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Tuesday, April 7, 2015

Investing in Water and Energy Insights with Jud Hill, Managing Partner at Blue Star Capital

Investing in Water and Energy Insights with Jud Hill, Managing Partner at Blue Star Capital

How Consolidation in the Fracking Industry is Creating Greater Efficiencies and Opportunities For Companies Treating Water

New York, NY - Point Roberts, WA – April 7, 2015 - and its water investment portal, issues an exclusive Q&A with Jud Hill, Managing Partner of Blue Star Capital, LLC.

Jud shares insight into some of the benefits in the recent drop in energy prices and how new efficiencies and opportunities have been created for service providers in the sector. His thought-provoking commentary provides a unique perspective and paints a more positive outcome for the relationship between energy and water for the future.


Jud, with your background in water and energy, you have insight into how boom and bust in the energy sector has impacted the opportunity for service providers in the water treatment business. First of all, can you tell us how the boom created such a high profile concern over water usage and treatment and how that built the opportunity?

A: Jud Hill, Managing Partner, Blue Star Capital, LLC.
The hydraulic fracturing for deep strata hydrocarbons (2 miles deep) has been around for many years.  It has only been in the last 5 to 7 years it has it gained dominance. Some 60 to 70 percent of the wells completed today are hydraulically fractured. Ironically, it is still referred to as unconventional horizontal drilling. A couple of points that are important to note about the relative usage of water in hydraulic fracturing. First - understanding the entire water value chain which considers the following: sourcing of fresh water, transporting or “provisioning” the water to the drilling pad, storing the water on-site in preparation for a frac, managing the return water coming back out of the well, post frac. This return water is referred to as flow-back, which is the water that comes back over 4 to 6 weeks post frac, followed by produced water which will last as long as the life of the well (twenty plus years potentially). The flow back and produced water then needs to be transported (by truck or pipeline) to an offsite location to be disposed of or recycled for reuse. Disposal is typically via a salt water disposal well (SWD) and recycle, albeit discussed at length, is a very small part of this water value chain…at least for the time being.

Each step of this value chain has a different price point depending on which shale formation you are operating in.  For example, in Texas (Permian and the Eagle Ford) where water is in short supply, fresh water is more expensive than disposal. In Pennsylvania (Marcellus) where water is prevalent, fresh water is much cheaper than transportation and disposal. Most importantly, the largest variable in this value chain pricing spectrum, almost independent of the shale formation, is the logistics or transportation costs. This is best demonstrated in Central Pennsylvania where SWD’s are currently illegal. The transportation costs can be as high as $15/bbl to haul the water to eastern Ohio to a permitted SWD. It is surprising that many of the Exploration and Production companies (E&P’s) don’t appreciate or manage the “all in” cost of water. There is a saying in the frac water business that the service provider that reduces the “windshield time” or hauling distance will win the customers’ business. In essence, frac water service is a logistics not a technology business.

As the public and government reacted to the sector, new regulations and rules also came into play. How did that impact the sector on both sides, from the energy companies to the service providers treating the water?

A: Jud Hill, Managing Partner, Blue Star Capital, LLC.
Public awareness and regulation are always important drivers in the water sector. The frequently unsaid reality is that industry doesn’t mind strong regulation. They want predictability (set a standard and don’t change it frequently) and consistently enforce the standards. A high regulatory bar keeps out the bad actors and on balance doesn’t affect the all in price of crude oil that much. Generally speaking, most of the experienced and well capitalized E&P players strive to be good stewards of the water supply and want to be seen as green/sustainable actors. The brand damage that comes from doing it wrong is far greater than the perceived savings of a few cents per barrel by trying to cut corners. Of course, treatment companies embrace strong regulation. Regulation is one of the under-pinning’s of ensuring that water is priced as a valued commodity and not a “free good” as some like to think.

What are some of the myths and misperceptions out there on the relationship with energy and water?

A: Jud Hill, Managing Partner, Blue Star Capital, LLC.
As mentioned in my previous answer and as crass as it may sound, behaviors are primarily driven by the pricing of the commodity, be it energy or water. Most folks know what they pay to heat and light their homes but many don’t know how much they pay for water. It is still very cheap. Furthermore, guess what the primary cost is in the pricing of water? - The cost of energy to move the water thru a pipeline.

Not a myth but a reality. More than 20% of California’s energy is used to move water around the state.

We all seem to know how much a gallon of gasoline cost at the pump…why? - Because it has a big impact on our disposable income. How much is a gallon of water that you draw from the faucet?  - Less than a penny.

Water and energy are inextricably tied. We now label it as the water/energy nexus.

Another misconception or unappreciated fact is that energy has many substitutes (e.g. oil, coal, nuclear, wind and solar).  Water has ZERO. The best example of perfect price inelasticity… without water, you will die (a need not a want) and, if need be, you will pay any price for it.

You recently told me in a phone interview how the recent drop in energy prices has created a new era of efficiency in the sector and how that has created an even better opportunity for the service providers. Can you run us through the cycle and where things stand today?

A: Jud Hill, Managing Partner, Blue Star Capital, LLC.
The water value chain I described previously has changed dramatically at $50 WTI
Three things are occurring:

  1. E&P drillers are shifting from exploratory drilling that allows them to “drill to hold” acreage which are new regions of a shale formation that are not well defined in terms of yield…at $100 bbl it can justify the risk…to what is referred to as “infield drilling” or drilling between proven wells where they own the reserves. This concentrates the water volumes into a smaller geographic area.
  2. The Moore’s law of fracking is at work….drillers are getting more efficient and better at drilling tighter frac patterns which translates to more wells per pad (3 or 5 moving to 10 to 15) causing a conservative increase of the amount of water used and produced by a factor of say three.
  3. And lastly, drillers are shifting from a “gel frac” formulation to what is called a “slick frac” approach. Gel fracs require about 75,000 bbls of water per frac where slick fracs require twice the amount of water - up to around 150,000 bbls per frac - a 2x multiplier for water.

So, assume the cumulative effect of these three drivers and you have dramatically changed the water value chain…increasing the water volumes in a smaller area of geography. Now it makes more economic sense to build a “hub and spoke” collection and treatment system. The spokes are a buried network of salt water gathering pipes (dramatically reducing the need for trucks…reducing windshield time…remember?) Everybody wins…the environment, road infrastructure, safety, public acceptance, greener and at around $2/bbl to transport the water, the E&P’s save lots of money. The hub is an SWD and potentially a recycling system to return clean salt water back to the drilling area with a sister return pipeline laid next to the collection pipe. Same set of savings apply to recycling by reducing the amount of fresh water required for the next set of fracs.

In closing , with analysts on both sides seeing energy prices going higher and lower in the year ahead, where do you see it headed and if prices rise will the new efficiencies in place be lost moving forward? Do you think the industry has learned to manage resources better and will hold on to that lesson?

A: Jud Hill, Managing Partner, Blue Star Capital, LLC.
I am not smart enough to predict where the price of oil is going, but as long as we price water as a valued resource - everybody will win.

Mr. Hill recently reestablished his management advisory firm with sector verticals to include energy, water environmental services, general industrial and life sciences. Particular expertise in the nexus between energy, water and agriculture. Advisory services range from M&A, capital structures (equity/mezz. and senior debt), and operations advisory including business strategies, markets and personnel optimization.

Has over 30 years of experience in both water and environmental service company operations as well as over a decade of private equity experience in the water industry. 
Prior experience includes serving as a Managing Director of NGP Energy Capital Management where he led the firm's efforts in sourcing, execution and monitoring of opportunities in the water and oil field services sectors.  Prior to NGP, Mr.Hill was a Managing Partner with Summit Global Management, Inc. where he was responsible for all private equity investments in the water sector. From 1999 to 2008, he served as a Managing Director of Aqua International Partners and then The Halifax Group, both affiliates of the Texas Pacific Group. Mr. Hill’s early career was with Atlantic Richfield and Westinghouse Electric Corporation where he held operating and executive roles in the environmental and water sectors.
Mr. Hill received a Bachelor of Science in Biology/Chemistry in 1977 from Edinboro State University and a Bachelor and Masters of Science in Environmental Engineering in 1979 from the University of Pittsburgh. He serves as a Trustee of the Water Keeper Alliance.

Currently serves on the Board Of Directors for Abtech Industries, Inc. and Greenstone Resource Holdings. Formerly served on the Board of Directors for Meineke Auto Care Centers, Soil safe Inc., North American Video Inc., Biotronic Systems Corp. and Westinghouse Bioanalytic Systems Corp.

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