Compared to fracking, enhanced oil recovery -- or EOR -- methods have never been in vogue. This has largely been attributed to the fact that the latter require high initial investment, not excluding availability of resources such as a steady carbon dioxide supply. As a result, investors are generally wary of such businesses as they are viewed to be profitable only if supported by high oil prices. But with EOR specialist Denbury Resources (NYSE: DNR ) initiating dividend payments for the first time this year, the market's perspective could change. But more importantly, to investors, this signifies that the Plano, Texas-based company has a stable business model capable of generating some solid long-term returns.
Not a sunset industry
Fracking, no doubt, has made U.S. energy independence a distinct possibility in the near future. But secondary and tertiary oil recovery methods have been quietly effective despite not getting as much attention as the former. In the United States, Denbury Resources is one of the few exploration and production companies that specialize in EOR techniques.
Operating primarily in the Gulf Coast and the Rocky Mountain regions, tertiary oil recovery constituted 55% of Denbury's total production in 2013. In this method, an already producing oil field is acquired -- generally one where production volumes through conventional methods are in decline. Through years of production, the reservoir's natural pressure gradually drops. Carbon dioxide and water are then alternatively injected into the formation, depending on the reservoir's characteristics. This reduces the viscosity of the remaining oil trapped in the formation, thus causing it to flow to the production well. The following graphic from the Department of Energy explains the process quite vividly:
Critics of EOR methods argue that costs involved are high and that low oil prices could markedly reduce profitability of such a business. Looking back, the past five years haven't been too impressive with Denbury's stock returns being essentially flat. The market hasn't shown a lot of enthusiasm toward EOR techniques so far.
Reality seems to look different though
But on a relative basis, Denbury's production margins have actually been higher than those of its peers. The following chart from Denbury's latest investor presentation (link opens in pdf) pegs the company's operating margin at nearly $70 per barrel of oil equivalent -- a very high number in this industry.
Adjusted three-year finding and development costs have been among the lowest at $18.42 per BOE. For an oil producer, I think this is considerably attractive since most companies involved with shale drilling have substantially higher production costs. According to The Economist, the breakeven price for oil producers from shale drilling ranges from $60 in the Bakken to $80 in Eagle Ford (paywall). So comparatively, Denbury's position looks pretty good as a low-cost producer.
A solid infrastructure up in place
To get tertiary oil recovery operations under way, the company needs a large supply of carbon dioxide. The good news is that Denbury already has access to cheap and abundant sources of CO2. Additionally, it has the pipeline infrastructure to move the gas to its fields employing tertiary recovery. Mississippi's Jackson Dome is Denbury's primary Gulf Coast CO2 source with a net interest in 4.8 trillion cubic feet of reserves. The company's Texas CO2 pipeline network is capable of servicing its operations at its Hastings, Oyster Bayou, Webster, Conroe, and Thompson fields. The net result is that the growing economy of scale reduces per barrel infrastructure costs. The five fields are estimated to collectively hold net reserves of 338 million barrels of crude oil and pipeline cost per tertiary barrel is expected to fall to $3.50 per barrel.
Up north, there's no dearth of carbon dioxide for the company's Rocky Mountains operations either. Late last year, Denbury secured long-term supplies from the Ridley Ridge area, which has an estimated 2 trillion cubic feet of net CO2 reserves. Additionally it has secured a daily supply of 65 MMcf/day from the ExxonMobil (NYSE: XOM ) operated Shute Creek from the LaBarge Area.
Foolish bottom line
In short, with all the initial investments already up in place, it's only a matter of time before cash flows increase and excess cash is returned to investors in the form of dividends. What's particularly encouraging for Denbury is its overall production profile -- 95% crude oil and the rest natural gas. The company aims to grow organic production between 4% and 8% through 2020 and at the same time anticipate dividend growth over the long term. Initiating an annual dividend of $0.25 for 2014, management is aiming to double that next year pushing up yield to 3.4%, assuming share prices remain constant. There's a lot income investors can look forward to with Denbury Resources.
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