Shale fracking has stood the world on its ear in the last decade. That's pretty well-known now. As a result, a number of service providers are going public to take advantage of the equity markets for business purposes.

In good times, which appear to be returning to the oil service business after a long hiatus, these companies tend to do well.

One thing we should never forget: oil is a cyclical business - meaning that it can experience extreme fluctuations between growth and decline. And when we are in growth phase, it is all too easy to forget about the downside of the curve. Expansion can get ahead of itself in this scenario.

In this article, I will opine on the cyclic nature of this business and focus on one new entrant, Liberty Oilfield Services (NYSE:LBRT ).

I hope fellow oilies will forgive me for bringing the shadow of Al G__e into this epistle. Whatever you may think of Big, "Green" Al, the lad had a way with words, and borrowing his now ubiquitous catchphrase for this section was just too tempting. I apologize if you have nightmares after reading this piece. I promise to make up for it by quoting Boone Pickens or Harold Hamm later in this article.

Oil service companies sometimes seem to follow a lemming-like approach to the markets they serve. To wit, if company A has a store in a certain area, company B will put one there too. Company C, seeing this concentration of competitors feels that it's missing out on what is obviously a great market (or maybe they just have great restaurants that cater to oilies in that area) and puts one there as well. Company D... well, you can guess where I am going with this train of thought. Most oil markets are over-supplied on a steady-state basis. Inconvenient truth #1.

(Source: C&J Energy Services site)

Let's focus on the Permian Basin, as that is the hottest shale play presently. Who's there? (In no particular order)

What that means is that when the market is rapidly expanding, as shale fracking did for the years prior to 2015, there is plenty of room for all comers. Some markets can wind up with a dozen companies (no, I am not exaggerating) all doing essentially the same thing. They make money and stay in business with incredible margins, as oil companies get desensitized to suppliers' prices when oil is going up.

The companies listed in the table above are just the fracking companies I could think of. I will guarantee you that there are at least another five or so "mom-and-pop" fracking companies serving this market that I couldn't track down. Many, as in the case of C&J Energy Services (CJ), have more than one store in this market. In the case of C&J, try fifteen locations in the Permian basin, as shown in the graphic from the company's website above!

Note to mom-and-pop frackers: If you read this and want to be included in updates to this article, please leave a comment to that effect in the comments section of this article or PM me.

When the worm turns (oilfield parlance for a reversal of fortune), it is not pretty. As growth levels off, plateaus, and then starts to decline, these companies can come crashing down faster than a TV preacher can talk Aunt Tillie out of her mattress money. As you can see, they drop like flies when the budgets start getting choked back.

Now, I do not mean to suggest for a minute that the situation in the Permian at present is anywhere near the blow-off silly top it was in the time frame represented in the graphic above. Far from it.

Drilling has returned to the Permian over the last year and a half, as the black line in the graphic below depicts. There is a decent market at this time.

My point is things can change rapidly (note the decline from late 2014 to mid-2016), and unlike in preschool, not everyone gets a chair when the music stops. Ok, I've either sold you on this point or not. I'll move the discussion along.

BTW, I haven't forgotten, I owe you one more inconvenient truth. Patience, please, it's coming.

The genesis for this article was stimulated by a couple of events that occurred in the last week or so. First was the news that Schlumberger (SLB) had bought the pressure pumping business and assets of Weatherford (WFT). This caught me a little off guard, to be honest. But after giving it some thought, it makes sense. Big Blue has always been weak in this low-cost, low-tech market. What better way to scoop up some market share and personnel (frack hands are highly sought after at present) and just ring the cash register?

The second thing the propelled the idea behind this story was an interview on CNBC Friday with Chris Wright, the president of Liberty Oilfield Services. He'd even brought a nice chunk of shale to the set for the show anchors to fuss over. Michelle Cabrusa-Carerra (who normally does her homework for interviews and is normally one of the best, and toughest, financial interviewers out there) was just gobsmacked that oil came out of this little ole piece of rock. Jeez Louise, do your homework, Michelle! Poor Chris was stuck in front of millions of people trying to explain fracking to her, while being interviewed himself by Brian Sullivan. That said, these two don't normally put on such a love fest, and Wright got off easy.

What struck me about this interview, other than Michelle's dumbfounded-ness that oil came out of solid-looking rock, was the amount of money Liberty had come away with - ~$200 million - and the IPO price for the stock, $17.00/share. It immediately rocketed up to a closing price of $21.82/share. Let's see how this stacks up against some companies that have been around for a while, some of which actually have earnings.

(Source: Data from SA, table by author)

It is not my intention to do a financial analysis of any of the companies in this table. But three things that pop out at me are:

Now, my stalwart readers know I am bit of an old headbanger. So the song title that comes to my mind as an investor when I see a table like that is...

So here is Inconvenient Truth #2. In times of stagnant or declining markets, big companies crush little companies. The Big Colors (SLB, Halliburton (HAL)) shift assets around the world, lay off everyone over 25 (I am exaggerating a bit here), and have the cash reserves and access to deep lines of credit to keep going through the tough times. The little guys just go bankrupt. Have doubts?

I am going to go out on a wee bit of limb and guess that about half the companies listed above were primarily in the shale fracking business. Do you see any Big Colors listed among them? Nope.

But I am willing to investigate a bit further before I head out for the hills. So let's look at what Liberty brings to the table.

Liberty is a pure play fracker. Rock cracking is what it does. Period.

Fellow author Steve Zachritz published a fairly detailed financial analysis of Liberty the other day, titled "Liberty Oilfield Services - Pump Up The Volume". I have no reason to dispute anything he said. I will limit my economic assessment of the company to a couple of points:

But overshadowing these two points in my assessment of Liberty's financial outlook, I would note that it is tied very closely to the improvement in the rig count seen in the EIA graphic above. I will have more to say about this later in this article.

If there was any doubt that the company is exclusively in the shale fracking business, this capture from its website should dispel it.

The chief long ball hitter with Liberty, and the thing that sets them apart from other participants in this business, is CEO Chris Wright himself. He is given credit on the Liberty website for basically creating the industry he now serves. Doing this at Pinnacle Technologies (now part of Halliburton), he developed the fracture mapping software that helps to interpret fracture mapping data. Booyah! A guy like this has stature in the industry and can open many doors for Liberty. Bullish.

From reviewing other senior management slots on their site, Wright has brought along the crew that helped make a success out of Pinnacle. So we will rate Liberty management as a strong team capable of bringing value to shareholders. Bullish.

More frack trucks are on the way. Currently at 19 active truck fleets with ~760K HHP, the company plans to increase it to 22 fleets ~1030 million HHP in 2018. If the revenue increases to support this capital expenditure, the stock price should move up. Bullish.

One of its innovations, and one that should command premium pricing, is Liberty's focus on noise control. I have worked on oil wells in urban settings, and I can tell you first hand that homeowners don't like the sound of oilfield activity while they are "bob-a-kewin". They will light up the oil company's phone lines with complaints. It's bad PR, and nowadays oil companies are sensitive to their public image (thank heavens!).

While I have a misty-eyed recollection of doing frack jobs and loving the sound the giant, 2,000-horsepower pumps make as they rev up to fracture the rock thousands of feet below the earth's surface, I am a sound junkie. Not everyone is. I like big noises, and I suppose that makes me a little weird. I will give you an extreme example of this addiction.

When I was in the USAF years ago, for recreation I would drive to the end of the runway at one of the B-52 bases where I was stationed and park my car while the Buffs (Big Ugly Fat Fellows) did takeoffs and landings. It is the most incredible sound experience you can have and live to tell about it. When the pilot hits full military thrust on his 8-Pratt and Whitney TF-33 engines, each capable of delivering over 17,000 pounds of thrust, 50 feet over your head... I do not have words to describe the sensation of power that runs through you. It's been 45 years since I last did this, and I remember it like it was yesterday. Ok, enough reminiscing.

This technology should have broad appeal to any company working in an urban, or near-urban, setting. Bullish.

I will let Liberty speak for itself here:

"Our customers primarily include major integrated and large independent oil and natural gas E&P companies. Our customer base includes a broad range of integrated and independent E&P companies, including some of the top E&P companies in our areas of operation such as Continental Resources, Inc., Devon Energy Corporation, Newfield Exploration Company, Noble Energy, Inc., PDC Energy, Inc. and Anadarko Petroleum Corporation. We have several customers, including Extraction Oil & Gas, Inc. and SM Energy Company, for whom we were the predominant provider of fracturing services in 2016, allowing us to maintain higher utilization and stronger financial results than many of our competitors during the recent downturn. For the nine months ended September 30, 2017 and the years ended December 31, 2016 and 2015, our top five customers collectively accounted for approximately 57.6%, 58.5% and 57.5% of our revenues, respectively. Extraction Oil & Gas, Inc. accounted for more than 10% of our revenues for the nine months ended September 30, 2017 and the years ended December 31, 2016 and 2015. For the year ended December 31, 2016, SM Energy Company and Noble Energy, Inc. each accounted for more than 10% of our revenues." (Source: Liberty S-1 Filing)

A couple of comments on my part about the company's client base:

If you are determined to be in this space, Liberty is a quality company that is very likely to do well as the oil price continues to march upward. I am neither recommending it nor steering you away. The main point of this article was to highlight the inherent risks in investing in small-cap oilfield service companies.

Just to be clear, Liberty is most definitely not a SWAN. It is a very speculative investment in a sub-segment of an industry that, while currently on an upswing due to improving market conditions, can plummet like a stone.

If you decide to invest in this company, I would wait for a pullback. It rose 23% above its opening price in one day when, coincidentally:

Anyway, I don't think you can come up with a better scenario for an oilfield IPO than that.

Patience is recommended here. Aunt Tillie, if you have any money the TV preacher didn't get, hang on to it just a little longer. K?

I hold the view that shale fracking is peaking. This comes from my knowledge of reservoir engineering fundamentals. It is a view shared by some other SA writers as well. Here are a few articles that discuss some of the emerging issues with shale frackers. "The Shale Party will end badly...", and another one, "Shale Oil Myths", and while we're having fun, one more, "Why The Shale Oil Miracle..."

If this view is even half right, there is going to be a shake-out not too far down the road for the service providers. Remember Inconvenient Truth #2. Big crushes little when the worm turns.

If you will permit one more data point that suggests to me the shale miracle is living on borrowed time: sand mines. Several companies are spending about a billion dollars in aggregate building new mines to supply the shale frackers. Hi-Crush Partners (HCLP), U.S. Silica (SLCA), and Fairmount Santrol (FMSA) are all jumping into the Permian, joining about 12 other companies already there.

This is the very definition of market exuberance, in my view, and usually defines the top of a market. I would extend my cautionary note to the sand suppliers as well. If fracking declines... well, you can only fill so many sand boxes at a time.

I promised you a quote from Boone Pickens (the self-appointed ambassador of the energy industry). Boone has left an indelible mark on this industry, and if there is anyone who best exemplifies the great people of this industry, it is he. I've heard that Boone is slowing down a bit at age 89. If that's the case, enjoy your rest, big guy, you've earned it.

"When you're hunting elephants, don't get distracted chasing rabbits."

I hope you enjoyed this article and found it to be interesting. If so, I achieved my objective in writing it. Please click the "Follow" button if you would like to see more of my work when it appears.

I am an oilfield expert with almost 40 years experience in the OFS industry. My intent is to give readers the benefit of those years of experience in my appraisals of companies or conditions in the oilfield. I am not an accountant or a CFA! As such, nothing I say in this or any other article should be construed as financial advice.

This article was written by

I am an oilfield veteran of 38+ years. Retired from Schlumberger since 2015. My background is drilling and completion fluids. I have authored a number of technical papers on completion topics. I have worked around the world- Brazil, Russia, Scotland, and the Far East. I still maintain a training and consulting practice and am always willing to help people who want to learn.

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Disclosure: I am/we are long SLB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.