I don't think there is a better oil stock for an IRA than Denbury Resources (DNR). It has the perfect combination of growth and income. The company also offers a certain level of security to investors because it profits from oil even if prices plunge, thanks to a combination of super low-cost production and hedging practices. Finally, I think the company's business model of giving older oil wells a new lease on life fits well with the idea of a good retirement. That's why I'm happy to add shares of the company to my IRA this month.
Breathing new life into old oil wells
Denbury Resources has a unique business model. The company acquires mature U.S. oil fields from companies such as ExxonMobil (XOM 2.85%) and uses carbon dioxide to enhance the recovery of the oil from those locations. It's a process that has been used in America since the 1970s, and one that's likely to become even more important to the country in the future thanks to companies like Denbury Resources.
It takes a fairly large capital commitment to start enhancing the recovery of a conventional oil field. Denbury Resources needs to build a carbon dioxide pipeline to the site, and to drill new wells to inject the gas into the field. However, once those costs are invested into the field, it produces a nice boost to oil production and cash flow.
A prime example of this model is found at Occidental Petroleum (OXY 4.96%), which produces 60% of its oil production from Texas' Permian Basin by using carbon dioxide to enhance recovery. This is Occidental Petroleum's most profitable business and should continue delivering profits for years to come. Denbury Resources is looking to replicate that success in the Gulf Coast and Rocky Mountains.
Well protected future
These projects are wildly profitable for a number of reasons. Because Denbury already knows the oil is there, it isn't spending extra money on exploration or on infrastructure other than for carbon dioxide. Furthermore, once carbon dioxide flooding begins, production doesn't rapidly decline as it does in places like the Bakken or Eagle Ford. Instead, production actually increases for the first few years before a shallow decline rate sets in. That enables Denbury Resources, Occidental Petroleum, and other companies to earn strong cash flow for years. It also enables these companies to profit even as oil prices plunge, with breakeven prices as low as $50 per barrel at some locations.
Denbury Resources also protects its cash flow by hedging a good portion of its production. In fact, the company recently converted all of its 2014 hedging contracts to fixed price swaps to lock in its cash flow for 2014. By taking the conservative route, Denbury Resources can ensure that cash keeps flowing from its wells even if oil prices do take a dive in 2014.
Solid long-term outlook
This strong combination of high-margin and low-decline oil production leads to a very conservative growth profile for Denbury Resources that works well in an IRA. The company projects to grow production by 4%-8% annually through the end of the decade. Furthermore, it just instituted a dividend that it expects to more than double over the next year, followed by steady growth thereafter.
This is all possible because Denbury Resources continues to make all the right moves, including those unpopular on Wall Street. One of its best long-term moves was a complex deal with ExxonMobil last year. Denbury Resources exchanged its Bakken Shale properties with Exxon's interests in two fields, one each in Texas and Wyoming, that were ideal for future carbon dioxide flooding. In addition, Denbury locked up access to ExxonMobil's carbon dioxide reserves in the Rockies, as well as some cash. It used that cash to buy assets from ConocoPhillips (COP 4.21%) that provide near-term production and cash flow, as well as adding future carbon flooding potential.
Denbury Resources isn't like most other companies. It makes plans with the next decade in mind. For example, it doesn't intend to use carbon flooding in the assets acquired from ConocoPhillips until 2021. That long-term focus should serve investors well.
Denbury Resources is a great oil stock to buy and hold in an IRA. It will provide investors with solid long-term growth and a growing dividend. That's why I plan on adding more shares of Denbury Resources to my IRA this year.