Halliburton Warns On Higher Fracking Costs

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Oilfield services provider Halliburton (NYSE:HAL) warned that its margins would continue to drop in Q2 because of higher pricing of a key raw material used in fracking fluid. [1] The company expects its operating margins for the quarter to slide down by 5% because of the shortage of gaur – a legume that is mostly sourced from India. While the shortage is expected to ease by next year, higher prices for gaur currently account for up to 30% of the price for fracking. The latest hit comes after Halliburton saw margins drop in Q1 after explorers shifted focus from pure gas to oil rich plays to offset the impact of low natural gas prices in the U.S.

We have a $42.93 price estimate for Halliburton, which is at a 50% premium to its current market price.

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Price hit

Gaur gum is a key ingredient in fracking fluid used in the hydraulic fracturing process that cracks open shale rock to stimulate the flow of gas to the well head. A shortage of gaur has resulted in a jump in the legume price, increasing the cost of conducting fracturing operations. Halliburton is looking to pass some of the cost increases to its customers, but the rapid increase in prices will dent its operating margins.

Although the shortage is expected to ease by next year, prices are rising because of an anticipated shortage later in 2012. In its Q1 conference call, Halliburton had expressed confidence that it would be in a better position to tackle a shortage of the raw material than its competitors because of its long-term contracts.

Haliburton’s margins in North America took a hit in Q1 because of the industry shift toward oil rich plays. The concentration of industry capacity in oil rich plays is putting downward pressure on the pricing of pressure pumping services in the region. A 7-8% drop in its EBITDA margin for 2012 could result in a 3-4% downside to our price estimate for the stock.

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Notes:
  1. Halliburton Warns of Lower Profit Margins, NYT []