Steady Production, Steady Returns...Usually

With growing US energy production, investors have two broad approaches to investing in energy producers: Invest in companies spending large amounts of money on exploration and production or invest in companies producing energy from established oil plays. Each approach has its advantages. Let's look at some examples.

Growing production across the globe
Buoyed by growing oil and natural gas production and aided by higher prices for both commodities, Noble Energy (NYSE: NBL  ) reported great operating earnings recently. Sales volumes from all four of Noble's major operations recorded record volumes. The company also reported earnings from operations of $0.97 a share compared to the previous quarter's earnings of $0.69 a share and last year's third quarter earnings of $0.41 a share. Unfortunately, losses from derivatives and higher taxes in Israel, among other things, brought earnings down to $0.56 a share.

The stock responded accordingly, rising almost $2 a share the day after Noble released its earnings. For the past year, Noble stock has climbed from roughly $47 a share to over $76 share. The stock currently sells at a premium of 29 times earnings, but the PEG ratio is a more reasonable 1.26. The market seems to believe that Noble's ongoing operations, particularly its U.S. and Gulf of Mexico assets, will drive earnings higher. If its exploration in Nevada produces oil like the company hopes, expect to see even more earnings growth.

Noble represents a growth play in the energy business. The company anticipates increasing production from all of its major assets, the U.S. in particular. This helps offset its riskier plays, for example its offshore exploration in Nicaragua. The company pays a dividend with the underwhelming yield of 0.8%. While the dividend has increased over the years, you don't invest in Noble for income.

Predictable production for predictable distributions
Vanguard Natural Resources (NASDAQ: VNR  ) seeks mature oil and natural gas fields with steady production and buys them from exploration oriented companies. This is a win-win situation for both seller and Vanguard. The seller receives cash to invest in other exploration activities, and Vanguard gets reliable production without major exploration expenses.

Vanguard makes no bones about it: It grows by acquisition. They routinely examine 50 or so acquisition prospects each year and go after those requiring little capital investment. For fiscal year 2012, Vanguard closed on three deals; it has closed on two so far this year. These deals have resulted in substantial increases in both proved reserves and production.

Vanguard also makes no bones about the fact it is all about safe distributable cash flow. It aims to have a manageable debt-to-EBITDA of 3.0, capital expenses well below cash flow and a distribution that has increased every year since Vanguard's IPO. Specifically, the distribution has grown from $1.70 a year in 2007 to a projected $2.49 a year for 2013. Currently, the distribution yields 8.8%. Best of all, the distribution coverage comes in at 1.05, an improvement over the previous quarter.

Predictable production for predictable capital gains, hopefully
While Noble seeks new oil and gas plays for capital gains and Vanguard seeks mature predictable plays for income, Denbury Resources, Inc (NYSE: DNR  ) seeks mature predictable oil plays for capital gains. In particular, Denbury acquires mature oil assets and, using CO2 recovery techniques (aka enhanced oil recovery or EOR), improves oil production and makes a buck off it in the process.

Well, it tries to make a buck off it. Denbury has an erratic track record of quarterly earnings over the past year and erratic annual earnings over the past three years. Part of this can be attributed to build-out activities surrounding its CO2 EOR business. Denbury has been expanding its network of CO2 pipelines to the Gulf Coast and the Rocky Mountains for future oil production. The company has also sold and acquired oil assets, which has affected its production levels. Denbury freely admits it has seen a negative free cash flow for the past several years and expects a modest positive free cash flow for 2013.

Read the company's investor presentation and one thing strikes you: The company is selling its future prospects. While the company enjoys solid financial health, growing production, and generally declining expenses, there is little mention of earnings or capital gains. The company does not pay a dividend. One disturbing chart shows no major increase in free cash flow until 2017.

 

The stock increased in price this past year, from $15 a share to just over $19 a share, but its five-year trend is hardly impressive.

DNR Chart

DNR data by YCharts

Final Foolish thoughts
No doubt, there is money to be made in U.S. oil production, and all three of these companies are in the thick of it. For capital gains, Noble looks impressive. For income, go with Vanguard. For hope and change, go with Denbury. Personally, I prefer proven track records and would avoid Denbury until it generates a more predictable pattern of growing earnings.

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