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The ‘Holy Grail’ Business Model for Water

Last week we discussed why water is one of the industry’s biggest threats… AND one of investors’ biggest opportunities.

To illustrate the problem, consider that well over 90% of the U.S. onshore produced water generated by the oil and gas industry is disposed into an Underground Injection well (UIC)/salt water disposal (SWD) well.

Only 5% is disposed of through either evaporation, pits or regular public-owned facilities. Almost ZERO is recycled right now.

It’s clear to me in speaking with water company executives that their customer base, the producers, truly want to be green—and not just because it’s good for business. But everyone also says it has to make sense economically to recycle and re-use that water.

And when it comes to trucking out water to disposal wells or recycling at the well site, Jonathan Hoopes, President of GreenHunter Energy Inc. (GRH-AMEX), says it will come down to simple economics:

“It will be the lowest cost option that wins.”

Dennis Danzik of Ridgeline Energy Services (RLE-TSXv; RGDEF-OTCQX) agrees, saying that cost pressures in the US are intense. “Most of the companies entering the water sector have unreasonable pricing expectations.”

I think there will be regulatory and public pressure for producers to recycle more water. That will potentially be a HUGE market that somebody—or somebodies—is going to fill. But the low cost technology isn’t in the market…yet.

GreenHunter and Heckmann Corp (HEK-NYSE) — another pure play in the fast-growing water market — have more diversified water management systems, vs. more niche lines like Ridgeline. When I look at their financials I see EBITDA margins ranging from 15%-30%. (The niche players have bigger margins.)

But the water treatment business model could be more exciting, as it will likely be based on throughput—customers will get charged so much per litre, gallon or barrel of water put through whatever recycling system is used.

With tens of billions of barrels of water being used, that could be the Holy Grail of the water sub-sector — a per gallon charge.

The reality is, however, that the growth in drilling in the major US shale plays is way ahead of how fast the water recycling/treatment industry can hope to develop. So the simple (but highly regulated) disposal of water through UICs/SWDs will be here for a long time.

Danzik adds that each oil and gas basin in North America has different needs; so solutions will obviously be different.

“Pennsylvania has water but no place to put it; Texas has no water but can dispose of it.”

“In the Marcellus, they’re in trouble, and that will increase as summer gets closer. In the North-east you have a real problem with disposal. The salt water disposal has been moved west; it has to be disposed of in western Ohio and Indiana and Virginia. They’re putting it in pits. They have to do something.”

“They (the producers) will have to pay full price per truckload, as much as $5,000 to $6,000. That will be the disposal charge. That will equal hundreds of millions of dollars.”

Again, that will be music to the ears of one lucky service provider in the new water sector… and their investors.

Longer term, Danzik sees the trucking industry as the most vulnerable to the changes happening in the fast growing water industry, as well-site water treatment increases market share (that’s his business, remember ;-)).

It’s a variable, high-cost service, and local residents don’t like the traffic or the sight of literally hundreds of trucks delivering water tanks and water around their area.

Hauling or recycling water, storing or disposing of it—Hoopes says that the water business is growing so fast that for awhile, everybody in the space should be a winner.

“Everybody’s market share is a small percentage; this is not a winner take all scenario yet. It’s too early. We’re all taking water management systems to a more mature status. I think there is a lot of potential to grow market share before we start butting heads too hard.”

- Keith

Part 1: Water: The Next Great Investment in the Oil Patch

Part 2: The Multi-billion Dollar Water Services Industry

by +Keith Schaefer



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