Denbury Resources: No Rocky Mountain High From Depleted Oil Fields

Denbury Resources (DNR), which recovers oil from seemingly exhausted oil wells, expects gains in production resultant from a recent energy acquisition. However, merger-related costs and infrastructure issues could challenge planned expansion to depleted fields in the Rocky Mountains.

Denbury is an industry leader in carbon dioxide (CO2) tertiary operations, which involves injecting sequestered carbon dioxide into mature oil wells to decrease reservoir viscosity, increase flow rate, and cost-effectively help pump out difficult-to-reach oil. The company has successfully recovered up to 17 percent of original oil deposit reserves using this enhanced technology.

Chief executive officer Phil Rykhoek forecast that the $4.5 billion purchase of oil producer Encore would more than double the potential of its enhanced oil recovery (EOR) assets to almost 650 million barrels of proven (and undeveloped) oil. Encore properties in the Rocky Mountains fit nicely into Denbury's overall EOR program, said Ryhoek, telling analysts on the fourth-quarter 2009 earnings call that anticipated EOR production from Encore properties will provide production growth in 2015 and beyond, about the time when the company's Gulf Coast tertiary fields are expected to hit production peaks.

Encore holds extensive acreage in the Williston and Powder River Basins of southeastern Montana and northwestern Dakota, which may yield substantial quantities of oil from both primary and EOR fields. Developing the new oil strikes and tertiary fields, however, will require lots of money and cheap, significant supplies of CO2 respectively -- neither of which Denbury possesses in excess.

Denbury management believes the increased size and scale of the company would lead over time to a lower cost of capital and prove meaningfully accretive (between 8 percent and 18 percent) to cash flow. Just because it sounds good, doesn't mean it is good (to paraphrase Duke Ellington):

  • Neither stand-alone company has been free cash flow positive in years, mostly due to finding and development costs. In 2009, Denbury had cash outflows of $479 million and Encore bled approximately $47 million in red ink;
  • Even plans of near-term debt reduction of $500 million through the sale of non-core assets, such as Permian Basin holdings in West Texas or Encore's natural gas gathering facility in Wyoming, would still leave the post-merged company with long-term debt of more than $3 billion, or almost 40 percent of total capitalization; and,
  • Management admitted on the fourth-quarter conference call that its $1 billion capital budget for 2010 is expected to be $150 million to $250 million greater than anticipated cash flows. The company plans to fund this shortfall with the aforementioned asset sales; $85 million in proceeds from the recent sale of a partnership interest in non-essential pipeline assets; and, an available $600 bank credit revolver. Given more than adequate oil and gas supplies and continued weakness in demand for domestic natural gas, the timing and amount of gas-related asset proceeds remains uncertain -- likely leading to an increase in debt borrowing (and related interest-payment outflows).
At December 31, Denbury owned proved CO2 reserves of approximately 6.3 trillion cubic feet (Tcf), extracted principally from volcanic structural traps in salt basins at depths of about 16,000 feet. The company-owned mine, Jackson Dome, is the most significant source of natural CO2 in the U.S. east of the Mississippi. However, most of these supplies are pledged to existing EOR operations The most efficient way to transport CO2 is via dedicated pipelines, which like natural underground CO2 reservoirs, are in short supply. Possibly because there are few natural sources in the United States and the cost of building the pipeline infrastructure to feed the CO2 to tertiary fields is significant. For example, Denbury spent almost $1 billion to construct its Green Pipeline, critical to rejuvenating depleted oil fields in southeast Texas.

At present, there is limited pipeline infrastructure to support planned CO2 -EOR operations in the Rockies. A proposed plan by Encore management to build compression facilities adjacent to a gas plant in Freemont County, Wyoming, and construct a 206-mile pipeline to transport the compressed CO2 to tertiary recovery projects at its Bell Creek Field in southeastern Montana never expanded beyond the planning stage, due to funding issues -- nor have CO2 -EOR projects using industrial reservoirs, sequestered from the likes of coal-fired power plants or ethanol facilities (likely due to congressional inaction on funding incentives, such as carbon-capture tax credits).

And the Colorado rocky mountain high I've seen it rainin' fire in the sky I know he'd be a poorer man if he never saw an eagle fly Rocky mountain high ~ Singer/songwriter John Denver (1943 â€" 1997)
The new Denbury Resources has more than 640 million barrels of potential recoverable oil with CO2 -EOR. Forget about new fields flowing in 2015 -- with free cash flow limited, development of tertiary fields in the Rockies will likely amount to nothing more than exciting possibilities.

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