A Different Kind of Oil Investment: CO2 enhanced oil recovery (EOR)

While headlines are focused on fracking America's top shale plays, another oil industry development is silently profiting in a big way.

CO2 enhanced oil recovery (EOR) is the third phase of extracting oil from a reservoir after the primary drilling and waterflooding EOR phases. EOR methods are used to pressurize mature wells, increasing the viscosity of the oil and pushing the oil to the wellbore. 

Since EOR is used in already proven wells, extracting crude skips the costly exploration expenses incurred by traditional oil E&P companies. Better yet, since the wells are mature, they can be acquired at a fraction of the original cost.

As far as CO2-EOR -- also known as tertiary recovery-- is concerned, Denbury Resources (NYSE: DNR) is the clear leader and the only company you need to follow in the space.

Why Denbury?

Denbury Resources has amassed an excellent portfolio of assets, targeting two areas, the Rocky Mountain and Gulf Coast regions, together comprising just less than 1 billion barrels of oil equivalent in total reserves.

What really makes these assets unique is Denbury's 1,100 miles of pipeline connecting the company's naturally occurring CO2 deposits to its mature oil fields. Since acquiring CO2 is restrictive, this natural supply gives Denbury a competitive advantage that cannot be replicated.

Denbury deploys a strategy of staged projects, which staggers the expected oil peaks in the injected fields, giving the company over 20 years of stable growth. If you take a closer look, EOR projects are front-loaded with capital expenditures and take a few years to ramp up. This type of production curve gives Denbury a future inflection point where production increases while capital expenditures decrease, giving investors years of free cash flow. With six operating areas already producing, Denbury anticipates hitting the free cash flow wedge in the next five years.

Years of growth

Since 1999 Denbury has amassed a 29% compounded annual growth rate, mostly on the back of one project that is now in a phase of slow decline. The great news is Denbury still has five plays in the early growth stage and six more promising projects slated for CO2-EOR injections over the next six years.

Margin appreciation

While growing production is great for oil companies, expanding margins is vastly more important for shareholders. Denbury has focused its attention on both lowering its finding and development costs and selling its crude at a premium, with over 93% of oil marketed as Louisiana Light Sweet crude, which commands a higher price than WTI-benchmarked crude.

This combination gives Denbury the highest operating margin in its peer group, collecting over $60 per barrel of oil equivalent. The company also stands up to declining oil prices, with breakeven prices significantly lower than those of the most prominent shale plays in the United States.

Source: Denbury Corporate Presentation May 2013

The value of an oil company is based on cash flows due to the volatility of oil prices, but over the long term Denbury seems like a screaming value. The company trades 30% over book value, and if it can hit its estimate of a decade of oil-heavy production with a growth rate in the low teens, shareholders should be well-compensated.

bottom line

Denbury Resources is a unique company with prized assets and a non-replicable competitive advantage. The maturing of conventional oil fields is ending the age of cheap crude, and Denbury is primed to expand its business and profit from its industry-leading tertiary recovery position. With $100 oil prices the new normal, Denbury is a company all Foolish investors need to consider.