Denbury Inc. (NYSE:DEN) Q1 2022 Earnings Conference Call May 5, 2022 12:00 PM ET
Brad Whitmarsh - Head of Investor Relations
Chris Kendall - President and CEO
Mark Allen - CFO
David Sheppard - SVP of Operations
Nik Wood - SVP of Carbon Solutions
Matt Dahan - SVP of Business Development and Technology
Conference Call Participants
Doug Leggate - Bank of America
Charles Meade - Johnson Rice
Richard Tullis - Capital One Securities
Michael Scialla - Stifel
Good day, ladies and gentlemen. And welcome to the Denbury's First Quarter 2022 Results Conference Call. My name is Juan, and I will be coordinating your call today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session [Operator Instructions].
I would now like to turn the conference over to your host for today's call, Brad Whitmarsh, Head of Investor Relations. Please proceed, sir.
Good morning, everyone and thank you for joining us today. I hope you've had a chance to review our news releases this morning and the supporting materials that are available on our Web site at denbury.com. We're certainly very excited to announce not only strong first quarter results, but also a significant new CCUS transport and storage agreement, as well as an authorized share repurchase program. I want to remind everyone that today's call will include forward-looking statements that are based on our best and most reasonable information. There are numerous factors that could cause actual results to differ materially from what is discussed on today's call.
You can read our full disclosures on forward-looking statements and the Risk Factors associated with our business in the slides accompanying today's presentation, our most recent SEC filings and today's news release. Also, please note that during the course of today's call, we may reference certain non-GAAP measures. Reconciliation and disclosure relative to those measures are provided in today's earnings release as well. This morning, our brief prepared comments will come from Chris Kendall, President and CEO; Mark Allen, CFO; David Sheppard, SVP of Operations; Nik Wood, SVP of Carbon Solutions; and Matt Dahan, SVP of Business Development and Technology are all here to participate in the Q&A.
With that, I'll turn the call over to Chris.
Thanks Brad. Good morning, everyone and thank you for joining us on today's call. It would be an understatement to say that the start to this year has been dynamic. Russia's activities have created turbulence in the energy markets and combined with demand growth have taken oil and natural gas prices to levels not experienced in many years. Further, increased energy costs are adding to already high levels of inflation, and supply chains and services continue to be challenged with rising demand. Considering that backdrop, I'm especially proud of what our teams have accomplished to start 2022. We are making great progress on all of our objectives and most importantly, we have continued to operate safely with our key metrics either at or near record levels. While we are all experiencing the effects of supply chain breakdowns in our daily lives, our team, careful planning and diligence, have thus far mitigated any significant impacts on Denbury’s business, keeping us firmly on track with our key development projects.
This morning, I'll focus on four primary topics; highlights from our first quarter results, as well as updates to our annual guidance; the $250 million share repurchase program we announced this morning; continued progress on our capital developments, as well as increasing momentum in our carbon solutions business. Denbury delivered robust financial and operating results in the first quarter, enhanced by our high leverage to oil prices. Operating cash flow before working capital changes totaled to $131 million for the quarter, resulting in free cash flow of $51 million, sales volumes, differentials and operating costs, were all in line with our expectations and guidance, and we exited the quarter with only $35 million in debt. Also, we concluded an amendment to our bank credit facility that increased the borrowing base by 30% to $750 million, while extending the facility's maturity and relaxing various restrictive covenants. Looking forward, we are maintaining our full year guidance ranges across sales volumes, capital and expenses. However, with the increased outlook for commodity prices and recent inflationary pressures, we anticipate that some of our cost items will trend toward the upper half to upper end of those ranges. Also, we have updated our income tax expense outlook for the current oil price environment, which reflects a higher anticipated tax rate and some cash taxes in 2022.
Regarding production, we anticipate that second quarter volumes will be slightly lower than the first quarter due to recent downtime for unplanned maintenance and late winter storms that occurred early in the second quarter. Production should ramp higher in the second half of the year as we see initial results from our 2022 capital program with fourth quarter volumes being the highest of the year. As oil prices have continued to strengthen, we've added to our hedge positions for 2023, primarily with collars that provide floor protection around $70 or higher, while also providing exposure to significantly higher oil prices. With an enhanced cash flow outlook, our board recently authorized a $250 million share repurchase program. As we've emphasized in the past, while maintaining a strong balance sheet, our capital allocation priorities are; first, to fund our production business at a sustaining to moderate growth level; second, to fund expected CCUS investments; and third, to return capital to our shareholders when generating sufficient free cash to do so. Based on our success to date and our view toward expanding our CCUS business, we anticipate meaningful capital needs in the future. However, at current commodity prices, we expect to have the ability to meet all of those needs, as well as to fund the share repurchase program.
Highlighting some of our recent operational accomplishments. Our CCA development continues to progress extremely well. Phase 1 CO2 injection commenced on February 1st, and as of today, we have 55 Wells on injection with a total rate of over 115 million cubic fee per day or over 2 million tons of industrial sourced CO2 on an annual basis. The project remains on plan for first tertiary production in the second half of 2023. This extraordinary asset is the largest EOR development we have undertaken with a total recoverable EOR potential of over $400 million barrels, more than twice our current proved reserves. Based on our exclusive use of industrial sourced CO2, all produced barrels will be carbon negative blue oil and should be some of our highest margin production.
The EOR focus side of our business is fundamental to the execution of our CCUS vision. Financially, it drives strong cash flows that allow us to organically fund our CCUS investments and new investment opportunities in the energy transition space. Technically, the pipeline, project management, wells, and subsurface skill sets that we have developed in our 20 plus years of EOR operations are the exact same skill sets needed for highly reliable CO2 transportation and sequestration. And operationally, EOR is still the only form of CCUS available at scale in the US today, providing offtake certainty for industrial customers to move forward with capture projects.
As I mentioned in our 2022 outlook call, this year will be transformational for Denbury CCUS business. Our carbon solutions team continues to make great progress, both in building out our sequestration capacity through new four space agreements, as well as reaching agreements with industrial partners for the transportation and storage of their CO2 emissions. Multiple agreements are continuing to advance and new opportunities are coming to us virtually every day. This morning, we announced the execution of a new term sheet for another significant transportation and storage agreement in the Gulf Coast, representing an incremental 2 million tons of captured CO2 per year. This is a planned chemicals facility, intended to be constructed in close proximity to our existing CO2 pipeline infrastructure. With this agreement, we have now reached an industry-leading 7 million metric tons per year of CO2 for new transportation and storage services. And based on what I see today, in terms of what we are working on, I believe we are on-track this year to substantially exceed our cumulative annual target of getting to 10 million tons per year.
While the agreements we have reached to-date have been for CO2 transportation and storage, we are offering industrial customers a full suite of service options, ranging from transportation and storage to transportation only, and even providing a full package that includes the implant capture process as well. Each of these solutions is being tailored to the unique needs of our industrial customers. I'm looking forward to updating you in the coming weeks and months as more of these agreements are completed and the growing scale of Danbury's CCUS business becomes more evident. Our buildout plan for Denbury's Gulf Coast CCUS system is to provide a highly-reliable and efficient network of sequestration sites located at key points across our pipeline infrastructure. The team is highly focused on the development of our contracted sequestration sites, and is engaging with the various EPA regions in support of our Class VI permitting process. As part of that effort, we are planning to drill multiple stratographic test wells later this year. In addition, we are continuing to build out storage capacity further, and I expect that we will complete several more sequestration site agreements in the coming months.
We have great momentum at Denbury. Our production business is generating strong cash flow and we are developing an incredible EOR resource with our CCA project that will drive volume growth beginning late in 2023 and into 2024, becoming the foundation of our production for future decades. Concurrently, our CCUS business is making important progress, the details of which we plan to further layout as we go through the year. As I close, I wanted to note that we intend to issue our 2021 corporate responsibility report in the near future. I encourage you to read through the report to learn more about Denbury's focus on sustainability. As I mentioned at the outset, I am extremely proud of what our teams are doing. Denbury has an incredible and energizing opportunity in front of us, not just to redefine the future of our company but to also provide the energy our world needs, while reducing carbon emissions in a meaningful way. Thanks for your time today and we'll now turn the call over for your questions.
[Operator Instructions]. And the first question comes from the line of Doug Leggate from Bank of America.
This is Clay. My first question just concerns Slide Number 12 and there is comment, a footnote on there and it indicates that you are considering a 2 to 3 times expansion in the Green Pipeline. And I think this opens the door to several questions, and I apologize because this is tiered, but I'm just trying to understand. So number one, are the read ways already in place? Number two, have you already gotten the critical mass of CO2 offtake to underwrite the expansion? And just kind of considering the lead time of construction, would you take FIDs, the four -- the Class Six permits are granted?
And so looking at that expansion of the Green Pipeline, and that's honestly something that we have been planning for some time. And what it's primarily based on is just the incredible volume of demand that we see coming. And so it's certainly not contracted today, as you can see from just our progress towards the goals that we have right now. But as we look at the agreements that we're negotiating, as we look at what is yet to come, the potential for what we can do here is enormous. And primarily, we can start with the line itself and adding pump stations at various locations to enhance the capacity and line loops within an existing right of way as per your question, we can do an awful lot of expansion just with that. Ultimately, we expect the expansion to take place over time. Remember we have about 16 million tons of capacity in the line right now, which is only being used at about a quarter of capacity. So we have quite a ways to go with the capacity that we have. And what that does is it gives us room to plan and execute that expansion in line with the projects that we think are coming that will ultimately take all of the capacity we have and require that expansion.
Just kind of looking at the distance of the pipeline versus the various storage options. It seems like this could be a tier development where the storage sites that are closer to the pipeline get developed first, and then New Orleans and will be Alabama later. Is that the right way to think about it? And in that context, how do you see the cadence of spending, when does it begin, ultimately, when do you see it concluding if you have those agreements set by 2025, 2026?
And I don't really -- I don't quite think of it as tiered development, Clay. I think of it as kind of an all of the above. I mean, if you were to look into Nik's team right now, you'd see that they're steadily churning on the permitting process for every single site that we have. And the idea is that every one of the sites is going to have a specific region that is best suited for emissions that are occur in that region that are captured. And so over time, we just expect that we can work all of these sites together. And like I mentioned just a minute ago, we're going to be adding more sites as we go building this over the coming years. But certainly, our view is towards matching with the projects that we are aware of that are either being executed or are in plans right now to have those sites available when that time comes.
You asked the question about the cadence of capital. And certainly, I would think that as we ramp this up, we want to do quite a bit of work next year. So I expect capital to meaningfully increase in 2023 as we build these sites out, along with the pipeline laterals that connect to the sites as well as to the emitters. And along the way, one thing that we're thinking about, Clay, is just we want to make sure going back to the efficiency of this system that not only do we have one site that's ideal for any particular emitter, but that we have redundancy in the system and that we can bring emissions to various locations across the system. That's part of the beauty of the system, the way that we think about it.
The follow-up question just trying to understand the value creation opportunity that's in front of you. As you continue to develop, how do you think about the incremental value of the contracts that you're adding? And ultimately, as you noted the skill, this project is significant, are you ultimately the right operator of this project? And I'll leave it there.
I mean, you know, honestly when I just look back at what Denbury does, for 21, 22 years now, we have been primarily focused on enhanced oil recovery using carbon dioxide. So if you were to look inside the company, Clay, you'd see a suite of technical and operational professionals who have handled all things CO2 for 20 plus years. And so from that aspect, I can't imagine anybody better qualified to be transporting and injecting CO2 even outside of EOR. Then I take it a step further and I just think about the infrastructure that we have in place. We have the longest operated CO2 pipeline network in the United States, split between the Gulf Coast region that you mentioned earlier, as well as in our Rockies region. So a great head start on infrastructure as well that I think really sets a backbone in place that allows us to access storage sites, that allows us to be close to emissions sites as well. And really at the end of the day, creates the most economic solution for industrial emitters to bring their emissions into the system and capture, put them underground permanently.
Our next question come from the line of Charles Meade from Johnson Rice.
I want to ask about the buyback. And so, when I look at it and so I think okay, $250 million authorization, it's a great arrow to have an quiver. But it doesn't necessarily mean that you're going to -- it's good to have that option, but having the option is different from committing to doing it. So what I want to ask is, how are you, the management and the board, thinking about the relative attractiveness of spending free cash, buying back your shares versus frankly to the point you've already been making on this call really -- seems like a really rich and deep opportunity set in front of you, not just on the CCUS side but even on the tertiary side. So how -- what are the guidelines, so how you and the board are thinking about that allocation decision?
I'll just share a couple thoughts on that and then I'll ask mark to share some of his as well. But like you, we see this abundance of opportunities within our EOR business, within the CCUS business, and we're focused on executing on all of those. We honestly just have the luxury with where prices are today to have cash flow on top of all of that, being able to do everything that we want to do and look at this buyback. And then honestly, when we look at where the share price is today compared to what we see as the value of this company and particularly, the potential ahead of us with CCUS that we are making gains on every single day, it just doesn't look like it's in the right place. And so that all -- those are my thoughts. I might ask Mark to just weigh in on some of the other elements to your question there.
Charles, as Chris said, we are obviously not pleased with the share price performance through the first part of this year. We recognize the weakness. We think the potential here is much, much greater. And so as we think about this and look at the free cash flow generation that we see, we want to be thoughtful about this. We want to consider all aspects of it. But we will think about a systematic approach and something that aligns with our free cash flow generation. And obviously, a share price will be a factor and so will all the legal aspects we need to take into consideration as we execute it. But that's how we are thinking about it today.
And then a follow-up question on the CCUS. So you guys, with this South Louisiana new build project, you are at 7 million tons per annum you have signed up and you said you, you want to be at 10 and you have multiple ways to get there. Should we be thinking more along the same lines of the sorts of deals you guys have brought to the table so far, or is there a chance that we are going to see something new and different? I mean to the extent that you could kind of guide our speculations a bit on that, I guess is what I'm looking for.
So to point out that we have continued on the progress that we have and we continue to see a pathway to continue to gain more emissions on the same type of suite of services, we provided previously is accurate. We continue to see new ways of servicing different emitters and different industrial partners, one of which is adding additional capture services to our suite of services. And so that's a new approach relative to what you may have seen in the past. And so I would add that to the services we could provide.
The way I think about Charles is just every one of our industrial customers has different needs and preferences, and what we are trying to do is just make sure that what we can provide meets that. And it may be just transportation in certain cases or it may be the whole kit and others.
Our next question comes from the line of Richard Tullis from Capital One Securities.
Continuing with the same discussion just previously with Charles, related to Den and Bury potentially expand -- or looking at expanding the suite of services. Am I hearing you correctly that maybe you would provide part of the equipment to capture the CO2 at the facility?
That's right, Richard. And if you think about it, there is a whole spectrum of what that looks like. A lot of the industry that is incentivized under 45Q today is pre-combustion. And so in many cases, the capture that you are talking about is really limited to CO2 compression and dehydration. And of course, handling 70 million tons of CO2 a year in our EOR operations, and I think compressing pretty much all of that, we just have a great depth of experience in compression, dehydration as well. So that's an easy step. And then as you go further and you start to become more integrated in the plants themselves, those are just decisions you make on a case-by-case basis. But we can see cases where it just makes sense. And it's the preferred solution that the industrial customer is looking for that all of that would be taken care of and allow them to continue to focus on the core business that they've been operating.
And Chris, if you could provide any more details on how you're thinking about this or the team is thinking about it. What level of investment would Denbury be comfortable with in that part of the service portfolio, and what sort of volumes would you be looking for, range of volumes from these particular emitters, is this on the lower end of the scale?
It could be a range of volumes that we're looking at. And so I don't think it's primarily one end or the other, Richard. But then really what I think about on your initial question as far as level of investment. What I'd say is, as we go further upstream, we would very likely look at partnerships with other entities that deal in some of that upstream work in a more day-to-day fashion than we do, for example, if it's beyond the compression and dehydration, I'd say. So it really depends on our approach there. But end of the day, what we'd look at in any case here is making sure that we're driving a good return on capital for our investors, while also providing the best solution for the industrial customer.
And just a last question from me, maybe for Nik, or maybe for you, Chris. Pipeline conversions, we've been hearing from some industry participants’ discussions plans to possibly convert natural gas pipelines to CO2 transporters. Just wanted to get your take on the expected cost involved there, the timelines to complete that sort of project, and really the effectiveness of converting pipelines to CO2 for transportation if I could get your thoughts there?
We talked about it a bit in the past, and just the nature of the operating pressure of moving CO2 in dense phase. For us, it's typically an anti 900 service, which has a maximum pressure above 2,000 PSI. And the conversions that we've seen have been with typically natural gas service that's around 1,400 or 1,500 PSI, which is harder to transport in dense phase. So we believe that the higher pressure is the most efficient, economical way to move CO2 at scale over distances. I think that conversions can be done. And in fact, we've even had some minor portions of our network converted. And so it's even within our own network we've had a bit of that. It's just it presents some, for us in our view at least, Richard, it presents some operational limitations and some costs of compression and needing to be sure that you can get to a pressure you can inject underground at the other end that works better for us. It is just something -- it really on a case by case basis how it works, we strongly prefer going with the system that we've talked about.
[Operator Instructions] The next question comes from the line of Michael Scialla from Stifel.
I had a question on the Class VI permitting process on Slide 11. You've given your estimates on first injection for your four project areas. Just want to gauge your level of confidence in that timeline, and when do you expect to submit Class VI permit applications for those projects and maybe any update on Louisiana receiving primacy over the process?
So when I think about the Class VI permitting timeline and where we're at, the permitting process is a continuous permitting process and that we have continuous interaction with the EPA. That includes downloading our information to the geologic sequestration data tool, which has been done for all of our sites already. We continued to progress the interaction on what I'll call the desktop studies of our different sites. That includes simulation, geologic modeling, working through the different seals and containment factors. As we get to a point where we are at a construction permitting process, we will get a construction permit from the EPA for Class VI construction. At that point, we will drill Class VI well and start the injection process. I still believe this is a 18 to 24 month process. We are in that 18 or 24 month timeline right now. And so we look forward to getting that first injection hopefully in mid ‘25.
Just on your question on primacy, that's one. What we have heard following the EPAs granting a primacy to North Dakota and Wyoming is that Louisiana should be next. I will tell you it had taken longer than we expected. We have great confidence in EPA just along with what Nick said, that we're going to continue to work that. I do think that over time that we'll see primacy granted to Louisiana and other states. But at least right now, I wouldn't say it's moving -- it should be closed but it seems to be moving a little bit slower than we expected.
Is it fair to say that the timeline you've built in there assumes that there is privacy granted to Louisiana, or is it more just assuming that the EPA controls it and there would be upside if Louisiana did get control?
Mike, I think it's more of the latter. We built the plan around EPA Class VI process. And once you do see primacy and you have the folks that are local to the state, you would expect some acceleration there. But at least everything that we have out right now is based on still working through the EPA and the Class VI process.
And wanted to get your thoughts on the legislative environment now. Anything in particular beyond 45Q that you could use to your benefit? I know for example, one of your peers plans to receive grants under the Infrastructure Investment and Jobs Act. Any possibility of Denbury doing something similar.
We have seen a few elements of the infrastructure bill that do some of that. And some of the folks that we are talking to have been working with the DOE toward grants for certain aspects of what they are doing. And so, I do see some of that coming along. Generally, the numbers are -- they help, but they are not game changers. For us the legislation that we think is interesting is just ultimately, I think it's inevitable that the tax credits, the 45Q tax credit will increase. It's just that today where the tax credit is, we already see a great business. We think it needs to increase overtime. And when it does, it's just that great business just becomes that much better. Just considering the current political environment, I know that there is some forces at work to push that forward, we will just have to see how it works out here.
And one last one for me. I just noticed and maybe it's not a big deal at all. But on Slide 5, you had listed ISO certification for Cedar Hills South and East Lookout Butte at Cedar Creek Anticline. Is that something that you have done for all your EOR projects or is that something unique to CCA?
We have actually completed ISO certification on Hastings and Oyster Bayou in the Gulf Coast. Cedar Hills is in process, should get that back here in a month or two. And we just continue working through the portfolio, should get the bulk of them done within the next year, certainly well ahead of any new emissions coming in that's going to require it.
Thank you. We currently have no further questions on the line. So I hand over to Brad Whitmarsh for any final remarks.
Thank you all for joining us today. Beth and I look forward to talking with many of you over the next several days. And we have got several conferences coming up, so we hope to see you in-person. Thanks again and happy Mother's Day to all the moms out there.
This concludes today conference call. Thank you so much for joining. You may now disconnect your lines.