- · TETRA Technologies, Inc. is undervalued in the current market weakness.
- · In this article, we will discuss just one lever the company has to pull in the Water and Flowback services segment.
- · We think TTI stock remains a buy at current levels subject to individual risk tolerance.
Introduction
TETRA Technologies, Inc.$Tetra(TTI)$ (NYSE:TTI) has a number of levers to pull in the OFS space that promote sustained and growing revenues and margins based on technology and service. We think the true value TTI brings to clients is not yet fully appreciated by the market in the current softness in oil-related equities.
The company's Water and Flowback Services segment is engaged in a rapidly growing business managing key aspects of surface water for oil companies. This service primarily takes on two aspects. The cleanup flowback of water and sand from recently fracked wells, and produced water from existing wells. This amounts to an addressable market in the billions of barrels annually from the Permian basin alone.
We think this under-valuation is a temporary situation, and the market will begin to rerate TTI's shares higher as oil prices stabilize this fall. We rate the company a BUY at current prices, subject to individual investor risk tolerance.
The thesis for SandStorm
It hasn't been that long since my last article on Tetra Technologies, but I think the market will soon begin to appreciate what a diverse opportunity they present. TTI is has remained about the same price wise since I last proposed them to you in August.
The "lever" we will be discussing today is sand separation using Tetra's proprietary SandStorm technology. Customer reception and demand for this equipment has been uniformly positive and on the increase. In a trip to the Tetra shop in Midland where these units are configured and redressed for the field, it was noteworthy to see the lack of equipment in the yard. This usually means that it's busy out on location and earning high margin revenue for the company. The Tetra shop supervisor commented that (paraphrasing)-
Once these left the shop it was rare for them to come back in less than a couple of months, and often as initial flowback turns into production this application continues and can extend the rental period over a year.
Rentals are the holy grail of the oilfield. Oil companies learned decades ago they weren't good stewards of periodically used pieces of equipment, and that it was better to rent rather than own them. This concept is literally the foundation upon which the oilfield service industry is built. Rentals often drive sales of consumables, pay out quickly- especially in times like these, and if built and maintained properly, last far beyond their actuarial life.
Now, let's look at the SandStorm opportunity which consists of the initial flowback of an individual well, and its later production over the course of its life.
Oil and gas reservoirs and sand
Class is in session on oil and gas reservoirs. If you've read much of my work - and you should read everything I write (a couple of times. Because, it's just that good!), you know that the mechanics of oil production are an interest of mine.
There are two maxims of oil production that don't get much attention-
- · All oil reservoirs will eventually produce water.
- · All oil reservoirs will eventually produce sand.
We will talk about the impact of water at a future time. Today we are going to look at sand production and how Tetra's approach to mitigating it can have broad appeal to E&P clients.
The thesis for SandStorm lies partly in the initial flowback and "unloading" of the well, and partly-longer term, to ensure that the sand that inevitably flows back with oil and gas production,is removed from the fluid stream. Here's a quote from one of the Tetra execs that guided us (a group of investors) on this field visit.
The SandStorm can reduce the risk of damage surface production equipment and prevent delayed production by removing flowback sand upstream of their test separators, production manifolds and piping systems.
Unlike, conventional sand separators the SandStorm is engineered to generate calculated centrifugal forces that separate the targeted particle sizes from the flow stream. It can capture the higher volume of finer sands that are more commonly used in hydraulic fracturing operations today. The industry’s transition to in-basin sands and the increased volume of sand being pumped per frac stage have driven the need for the SandStorm technology.
Look at the language used in this quote. "Removing risk," and "preventing delayed production from damage to surface equipment." This matters to oil companies hugely in these times of supply chain disruptions and high pricing for oil. Not taking anything anyway from the company's sales and management folks (who are among the most intensely motivated and dedicated folks I've run into in my 42 years of experience),but this stuff isn't hard to sell.
Now let's look at the fracking process
Let's start out by reviewing the fracking process that installs a series of vertical lenses at right angles to the bedding planes of the sediments comprising the reservoir. The objective is to place a permeable pathway back to the bore hole for oil and gas, and the water that accompanies it. Let's understand, these wells almost always make water along with the oil and gas. As the well ages, more water is made in relation to the oil and gas and eventually the well is no longer economic, and it gets a shot of 16# Class-H cement and a couple of abandonment plugs. Its job is then done, hopefully never to be heard from again.
Once the well is drilled to measured depth, the fracking process begins. Casing that will provide strength and isolation to the well bore, is run and cemented. Then a "gun" assembly is run on wireline to perforate the steel casing, and cement annuli, providing a pathway into the reservoir for the sand and water that will follow. This begins a series of "stages" where a section of the reservoir is "perfed", then with the drill string removed, sand carried by water (mostly) is pumped at a pressure above the fracture gradient of the rock at high rates. The initial stage is isolated with a drillable plug-(made of composite materials and in some cases may be soluble), and the process is repeated back toward the heel of the well. Over a length of a couple of miles the stages can run into the hundreds. Acoiled tubing unit is then mobilized to drill out the plugs and the loose sand that remains.
It is now time to begin the Flowback process. Water mixed with loose frac sand in the well bore begins to flow back as the well unloads, and must be separated at the surface. The SandStorm equipment you see in the pic below, (supplied by Tetra) is designed to removed friable particulates from the flowback fluids stream. These use centrifugal forces to separate and drop heavy sand and plug parts into the bottom chamber of the units you see below. Each of these individual SandStorms can hold about 500# of solids, giving it an extended "run" time before cleaning out. Water goes to holding tanks for further clarification. As I said, we will discuss water recycling in a future article.
Ok drill crew, if I haven't bored you so far...we're fixing to getnerdy. The use of physics and centrifugal/centripetal forces in the oilfield is as old as the oilfield itself. Entrained solids have been a problem that dates back to Colonel Drake. From vibratory equipment called shakers, the more advanced of which use elliptical motion in conjunction with screens to help separate solids by size and specific gravity, tohorizontal centrifuges, to desanders anddesilters, unwanted solids-more types than I am going to try and recount here, have used these principles to remove them from the fluid stream. If you follow the links you will see representations of these types of equipment, most of which rely on the same principles of physics that SandStorm does. SandStorm does it better as noted above.
So, Tetra didn't discover the concept of centrifugal forces, that was an outgrowth of some work done a few hundred years ago by a deep thinker known as Isaac Newton.Maybe you've heard of him? What they have done, is take these existing concepts and make them better and more efficient. The equipment is modular, meaning it can be run as a standalone or in a series as you see above, and containsreplaceable internal components that start the solids separation process. These are sales items that are charged to clients.
SandStorm provides real and meaning value to clients, and is step-change improvement over prior technology in this space.
A word about the market size
For simplicity's sake we will just talk about the Permian basin. It is half of U.S. shale production, so it's a valid yardstick. The volumes of flowback and produced water that must be dealt with in this basin arestaggering. In the billions of barrels-yes I saidbarrels annually, not gallons. Consider there are approximately 8K new wells completed in the Permian annually, that join an approximate 40K wells already on production. If these wells are making a 500 bbls of water a day, that's 10.2 bn barrels a year! (Simple math, right? I could be (probably am) off 10-20% either way. Whichever...it is a huge freaking number.)
TTI doesn't breakout the SandStorm revenue from its Water and Flowback Service Segment, but notes segment revenue growth QoQ of about 10% to ~$65 mm. So revenue is improving nicely. If we assume further increases, and remember this segment has a long tail in produced water reclamation that is not directly linked to the rig count, revenues could top $80 mm per Qtr by YE 2022. For Q-2 TTI reports adjusted EBITDA of $8.2 mm, or $32 mm on a run rate basis. Factor in the revenue growth and EBITDA could hit $9-10 mm for Q-4, 2022, or $38-40 mm for the year run rate. If you assign a modest multiple to that of 7 you have a $280 mm business, slightly more than half TTI's current valuation. In 2023 with the growth factors in place we could see continued expansion in the top and bottom lines that would swell the valuation of the business toward $350 mm. In short there is underlying value in the TTI pso that is not yet reflected in the stock price.
Here are management's comments about the SandStorm technology from the quarterly report.
We continue to add TETRA SandStormTM (“SandStorm”) units to United States onshore markets at rates approaching pre-pandemic pricing. We continue to see strong utilization for our SandStorm technology and continue to invest additional capital for new units as activity remains strong.During the quarter, we secured a patent on this unique sand filtration technology. Our focus on produced water treatment and recycling continues to generate results with four new recycling projects added during the second quarter.
Revenue growth was a result of the continued increase in the number of integrated projects and customers, high utilization of SandStorm units and market share gains with private oil and gas operators.
Risks
TTI is still considered an OFS co primarily, and rightly so. In that scenario it is certainly susceptible to the slings and arrows of outrageous fortune. Outrageous fortune seems to be dogging us right now, but I think better days are ahead as you know. Nevertheless, any change to our general thesis for oil could hamper TTI's growth, and the share price accordingly.
Your takeaway
The revenue stream from Water Treatment and from Sandstorm in particular is not directly linked to the rig count. The days of disposing of water down wells are coming to an end. Seismic activity in the Permian is on the increase and change must come. Water is not an inexhaustible resource. The Permian is a desert. It gets about 10" of rainfall (usually all at once) per annum. Fracking uses millions of gallons per well. Recycling is the only answer to this equation.
Tetra's unique an innovative approach to this problem has brought client accolades as savings have become apparent. One TTI exec commented to me during our trip-
Our customers have recognized cost savings of $10,000 or more as the result of the SandStorm’s ability to reduce the amount of abrasive particles it captures before the flowback stream reached their production facility. They are also benefiting by an additional savings of as much, as, $5,000 from damage to the flowback equipment after a well pad is completed.
I think TTI remains a buy at current levels. The company rose sharply toward $4.50 early this month before being dragged down with present market worries. I think the overall story is still intact for $100 WTI as we exit 2022, and soon we will see this company resume its upward price trajectory.
Analysts are bullish on the company at present prices. One analyst has just raised his estimate to $9.00. The low side is $6.00, and the average is $7.00. In my article on thelithium potential at TTI, I came up with a stock price in the $8's, so I'll stick with that. The bottom line is growth is not yet priced into the stock, and I expect that to change when the true oil supply situation becomes better understood.
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