Does 1+1 Equal 3 in the Oil Patch?

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In May 2008, Encore Acquisition (NYSE: EAC) hung up the "for sale" sign -- the oil & gas company has finally found its exit.

The $50-per-share merger consideration offered by Denbury Resources (NYSE: DNR) -- which Encore's Board has embraced -- is roughly 25% below where Encore was trading back then. Of course, oil was also hovering around $130 at the time. This still looks like an acceptable outcome for Encore shareholders. As long as they built their stake in the company outside of the energy sector's manic phase, they've done pretty well.

From the perspective of Denbury shareholders, though, I'm not crazy about this deal. On the surface, there is some synergy between these two E&P companies. Both have focused on applying enhanced oil recovery techniques to boost production from old, tired fields. Denbury will build out its opportunity set with this purchase. But is this really the time or the place to be making such a move?

It seems like only yesterday that Denbury, preoccupied with liquidity issues, was digging in its heels. Just over a year ago, the company shelved its $600 million acquisition of the Conroe field, cut its capital expenditures, and largely hedged its 2009 production. These were smart steps that the market initially ignored, as Denbury shares were marked down to the single digits in November.

In the same vein, Denbury's Barnett Shale fire sale seems like only a minute ago. In May of this year, the company was deleveraging right alongside Delta Petroleum (Nasdaq: DPTR) and Brigham Exploration (Nasdaq: BEXP). The company let go of those assets for a song. Now it's buying new ones at fair, but not fantastic, prices. Yes, they are largely oil-focused, unlike the Barnett assets that were sold for $1 per metric cubic foot (Mcf). But unlike the brilliant purchase of Citigroup's (NYSE: C) Phibro trading operation by Occidental Petroleum (NYSE: OXY), this deal just doesn't look all that opportunistic.

In addition to a nice position in the Bakken, Encore brings some Rockies-based enhanced oil recovery projects to the table. Denbury's self-identified "significant strategic advantage" is its control of a major CO2 deposit and pipeline infrastructure in the Gulf Coast region. These new properties do not play to that strength.

Rather than strategic advantage, the dominant thought processes here appear to be of the "bigger is better" variety. Denbury management points to the deal's accretiveness to cash flow per share, and the likelihood of a lower cost of capital over time. These things may come to pass, but Denbury is also diluting its focus (or enhancing diversification, if you prefer the company line) and saddling itself with fresh debt that could pose challenges.

While I don't expect a repeat of the situation faced by Precision Drilling Trust (NYSE: PDS) following its takeover of Grey Wolf, I also can't rule out the possibility of the credit markets having another spasm. It just seems odd for Denbury to regain an appetite for financial risk so soon after its recent scare.