When it comes to the energy industry, the saying, "What's good for the goose is good for the gander," doesn't apply. Last week, WPX Energy (WPX) announced that it would be spinning off an upstream MLP. At the same time, though, Denbury Resources (DNR), what could be considered an ideal MLP candidate, has decided to not go down that route. Aside from the obvious difference that WPX is a natural gas driller, and Denbury is an oil-only player, why have these two companies gone in different directions? Let's take a look at the decisions made by WPX and Denbury to determine why they made these decisions.
Cashing in on Colorado
WPX Energy has carved out a position as a top natural gas driller in the Piceance Basin of Colorado. Unlike many of the shale assets that we have come to know in the U.S., this region has a very thick shale formation that can be as much as 2,000 feet thick.. Also, because of the geology of the region, these wells have a tendency to have longer productive lives.
With over 4,000 producing gas wells in the Piceance to date, and a drilling inventory of more than 10,000 prospective well locations, WPX has decided that it will drop down its mature, producing gas wells into its own MLP. As more and more wells are drilled by the existing company, they will be dropped down into the MLP.
To give the best comparison, the new MLP from WPX will most closely resemble Vanguard Natural Resources (NASDAQ: VNR). Vanguard does a very minimal amount of drilling on its own and, instead, buys properties that are already producing oil and gas. This allows it to generate loads of cash and return it to shareholders. It appears that WPX is modeling its MLP around the same idea: do all of the drilling and exploration up at the C-corp level, get the well producing, and then sell it off to the MLP to fund further drilling programs, as well as earn cash from the MLP distributions.
WPX has said that this MLP will deal exclusively with its assets in the Piceance basin. If proven successful, though, it's not too hard to imagine the company extending the MLP's reach to its other properties, such as the San Juan Basin, and the Powder River Basin.
MLP? No thanks
For the past few quarters, Denbury Resources has been mulling over several options regarding how to best return value to shareholders, and continue to develop its properties. This quarter, management announced that it would not pursue an MLP, but instead, initiated a dividend at the c-corp level, and will increase its share-buyback program. It was determined that the injection of capital that Denbury would receive from the initial sale, as well as the cash from having incentive distribution rights, is not as lucrative as keeping everything in-house.
The reason that this makes the best sense for Denbury is that capital allocation for the company is very long term. The company uses CO2 injection to pull oil out of old and abandoned oil and gas wells. Some of its drilling locations haven't been drilled since the 1940s, and have not been producing oil for decades. The use of CO2 flooding takes years to develop a field because it requires securing a CO2 source, building out the pipeline infrastructure, and then injecting CO2 for many months before oil actually starts to come out of the well. This will increase slowly for many years. Denbury's Bell Assets that were just brought on this year will not reach peak production until between 2019 and 2021.
This method has proven very successful by Denbury in the Gulf Coast region. Occidental Petroleum (OXY 0.58%) has been able to maintain its position as the top producer in the Permian Basin because CO2 flooding has opened back-up reserves that companies had long since abandoned. This is also allowing both Denbury and Occidental to redevelop other mature areas, such as the Rocky Mountains, California, and the Middle East.
Unlike many exploration and production companies that could take a quick injection of capital, and translate it into an extra working rig or two. CO2 oil recovery needs more careful, long-term planning that requires a more steady cash flow to fund these operations. By keeping all of its producing assets in-house, and not dropping them down into an MLP, Denbury can make more coherent capital allocation decisions.
It's still very likely that the company could also have been successful had it decided to go down the MLP route, as well, so staying the course was probably the better of two good decisions. Plus, the company is targeting a 3% dividend yield by 2015, with large share buybacks on top of that, which should be good news to any investor.
What a Fool believes
In the grand scheme of things, the decisions by both WPX and Denbury were neither right nor wrong, because spinning off an MLP isn't a deal-breaking move for either of them. The more important factor that you should consider with these two comapnies is that they are both very efficient operators that have have a clear focus on generating strong returns on their respective core assets. This trait is much more likely to result in success for these two companies than the decision to have an MLP or not.
