Shares of fertilizer manufacturer Intrepid Potash (NYSE:IPI) rose nearly 25% in the final month of 2017 on the continued momentum of crude oil prices.
Wait, what? It's true. The company's unique production methods, which rely on pumping mineral-containing brine underground and then into solar evaporation ponds, require it to secure significant water rights in New Mexico and Utah. Pair that with its geographic proximity to the Permian Basin, America's most important oil-producing region, and there exists an opportunity to create a new revenue stream selling water to fracking operations.
That has long been the plan on paper, but Wall Street thinks rising energy prices now make it a more realistic possibility. The reasoning is simple. More favorable economics could push oil companies to increase production, which could be relatively easy to do in the Permian Basin. In November 2017, it was home to over 2,600 oil wells that were drilled but not fracked. If operators finally flip the switch in 2018, then they'll need not insignificant volumes of water.
Can the curse-stricken Intrepid Potash cash in on the opportunity?
The fertilizer company hasn't been shy about the potential to monetize its water rights. Management says it has pre-arranged commitments for $15 million in annual water sales for the next five years and expects to generate $20 million to $30 million in revenue from water sales in 2018.
That might be pretty big if the revenue stream incurs relatively little expenses, as expected. Well, actually, water sales haven't been counted as revenue to date, but rather as a line item in other operating income. Management could create a new revenue segment if the lofty goals are met, which may be possible considering the growing momentum in the second half of the year.
Intrepid Potash reported $3.3 million in operating income from water sales in the first nine months of 2017, including nearly $2 million in the last reported quarterly period. By comparison, the $124 million in fertilizer sales in that same three-fourths of the year generated just $4.6 million in gross profit.
Water could be a difference maker for Intrepid Potash, especially considering potash selling prices have shown no signs of (a long-awaited) recovery. Investors should be encouraged by the increasing rate of water sales witnessed in the third quarter of last year. I would simply caution investors to remember that there's a long way to go to reach the guided range of $20 million to $30 million in sales this year.