the most crucial elements for energy companies. It can be used for fracking, but also for cooling and refining processes. As such, the major oil and gas companies are using and will continue to use more and more water. FracFocus Moreover, the oil industry is witnessing a massive surge in large-scale projects, particularly in Texas, where \"Monster Fracks\" are becoming the new norm. These mammoth undertakings, which each demand over 16.8 million gallons of water, now account for nearly 60% of all fracking-related projects. This growing dominance of Monster Fracks signals a shift towards ever-larger, resource-intensive operations, underscoring the magnitude of water consumption in modern energy production. FracFocus Despite this growing use, fracking techniques come with its lot of consequences for the environment, especially regarding the impact it can have on water. Many companies are using \"Flowback\" aqueous solutions. With these types of solutions, a volume close to 20-40% of the water injected into the well can flow back to the surface. This generally occurs 3-4 weeks after the water has been injected. Fracking not only uses a great amount of fresh water, it might also contaminate it. To point out the massive amount of water that is needed, we wanted to show you how many barrels of water are necessary to produce one barrel of Oil. That's astonishing. Company Presentation In 2021, for one barrel of oil, it was needed to use the equivalent of 4 barrels of water. It highlights, in our view, the crucial role of water within this industry. As the use of water and sustainability are becoming more and more important, we believe that ARIS has a major role to play. After having all these elements in mind, let's dive into what makes ARIS so unique: Revolutionizing Water Management in the Oil & Gas Industry: Deep dive into ARIS Business A Unique Process We believe that ARIS is a particularly interesting name. By being completely integrated, ARIS is the only company that can provide a full-cycle water handling and recycling service. In our opinion, this capacity answers perfectly the challenge encountered by oil & gas exploitation companies, within the Permian Basin. Historically, oil companies tended to extract water from the ground. Then it used this water after mixing it with sand and chemicals to create an aqueous solution employed for fracking. In the end, water would come back to the surface with oil and gas while being potentially contaminated. Here's a graph to give you a representation of the process: NewYork Times Magazine Thanks to players like ARIS, the way water is being used within the oil industry is being revolutionized. With ARIS, the water cycle looks like this: Company Presentation With its unique infrastructure and years of know-how, more than 35 oil & gas companies are trusting and benefiting from ARIS's full-cycle water management solution. As these customers engage in oil and gas extraction from both existing and newly completed wells, ARIS will gather the water produced from these wells via pipelines. The gathered water then goes through handling, treatment, and recycling processes. Depending on the quality of the water, it will be treated and recycled or disposed of. The firm revenues are divided in two segments: - Produced Water Handling: Linked to gathering, transporting, and, unless recycled, handling produced water generated from oil & gas production. This segment represents 76.5% of revenues. - Water Solution business: Including the sale of recycled water and groundwater for well completions. It represents 23.5% of revenues. It is important to note that several energy leaders trust ARIS which shows the quality of the firm. The group is working with giants like ConocoPhillips (COP), Occidental Petroleum Corporation (OXY), Exxon Mobil Corporation (XOM), Marathon Oil Corporation (MRO) and Chevron Corporation (CVX). However, ARIS revenues are very concentrated as shown by its recent Q4 print where 4 players represented almost 80% of the firm's revenues. Company Presentation Even if the group has a concentrated client base, it is working with customers of quality. As a matter of fact, as of 2021, ARIS top three top three customers accounted for approximately 30% of Northern Delaware oil production and approximately 20% of total Delaware and Midland production. A Perfect Location and a Unique Infrastructure ARIS process is unique. We believe that the firm has two key advantages: its advanced infrastructure, and its strategic location in the Permian Basin, a region renowned for its prolific crude oil and natural gas production. This basin, spanning over 75,000 square miles across West Texas and New Mexico, is the most important U.S. hub of drilling activity and oil production. That's why it offers, in our opinion, significant advantages to operators like ARIS. According to the U.S. Energy Information Administration: In 2021, the Permian Basin accounted for about 43% of U.S. crude oil production and 17% of U.S. natural gas production Note that, the Midland and Delaware sub-basins offer among the lowest breakeven oil prices in the country, further reinforcing the Permian's status as a leading basin. Rystad Energy, Wells Fargo Securities The firm's assets are situated in core areas with some of the highest returns on unconventional plays in the United States, making them integral to ARIS's customers' long-term development plans. The company's robust infrastructure, comprising over 745 miles of pipelines, 48 water handling facilities, and 10 high-capacity recycling facilities, allows for large-scale water management, serving multiple operators simultaneously. We believe that this kind of infrastructure creates substantial barriers to entry for competitors, offering a unique blend of scale, sustainability, and strategic positioning. Company Presentation A Contract Structure Ensuring Revenue Stability and Sustainable Growth To secure cash flow and support its sustainable growth, the firm has long-term contracts with its clients. These long-term contracts are appreciable as they give some visibility on the firm revenue while allowing the projection of new investment and maintenance projects. In this sense, ARIS has two types of contracts with its clients, which are usually long-term arrangements. All produced water transported through gathering pipeline infrastructure for handling or recycling is subject to fee-based contracts, typically adjusted annually based on the Consumer Price Index. These two types of contracts are: - Acreage Dedications: through this type of contract, all water produced from current and future wells that ARIS clients own and operate is stored in a dedicated area of the firm system. This kind of contract represented 83% of the firm's revenues for the last quarter. - Minimum Value Contracts (MVC): through this type of contract, ARIS customer's MVC contracts ensure that customers either deliver a minimum daily volume of produced water to our pipeline network at an agreed fee or pay a deficiency fee if they fail to meet the daily volume for a specified period. The kind of contracts represented 14% of the revenues for the last quarter. The remaining 3% were related to spot transactions. Company Presentation Thanks to its wise contract negotiation, ARIS contracts have an average remaining life of 7.8 years. This represents more than 625,000 acres. In our view, the quality of ARIS's client base and the way its revenues are generated through long-term contracts offer substantial visibility into future revenue streams, supporting prudent and organic growth of the firm operations. Pioneering Sustainable Water Management and Innovative Solutions We think that ARIS is standing out as a unique player capable of leading the way in sustainable water management. By recycling and managing water through its proprietary pipeline network, ARIS reduces the carbon and water footprint of its clients while achieving significant economic and environmental benefits. We believe this is especially important in a world that is increasingly aware of the challenges posed by oil and gas exploitation. This approach not only eliminates the need for trucks but also helps operators achieve their sustainability goals, making ARIS a crucial partner in the energy sector. According to elements found in ARIS Form S-1: In the six months ending June 30, 2021, and the year ending December 31, 2020, ARIS eliminated around 1.0 million and 1.8 million truck trips, respectively, avoiding approximately 89,000 and 160,000 metric tons of carbon dioxide equivalent emissions. Another interesting element to consider, ARIS collaborates with scientists and universities to innovate and identify technologies for the beneficial reuse of produced water. In partnership with the U.S. Department of Energy and the New Mexico Produced Water Research Consortium, ARIS is advancing initiatives related to water management and beneficial reuse, including irrigation, aquifer recharge, and carbon sequestration through direct air capture. Additionally, ARIS is pursuing multiple opportunities, including a successful desalination pilot with ConocoPhillips, Chevron, and ExxonMobil, treating water to a high standard suitable for various uses. The pilot will conclude by the third quarter of 2024 and we look forward to it! Finally, Aris's project with the Department of Energy, in collaboration with Texas A&M's AgriLife Center and New Mexico State University, is studying the impact of treated water on crop growth and its ability to sequester carbon in crops and soil. ARIS is also testing membrane desalination technologies with the National Alliance for Water Innovation. We believe that all these imitative could lead to the generations of new revenue streams related to mineral extraction. You can find below minerals on which ARIS is working: Company Presentation Financial Analysis and Valuation We first identified 4 peers operating in the Midstream Gathering & Processing industry, we then compared them to ARIS. Bloomberg When looking at the data, it is clear that the company, despite its important infrastructure, has a stronger balance sheet. It is characterized by a short-term liquidity that is comparable but a healthier long-term ratio, with a leverage of only 2.6 versus an average of 4 for its peers. DCF Model As the use of water is becoming more and more important, we expect an average top-line growth of 6% for the upcoming 5 years. These expectations are based on The American Oil & Gas reporter forecasts showed below: American Oil & Gas Reporter You can see that from 2023 to 2028, demand should increase from 18 MM barrels per day to 23 MM barrels per day. Following the company guidance that can be found on ARIS fourth quarter and full year 2023 presentation, we expect operating margins and EBITDA improvements thanks to electrification initiatives, cost-out initiatives, and revenue escalation clauses contained in long-term contracts. We expect the firm's leverage to remain close to x2.5. Company Presentation We also expect a 40% reduction in Capex for the year 2024 combined with stabilization for the upcoming years. Company Presentation By incorporating these assumptions within our models, we then forecasted FCF and proceeded to our DCF, where we expect a FCF Growth of 22% for the 5 upcoming years. We used a perpetual growth rate of 3% and a WACC of 8.69%. Bloomberg, Author Combining all these elements, we reach, with our DCF Model, a target Price of $17.14 representing a 22.4% upside. Peers' analysis Using the comparable approach, we see that ARIS trades at a significant discount when taking into account the P/E ratio method and also the EV/EBITDA multiples method. The PE ratio method could imply a 15% upside, while the EV/EBITDA approach could imply a 45.73% upside. Bloomberg, Author We decided to attribute a 50% Weight to our DCF and a 25% - 25% weight to our PE and EV/EBITDA analysis. These elements lead to a 26% upside and a Target Price of $17.5 Our Expectations for Q1 2024 ARIS is set to unveil its Q1 2024 report on May 8th, drawing focus to key metrics of interest. We anticipate margin enhancements stemming from electrification initiatives and cost-saving measures, alongside nearly 6% growth in top-line revenue and a significant decrease in capital expenditures. These factors stand out as pivotal elements for consideration, and we will follow them carefully. Refer to the table below for a detailed breakdown of our expectations. Bloomberg, Author Risks Even though ARIS looks like an attractive opportunity, we believe that several risks are to consider: ARIS's revenues are highly concentrated among a few key clients, making it vulnerable to disruptions in business relations, financial stability, or strategic shifts from these clients. Secondly, the company's success hinges on the efficient management of water resources, including recycling and handling services, which could face operational disruptions, environmental incidents, or technological challenges. Additionally, one of the most important risks to consider in our opinion is ARIS susceptibility to industry cyclicality and macroeconomic factors that could influence oil and gas companies' investments, directly impacting water consumption for fracking and other processes. Even if this risk is reduced by ARIS's long-term contract structure, it is still a factor to consider. Evolving regulatory pressures that may tighten water management laws or restrict fracking practices, increasing operational costs, and limiting market opportunities are also to consider. Finally, technological competition, inflationary forces, interest rate changes, and supply chain disruptions could increase operational costs and reduce client demand, affecting ARIS's financial health and revenue growth. Conclusion We believe that ARIS plays a pivotal role in the oil and gas industry, offering comprehensive water management solutions that address both environmental and economic concerns. Its integrated infrastructure and recycling capabilities provide essential support to industry players, enabling them to meet sustainability goals while managing water resources efficiently. ARIS's strategic location in the Permian Basin, coupled with long-term contracts and innovative approaches to water recycling, positions the company as a leader in sustainable energy operations.  Despite facing potential challenges such as regulatory pressures, technological competition, and client concentration, ARIS has demonstrated resilience through its strong balance sheet, extensive infrastructure, and ability to secure revenue streams. The company's ongoing collaborations with scientists, universities, and industry leaders, along with its desalination pilots and potential for new revenue streams from mineral extraction, reinforce its unique position in the market and could lead to many more opportunities in the future. With sustainable growth strategies and prudent financial management, we have the conviction that ARIS stands to benefit from the growing importance of water in the energy sector. 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