Transitioning Fracking Fleet To Natural Gas Can Help Baker Hughes Improve Margins

Baker Hughes (NYSE:BHI), one of North America’s largest oilfield service firms, is converting part of its fleet of hydraulic fracturing pumps to accommodate both natural gas and diesel fuels. ^[1] The firm first began the project on a trial basis in Canada and successfully converted a fleet of “Rhino” frac pumps to bifuel. Now the firm plans to expand the program into the United States. The move is expected to cut costs and also reduce emissions.

Hydraulic fracturing involves injecting a mixture of fine sand, water and chemicals into shale rock formations that lie thousands of feet underground to create fractures or cracks in them and stimulate the flow of gas and oil. While hydraulic fracturing has helped America tap into its vast shale gas reserves, it has also received a bad rap from environmentalists on concerns that it emits harmful effluents and uses an excessive amount of water. While increasing the proportion of natural gas fuel over diesel in frac pumps will reduce emissions of carbon dioxide and particulate matter, it is unlikely to alleviate any of the other environmental  concerns of fracking.

How Will The Move Help Baker Hughes?

The pressure pumping business has been facing headwinds over the last year. First, a severe shortage and rising prices of guar gum, a raw material used as a binder in fracking fluids, negatively impacted profits industry-wide. More recently, the relatively low natural gas prices have prompted oil and gas companies to tap into liquids like shale oil over gas since they offer better prices and margins. Given that fracking for oil requires less capacity than gas, it has caused an oversupply of fracking equipment in the market and a decline in pricing power for oilfield service firms.

This has prompted firms like Baker Hughes to explore methods to reduce their costs. The frac pumps that are used to pressurize and inject the fracking fluid are particularly energy intensive. About 1.2 billion gallons of diesel are estimated to be used annually across the industry to power fracking pumps and a single fracturing  job can consume up to 7,800 gallons of diesel. ^[2] Substituting diesel (which costs as much as $5 per gallon in some areas) with cheaper natural gas could cut fuel costs and improve Baker Hughes’ EBITDA margins in North America. Baker Hughes estimates that bifuel pumps can reduce diesel usage by up to 65% without the loss of any hydraulic horsepower.

We believe that substituting diesel with natural gas could also have some other advantages. Logistics costs could be reduced as less diesel would need to be transported to fracking sites. Since the bifuel pumps are capable of running twice as long compared to those running on diesel, it could help reduce the idle time of fracking jobs. Given that gas engines typically run quieter with lower vibrations than diesel, it could potentially reduce maintenance costs as well.

We have a price estimate of about $53 for Baker Hughes, which represents a 30% upside from the current market price.

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1. Baker Hughes Press Release [↩]
2. Fracking cheaper if diesel ditched?, San Antonio Express News [↩]