New Money From Old Fields?

A friend of mine has a T-shirt that says "old age and cunning beats youth and vitality every time." I thought of this when reviewing energy companies that focus on mature oil and gas fields rather than finding new fields. Below are three companies producing oil and gas from mature energy plays. Do any of them offer an advantage over other producers?

Left for dead, coming back to life
Back in 2010, ExxonMobil sold some of its Gulf of Mexico assets to Energy XXI (NASDAQ: EXXI) for slightly more than $1 billion. As Fellow Fool Matt DiLallo pointed out, these assets had been dormant since 2005 and just didn't "move the needle" for ExxonMobil. Energy XXI, on the other hand, saw potential to develop these fields with horizontal drilling. The purchase now looks like a shrewd move.

Energy XXI claims its horizontal drilling can produce three times as much oil, in terms of an initial production rate, as a comparable field onshore. Offsetting the production is a higher drilling cost: $11 million per well for offshore horizontal drilling versus $5 million to $9 million for onshore.

So why is the stock trading at its 52-week low? In February, the company reported second-quarter earnings that were substantially lower than from the year before. This was attributed to reduced oil sales, higher taxes, and ineffective hedging. This followed similarly reduced earnings for fiscal 2013 compared to 2012.

Looking forward, the big news is the merger of Energy XXI with EPL Oil and Gas. This will increase production by almost 50%. The new production is largely oil, and the merger will give Energy XXI seven of the 12 largest oil fields in the Gulf shelf region. Energy XXI projects $50 million in savings over the next two years through reduced lease operating, insurance, and general and administration expenses. This last cost reduction will come by eliminating the "majority of the executive suite."

CO2 for more oil production
All oilfields suffer production declines. One way to squeeze more oil out of a declining field is to inject carbon dioxide (CO2) into the reservoir to force more oil out. Denbury Resources (DNR) does this as a specialty. The company captures CO2, pipes it to oil fields, and then injects the CO2 into reservoirs to enhance oil recovery. No exploration expenses are incurred, making this a low-risk production strategy.

Which is not to say the strategy always produces desired results. While Denbury's 2013 production rose 2% from the previous year, net income, revenue, and cash flow all declined. Management attributed these disappointing results to lower oil revenue and higher operating costs. In particular, assets in the Bakken with low production costs were sold, and CO2 injections in its Bell Creek assets in Montana were started. The initial steps in CO2 injection are the most expensive, and management believes production costs at Bell Creek will decline over time.

According to its latest investor presentation, Denbury forecasts a 4%-8% organic growth rate through 2020. Of course, acquisitions should give production a boost, too. Growing with this production is a newly initiated dividend. Projections are for an annual dividend of $0.25 per share for 2014 and $0.50 per share for 2015. That $0.50 per share dividend is easily supported by last year's admittedly disappointing earnings; I suspect the company will likely make good on its dividend promise. The current yield is 1.5%.

Grabbing gas few others want
Crude oil today produces more profits than natural gas. Not surprisingly, most energy producers focus on producing crude oil and treat natural gas almost as an annoying byproduct. Vanguard Natural Resources (NASDAQ: VNR), on the other hand, happily embraces natural gas assets. Perhaps it sees this as a "buy low, sell high" sort of opportunity.

As a master limited partnership, it's not surprising that Vanguard pays a bigger dividend (8.5%) than Energy XXI (2%) or Denbury (1.5%). The stock has moved sideways for the past two years -- again, appealing to income investors who want steady results and no unpleasant surprises. The distribution has grown from $1.70 in 2007 to a projected $2.52 in 2014. The distribution is paid monthly.

What does the future hold? Well, a shift in strategy. Traditionally, Vanguard acquired stable, low-decline, long-life assets. Its most recent acquisition in Wyoming will require drilling for natural gas. That is, Vanguard will spend money looking for natural gas rather than on buying producing assets. To be sure, the Pinedale and Jonah Fields plays are low risk, and Vanguard has teamed up with experienced drillers rather than drill alone. Time will tell if this new strategy pays off.

Final Foolish thoughts
Some things improve with age. Oil and gas assets don't. All wells experience production declines, and some decline faster than others. All three of these companies exploit known energy plays using different strategies. For income investors, Vanguard wins, hands down. For those looking for growth, Energy XXI looks to be the most interesting. Its acquisition of EPL should drive earnings higher almost immediately. Longer term, if its horizontal drilling of its former ExxonMobil assets proves as successful as some of its early results, Energy XXI should reward its investors well.