Denbury’s Buried Carbon Charm – WSJ


Energy companies these days can attract investors in one of two ways: Pitch a great low-carbon idea or generate heaps of cash.

Denbury Inc.


DEN -0.54%

might be one of the few that manages to tick both boxes.

Denbury Inc. (DEN)

  • Recommendation: Buy
  • Price: $93

Since 1999, Denbury has specialized in so-called tertiary oil recovery, which occurs after other producers have depleted a well through internal pressure and some additional effort—such as injecting water. Denbury recovers the last drops of oil out of those wells by injecting carbon dioxide. It is the only publicly listed company that primarily uses this method, which inherently involves less exploration risk because Denbury is producing from already-discovered wells.

While a net-zero emissions scenario probably wasn’t in Denbury’s original business plan two decades back, today’s push—both from governments and investors—toward minimizing emissions has put the company’s carbon dioxide gathering infrastructure at just the right place at the right time. Earlier this month, the U.S. significantly stepped up federal tax credits for carbon capture and made it easier to claim such subsidies by allowing direct payment.

Denbury is already scope 1 and 2 negative, meaning that it more than offsets the carbon dioxide it releases through its operations. It is the only fossil fuel producer with a goal of fully offsetting scope 1, 2 and 3 carbon emissions (scope 3 would include the end use of those oil barrels) by 2030. Even green-minded European oil majors have more-distant targets:

Shell

and

BP

both have set a target to reach that milestone by 2050.

Though Denbury still gets most of its carbon dioxide from naturally occurring sources underground, the hope is that it will eventually get more of it from industrial customers looking to offset carbon emissions—and charge them accordingly. Carbon emissions have been difficult to abate for factories that produce cement and petrochemicals, for example. Under existing contracts, Denbury actually pays its industrial providers of carbon dioxide, which include

Air Products

’ hydrogen plant and

Nutrien’s

ammonia plant. Industrial sources accounted for roughly 15% of the carbon dioxide Denbury used for its Gulf Coast operations last year.

In newly negotiated contracts, industrial customers are expected to pay Denbury to take the carbon dioxide. Denbury has lined up contracts to take 7 million metric tons of carbon dioxide annually from industrial customers—including Mitsubishi—and is on track to execute 10 million tons a year of agreements by the end of this year. Permanently storing the carbon generates much higher tax credits than using it for oil recovery, so Denbury has identified some underground storage sites, which will require permitting and development.

Denbury hasn’t disclosed specific terms on the contracts, so it is difficult to suss out exactly how attractive this new revenue stream will be. But, unlike some low-carbon or clean-energy technology stocks that promise profits in the distant future, Denbury already generates profits today, which means the carbon business would be a nice cherry on top rather than a necessity.

The company also has more cash-generating potential going forward because its hedging requirement was lifted this year. After emerging from bankruptcy in 2020, Denbury was—under its bank-credit facility—required to hedge a portion of its hydrocarbon production through mid-2022, limiting the upside from high oil prices, according to a research note from Citi equity analyst Scott Gruber. Now that Denbury’s balance sheet has improved and those hedging requirements are gone, it can see more upside from high oil prices. Analysts polled by FactSet expect Denbury to generate $198 million of free cash flow this year—more than double last year’s sum—followed by a 56% increase in 2023.

Given those unique advantages, its shares aren’t exactly a bargain compared with other oil producers. Denbury’s enterprise value is roughly 6.7 times expected earnings before interest, taxes, depreciation and amortization—an 80% premium to a broad basket of oil and gas exploration companies. Energy stocks with green credentials, though, fetch far higher multiples:

Bloom Energy,

a solid oxide fuel-cell company that still uses natural gas to power its battery systems, fetches a multiple of about 52 times on the same measure, for example.

Denbury’s share prices surged recently after Bloomberg reported that the company was exploring options, including a sale. Such an exit doesn’t seem far-fetched given U.S. oil producers’ keen interest in carbon capture.

Exxon Mobil,

for example, has said it would spend $15 billion on emission-reduction projects through 2027. Buying Denbury would cost less than a third of that budget and would give it exposure to the largest carbon-dioxide pipeline network in the U.S., spanning more than 1,300 miles and located close to high emitters.

Given hurdles to permitting, competitors will find it difficult to build up rival pipeline networks. While natural-gas pipelines can be repurposed for transporting carbon dioxide, they aren’t optimized for the task given that carbon-dioxide pipelines generally perform at a much higher level of operating pressure.

Oil prices could be near a cyclical peak, but the cost of emissions is bound to grow. Denbury might be one of the few fossil-fuel producers in the U.S. that can reap the benefit.

Write to Jinjoo Lee at jinjoo.lee@wsj.com

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