Water is the often ignored main character of the oil and gas industry – its lifecycle components, from sourcing to disposal / reuse, increasingly critical across the value chain.

Sourcing - Location, Location, Location. The water sourcing puzzle in the oil and gas industry is governed predominately by geographical availability, and by definition, economical availability depending on the region of activity. Much like the highly publicized frac sand industry, water sourcing methods and sources are determined by regional competition and dynamics surrounding other industry water withdrawal needs, climate-driven factors, and public relations.

Transportation – E&P, midstream, or OFS? An array of models are being played with on the transportation side of the water business with a combination of ownership and service/infrastructure models employed. A bifurcation in business model and subsequent valuations is occurring in the water transportation space where water management providers with pipeline infrastructure and associated contracts are seeing valuation uplifts relative to legacy solutions that utilize trucking.

Disposal – the looming bottleneck. Bigger wells with larger water cuts are exacerbating the need for disposal infrastructure. Varying widely by basin, the number of SWDs and other disposal infrastructure means will need to be dramatically increased. Specifically in the Permian, 6.5 barrels of water are produced for every single barrel of oil – given lofty production goals in the basin, read: SWD investment.

Reuse – I’ll believe it when I see it. Unsubstantiated cost savings and lack of scale have kept reuse and recycling technologies on the sideline as an alternative to traditional disposal methods. Until a step change in technology is put forward with scale to service the needs of leading edge completions, reuse and recycling efforts will continue to supplement traditional methods on the fringes.

Sourcing Dynamics:

• Increasing well complexity: Deeper wells, longer laterals, and increased proppant intensity continue to enhance hydrocarbon recovery leading to an increase in water usage for completions operations.
• Freshwater vs. alternative sources: Substantial investments in treatment technology and infrastructure continue to evolve. Leading operators have started to use treated brackish water and recycled produced water for use in hydraulic fracturing completions, although not on a large scale.
• Basin dynamics: Water supply disparities exist across onshore basins, primarily influenced by geology, water withdrawals from agriculture, human activity, and climate-driven drought.

Transportation Dynamics:

• Opex vs. capex: Operators are evaluating cost-effective alternatives to hauling water via truck. Business models to invest, own, and operate water management infrastructure are being analyzed based on factors such as long term demand, distance, and leasehold coverage.
• Self build vs. 3rd party build: Self build initiatives allow full control of design and operation with no counterparty risk on contracts while third party buildouts are beneficial through specialization, economies of scale from shared assets, outsourcing risk, and minimal capital requirements.

Through 2022 water hauling as a percentage of the total water management market share is expected to decline, while pipeline infrastructure increases. This trend demonstrates operator adoption of pipeline and layflat infrastructure, reducing trucking’s influence on the supply chain and also pushes the industry towards a more midstream type model.

Source: IHS Markit, H2O Midstream. (1) Includes treatment, flowback, and pre-treatment.

Disposal Dynamics:

• Basin dynamics: Produced water volumes per well heavily fluctuate based on basin. Permian wells experience large volumes of produced water while wells in the Eagle Ford encounter significantly lower water cuts.
• Disposal demand: As Permian production is expected to rise by nearly 700,000 barrels per day through 2020, an anticipated 273 incremental saltwater disposal wells will need to be added each year to achieve the basin’s future production targets.

• OFS vs. midstream valuation: Oilfield waste management providers with contract secured scale (predominately through pipelines and long-term contracts) are transcending traditional OFS valuations and being viewed like midstream assets.

• Operator disposal considerations: E&P-owned and operated disposal may divert capital from drilling programs, although provides lower backend costs after the well is completed. Using a third-party vendor allows for a self-determined capital outlay and requires fewer employees.
• E&P divestitures: Producers are looking for ways to raise capital without selling prized, core producing assets. Disposal infrastructure divestitures have been an efficient way to redeploy capital into the core E&P business.

Possessing attractive underlying fundamentals, midstream oriented water lifecycle businesses receive higher valuations when compared to traditional OFS counterparts. While a portion of the valuation discrepancy is tied to the tax efficient MLP structure, some of the valuation difference is related to the fundamental business model of MLP qualifying assets.

Source: Digital H2O, EIA, TPH, Credit Suisse, investor presentations. Note: Produced water figure assumes an average water cut of 4:1.