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Denbury Posts Record Earnings, Reduces 2009 Spending

Despite posting record quarterly earnings during 3Q2008, Plano, TX-based Denbury Resources Inc. is following a number of its oil and gas producing peers in slashing its 2009 capital budget due to the bleak U.S. economic outlook. The company also noted that the troubling financial climate has made the planned unloading of its Barnett Shale assets more difficult than first expected.

Denbury posted record quarterly earnings of $157.5 million, or 64 cents/share, which is more than double 3Q2007 net income of $68 million, or 28 cents/share, and 38% more than 2Q2008 net income of $114.1 million.

The independent oil and gas company said the sequential increase in quarterly net income between the second and third quarters of 2008 was primarily attributable to noncash fair value adjustments on the company's commodity derivative contracts. As a result of declining commodity prices, during 3Q2008 the company recognized an $86.1 million ($53.5 million after tax) noncash fair value gain on derivative commodity contracts, partially offset by a $30.4 million charge relating to a forfeited deposit on the canceled Conroe Field acquisition.

Comparatively, during 2Q2008 the company recorded a noncash fair value charge on derivative contracts of approximately $30.2 million ($18.8 million after tax), a net swing of $116.3 million ($72.3 million after tax) in derivative contract fair value adjustments between the two quarters without giving effect to the nonrecurring charge of $30.4 million relating to the forfeited acquisition deposit.

Denbury said production for 3Q2008 was 45,913 boe/d, a 12% increase over 3Q2007 production after adjusting the 2007 period to remove production from the company's Louisiana natural gas properties sold in December 2007 and February 2008, and a 2% sequential decrease when compared to 2Q2008 average production.

The producer noted that hurricanes Gustav and Ike combined to reduce 3Q2008 production by approximately 1,250 boe/d, of which approximately 550 b/d related to the company's Phase I tertiary oil production. In the Barnett, Denbury's average production increased 23% to 12,339 boe/d in 3Q2008 as compared to average production of 10,063 boe/d for 3Q2007. Barnett Shale production was down 8% on a sequential basis from levels in 2Q2008, as the company deferred an estimated 650 boe/d in 3Q2008 as a result of the two hurricanes shutting down third-party pipelines and facilities in the Gulf Coast, which in turn required the company to shut in a significant portion of its Barnett Shale production for a period of time. Denbury said production from the area has been relatively steady during 2008 with the company's current drilling program of 45 to 50 wells per year.

"We're glad to report that our tertiary production is generally on track and by the end of October was producing almost 22,000 b/d," said Denbury CEO Gareth Roberts. "Like most of our peers, we have scaled back our 2009 capital spending program in order to maintain a strong balance sheet, but unlike most, even with the scaled back spending, we are able to project a 23% increase in 2009 tertiary oil production. We are able to do this because much of our anticipated growth in tertiary production is expected to come as a result of capital spending in prior years."

Adjusting for the deferred production relating to the two hurricanes, the company said its third quarter production results were generally on track with its prior guidance. The company said it is leaving its guidance for 2008 unchanged, except for a slight adjustment to account for the deferred production, or an adjusted guidance of approximately 19,850 b/d for estimated tertiary production and 46,650 boe/d for the entire company. Denbury said it currently estimates that it will spend between $900 million and $950 million in 2008, less than its current budget of $1 billion, although a portion of the unused budget may be carried over into 2009.

In early October, Denbury announced its preliminary 2009 capital budget of $825 million, an amount that did not include the Barnett Shale assets or any possible carryover items from 2008. If such items were included, the total capital budget estimate would have been almost $1 billion. "In light of the continued lack of liquidity in the capital markets, the company has further revised its all inclusive 2009 capital expenditure budget downward by $250 million to $750 million," Denbury said. "The revised 2009 capital budget retains approximately $485 million relating to the company's CO2 pipelines, the majority of which is for the Green pipeline, and assumes the company lease finances approximately $100 million of tertiary production facility expenditures, which is conditioned on obtaining acceptable lease financing terms."

A number of industry watchers expect more cutbacks across the energy sector in the months ahead (see NGI, Oct. 27a). Several North American-based energy companies in recent days have announced plans to cut back on their exploration and development projects for at least the short term (see NGI, Oct. 27b). Among others, Chesapeake Energy Corp. slashed its spending through 2010, and CEO Aubrey McClendon said last week that he expects the industry to lay down 300-500 gas rigs in the coming year (see NGI, Nov. 3).

Denbury said the revised budget incorporates significantly reduced spending in the Barnett Shale and in other conventional areas such as the Heidelberg Selma Chalk and a slower development program for its tertiary operations. Based on this revised capital budget, the company's 2009 tertiary oil production is projected to be approximately 24,500 b/d and the company's total production (including the Barnett Shale and the assumed purchase of Hastings Field effective Feb. 1, 2009) is projected to be approximately 50,000 boe/d, a projected increase of 23% for the company's tertiary oil production and a projected increase of 7% for the total company production over estimated 2008 totals.

"We continue to market our Barnett Shale properties, but due to current market conditions, we have begun to make plans assuming that the properties will not be sold," Roberts added. "[W]e have significantly scaled back our projected Barnett Shale spending during 2009, which will cause our Barnett production to gradually decline during the year, but we desire to use the cash flow generated from those properties for our other needs. With the additional reductions in capital spending, the likely cash contribution from our Barnett Shale properties, and the decline in the projected purchase price of the Hastings Field (as a result of the reduced oil prices), we believe that we are well positioned to continue our business model, although at a reduced development pace due to commodity prices.

"Based on current commodity prices of $65 [per barrel] and $6.50/Mcf, we project that we will borrow between $400 million and $500 million by the end of 2009, far less than our availability under our bank credit line, a bank line that was increased in early October 2008 from $350 million to $750 million. Given that approximately 75% of our 2009 oil is hedged, we believe we can stay close to these projections even if prices further deteriorate, and we stand ready to further reduce 2009 expenditures should that be necessary. For 2010 and future years, we will adjust our capital spending as needed to match our cash inflows so as to maintain our liquidity, and even if prices decline further, we believe we can deliver recurring production growth in spite of the market conditions."

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