Company focuses on modest growth, larger dividends, good returns
Don Stowers, Editor - OGFJ
OIL & GAS FINANCIAL JOURNAL: Denbury Resources is the only pure-play CO2 enhanced oil recovery (CO2 EOR) player in the oil and gas space. Can you explain to our readers how the process works and how your strategy differs from a traditional E&P company?
RYKHOEK: Our strategy, process, production, and asset cash flow profile is substantially different from the rest of the oil and gas industry. In brief, we purchase mature oil fields, inject carbon dioxide (CO2) into them, and recover as much as 50% more oil than what has been produced to date. Since we are working with oil fields that have previously produced millions of barrels of oil, we know that the oil is there, thereby eliminating one of the bigger risks in the industry.
Due to the extensive number of old oil fields in the United States today, this is a very repeatable and sustainable process, limited only by access to significant volumes of CO2 and the ability to get the CO2 from the sources to the oil field via pipeline. We have competitive economics, and we are even environmentally friendly to the extent that we use anthropogenic (man-made) CO2 as the CO2 will remain in the ground at the conclusion of the flood. Since this process requires significant sources of CO2 and CO2 pipelines, our ownership and control of most of the current CO2 sources in our two operating regions and control of over 1,100 miles of CO2 pipelines (and growing), give us a significant strategic advantage.
Once delivered to the field the CO2 is injected into the oil-bearing reservoir. As the CO2 moves through the reservoir, it alters the chemical properties of the remaining oil in place and acts to separate the residual oil from the reservoir rock, increasing its mobility. The combined CO2 and oil mixture can then be more effectively driven towards the producing wellbore thereby recovering additional oil over and beyond what could be produced without the CO2.
OGFJ: What are the absolute necessities for your EOR projects? You have previously noted that you must find and acquire ample CO2 supplies, but what else do you need?
RYKHOEK: There are many components necessary to carry out an efficient and successful CO2 EOR project. As you noted in your question and as mentioned previously, the first (and possibly most critical) step in implementing a CO2 EOR project is to secure access to substantial volumes of CO2. We source our CO2 from both naturally occurring underground reservoirs and anthropogenic sources. In addition to securing access to CO2, the EOR process requires an inventory of oil fields, pipelines to transport CO2 from the sources to the fields, and the proven technical and operational ability to install and operate a CO2 flood. While the EOR process has been used in the industry since the '70s, its application has been limited to areas near substantial CO2 supplies.
OGFJ: Where are your CO2 EOR operations, and how successful have your EOR efforts been to date?
RYKHOEK: Our CO2 EOR operations are currently located in two areas - the Gulf Coast and Rocky Mountain regions of the United States. We have successfully grown our CO2 EOR production from less than 1,500 bbls/d when we started in 1999 to over 40,000 bbls/d of EOR production as of the second quarter of 2014. Based on the performance of our tertiary floods and the results of floods operated by others, we estimate we can recover between 10% to 20% or more of an oil field's original oil in place with CO2 EOR, which is often about as much production as each of the primary and secondary (waterflood) recovery phases.
OGFJ: Sounds like Denbury Resources has been tremendously successful. How could it be that you are the only CO2 pure-play in the space?
RYKHOEK: Quite simply, the large quantities of CO2 needed to implement a CO2 flood are not readily available and since CO2 is not economically transportable except via pipeline, the construction of pipelines needed to transport CO2 from source to oilfield can be difficult to justify unless a company has a large enough supply of CO2 and a big enough concentration of suitable oilfields in a particular area. As a result, most companies do not have the ability to implement a CO2 flood at one of their oil fields, let alone become a pure play.
Photo by Brandon Parscale
OGFJ: Are you seeing any increase in competition? If not, why not - what are the barriers to entry?
RYKHOEK: We are starting to see some limited competition for CO2 supply, primarily CO2 being captured from man-made sources. However, there are few anthropogenic sources today that are large enough, or close enough to an oil field to justify a pipeline between the CO2 source and the oil field, so the availability of CO2 and the ability to transport the CO2 are significant barriers to entry. In addition, while the technology is not new, there is a significant learning curve for the process, so an additional barrier to entry is the lack of EOR technical expertise. Lastly, since the pipelines to, and facilities at, the oil field can be costly and must be built before the oil is produced, it does require a strong financial position. While we don't expect to secure all new man-made supplies, our strong financial position, long operating history, large inventory of floodable oil fields and extensive pipeline infrastructure make us an attractive partner for the industrial facilities that plan to capture CO2.
On the acquisition front, there has always been, and we expect always will be, competition for the long-lived, low-decline rate oil producing properties that are well suited for CO2 flooding. However, we've been able to opportunistically acquire assets to build our deep inventory of CO2 EOR projects, and we expect to continue to have success in the future.
OGFJ: Last year you chose not to create a master limited partnership (MLP) with some of your assets. What drove this decision and do you think Kinder Morgan's recently announced plans to transform its MLPs into a C-corp indicate the MLP structure will be less attractive going forward?
RYKHOEK: Our management team and board of directors are constantly looking for ways to create value for our shareholders. One option we evaluated last year was the creation of a midstream or upstream MLP. We concluded that for our specific financial and tax situation and integrated CO2, pipeline and oil field assets, we could create more long-term value for our shareholders, by remaining a C-corp and using the growing amount of free cash flow we expect to generate to initiate and grow cash dividends and ultimately create what we believe will be a very unique growth and income story in the E&P space. As for publicly-traded MLPs, the long history and sheer size of the sector indicates the structure is attractive for certain entities and asset types.
OGFJ: "Growth & Income" is Denbury's tagline. Why is your operational strategy so conducive to support both production growth and returning free cash back to shareholders?
RYKHOEK: We have the somewhat unique ability to keep our capital spending constant within a relatively tight range and still grow production, thereby increasing free cash flow and dividends, assuming relatively consistent or increasing oil prices. This is made possible due to the relatively low-decline production profile of an EOR flood and the significantly higher dollars returned from each dollar invested.
Our new focus on income, further amplifies our internal emphasis on value creation, making sure that each investment generates a good rate of return and adds value to the Denbury shareholder. Due to the integrated nature of our CO2 supply, CO2 pipelines and CO2 facilities at each of our oil fields, it is difficult for us to grow at a competitive pace with many others in the industry. However, we can generate good returns, grow at a modest and consistent pace, and generate free cash, a combination that most of the industry would find difficult to duplicate.
OGFJ: What is your current production and dividend growth outlook and how do you foresee those changing over the long-term?
RYKHOEK: We have stated that we will grow production at a 4% to 8% annual rate through the end of the decade. We expect to accomplish this without significant increases to our capital expenditures and without spending a material amount more than we make. We plan to double our dividend in 2015, from our current annualized rate of $0.25 to $0.50 to $0.60. Assuming relatively constant crude oil prices, we believe that over the long term we can grow our dividend at a rate in excess of our annual production growth rates.
Photo courtesy of Denbury Resources
OGFJ: Many E&P companies your size look at production growth as their key metric. How does Denbury measure its success and what metrics do you focus on?
RYKHOEK: We are more focused on value creation than on production growth, even though we do, as stated above, anticipate long-term production growth. We are also focused on our free cash flow generation as those funds are then available for dividends or other cash uses. Internally, we focus on our rates of return, but externally one metric we like to use is the capital efficiency ratio, which measures how much cash flow we generate from the dollars we invest to develop our reserves.
OGFJ: I have to ask, why focus on CO2 EOR in the middle of a shale revolution? And as a follow on, why should investors buy Denbury (DNR) rather than a shale player?
RYKHOEK: I think one of the biggest advantages is that we generally control our own destiny due to limited competition. As you know, it is difficult to obtain and maintain a strategic advantage in anything in today's competitive business world. Of course, that would not mean anything if we weren't able to generate good returns, growth, etc., but as generally discussed previously, I believe our positive results are self-evident. Since our production profile is so different than the shale players, I don't think we usually compete for the same shareholder, as about the only relevant similarity is that we both produce oil. If an investor wants modest growth, growing dividends, and good returns, then they will be interested in Denbury. If they are solely focused on high growth rates, we are likely not the stock for them to buy.
Photo courtesy of Denbury Resources
OGFJ: What are the biggest operational challenges you face as a CO2 EOR company?
RYKHOEK: As with any business, we must keep our cost structure competitive and must also manage our projects to ensure we meet our completion targets, closely monitor the floods for conformance issues (i.e. is the CO2 properly touching and combining with the oil), and continually develop innovative new ways to increase the efficiency of our CO2 floods. Additionally, it is more difficult to accurately forecast the timing and magnitude of a production response to the CO2 injections than it is to forecast the production response from a shale well, which makes it difficult to manage Wall Street expectations.
OGFJ: In closing, can you talk to our readers about how sustainable the "Growth & Income" strategy is for Denbury and its investors?
RYKHOEK: We believe our strategy is highly sustainable and truly is the ideal strategy for a company purely focused on CO2 EOR. In our operating areas it has been estimated that there are up to 10 billion barrels of oil recoverable with CO2 EOR, of which over one billion barrels are located in oil fields we operate. With the competitive advantage our access to CO2 supplies and pipelines provides, we expect to be involved in the development of a large portion of these resources for many, many years to come.
OGFJ: Thanks very much for your time today.
