Denbury Inc (DEN) 2021 Q3 法說會逐字稿

Greetings and welcome to Denbury's Third Quarter 2021 Results Conference Call. My name is Daryl, and I will be your operator for today's call. (Operator Instructions) Later, we will conduct a question-and-answer session. (Operator Instructions) I would now like to turn the conference call over to your host for today's call, Brad Whitmarsh, Head of Investor Relations. Please go ahead, sir.

Good morning, everyone, and thank you for joining us today. I hope you've had a chance to review our earnings release and supporting materials that we released this morning. They're available on our website at denbury.com, and we may reference certain slides as we make our prepared comments.

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 these measures is provided in today's earnings release as well.

This morning, our prepared comments will come from Chris Kendall, President and CEO; Mark Allen, CFO; David Sheppard, SVP of Operations; and Nik Wood, SVP of Carbon Solutions.

And 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.

In last quarter's call, I noted 3 key areas to watch in the second half of the year where Denbury would be unlocking substantial value for our shareholders and propelling our company towards an exciting future. This morning, I will provide a brief update on each, and then Mark, David and Nik will provide more detail.

The first of those key catalysts was strong execution on our base EOR-focused business. I'm incredibly pleased with our results across the board. Safety performance is better than it has ever been. We've continued to deliver on the plan with quarterly operating and financial results meeting or exceeding expectations in all areas. Further, we exited the quarter with no borrowings on our credit facility, and we anticipate having 0 debt on the balance sheet early next year.

The second catalyst was executing on our flagship CCA development project. David will share more detail, but the project is ahead of schedule, is at or below budget and is on track for initial CO2 injection in the first quarter of next year. Importantly, we have incurred 0 recordable safety incidents over the entire project to date, a remarkable achievement by the team which underscores our core emphasis on safety.

All production from this project will be carbon-negative blue oil. And we continue to believe that our enhanced oil recovery business, utilizing industrial source CO2 emissions produces the most environmentally friendly barrel of crude oil on the planet. We are progressing the blue oil third-party verification and CI score process that I mentioned on last quarter's call, with completion of that project planned around year-end.

The third key catalyst I noted last quarter was progressing agreements with companies seeking to capture their CO2 emissions as well as agreements with the owners of potential storage sites, in each case, to begin unlocking the massive value potential that we have for CCUS with our Carbon Solutions business. During the third quarter, our Carbon Solutions team executed initial term sheets for our CO2 transport and storage services, including the previously announced ammonia project with Mitsubishi and the joint evaluation agreement for low-carbon solutions with Mitsui.

These are just the first of what I am confident will be many agreements. I am excited and encouraged by the number of agreements we are negotiating as well as the cumulative volume potential. I anticipate we will have executed even more agreements for CO2 transport and storage by the end of the year.

At the same time, we have continued work to secure underground CO2 storage access along our infrastructure to provide long-term safe sequestration of CO2 for our customers. The agreement with Gold Coast Midstream Partners that we announced this morning represents the first of these sites, providing a substantial storage opportunity in the Houston area. Total storage potential at this location could be up to 400 million metric tons, and we're thrilled to be working with Gulf Coast Midstream Partners on this project.

We are also working to add sites across our infrastructure network, and I expect that the proximity of these locations to our pipeline system will provide a very economic, reliable and flexible storage solution for our customers.

I often get asked about the competitive landscape in CCUS. Considering the magnitude of the CCUS opportunity, I expect there may be many potential competitors who will work to enter this market. That being said, I do not see another company capable of providing the complete package that Denbury provides today, ranging from our industry-leading CO2 infrastructure footprint, our deep technical expertise in the complete spectrum of transporting and storing CO2 and the certainty that our currently operating system can provide.

Before handing over to Mark, I wanted to comment briefly on the latest draft of the House Reconciliation Package, which includes enhancements to the 45Q tax credit. While there are many details to work through in the language and the entire package is, of course, subject to Congressional approval, these enhancements are consistent with our expectations for increased CO2 emission capture incentives with greater support for both dedicated storage and EOR storage.

The proposed increased tax credit levels should begin to incentivize higher cost and capture industries like cement and steel manufacturer as well as certain other post-combustion emissions. The draft package also includes other enhancements to 45Q such as an extension of the capture construction period, a reduction in the minimum facility size that qualifies for the credit and a shift from a tax credit structure to direct pay. If passed, I believe these changes will expand and accelerate the growth of the U.S. CCUS industry, leading to significant reductions in industrial CO2 emissions.

Before I wrap up, if you haven't had a chance to read our corporate responsibility report that we issued in September, it is available on our website, highlighting our progress in mitigating direct and indirect emissions as well in enhancements in safety and governance. Denbury has a unique and impactful ESG strategy, and we are dedicated to being a leader in sustainability as we all work to create a new energy future.

Mark, I'll now turn it over to you.

Thanks, Chris, and good morning, everyone. Today, I'll provide a brief review of Denbury's financial results for the third quarter before handing the call over to David for a more detailed operations review.

As Chris mentioned, our third quarter results were bolstered by higher sales volumes and realized oil prices, which led to quarterly highs this year for revenues, net income and operating cash flow. Adjusted net income for the third quarter was $40 million or $0.74 per diluted share as compared to GAAP net income of $83 million with the primary difference being the mark-to-market change of our oil hedges. Operating cash flow for the quarter was $104 million or $78 million adjusted as positive working capital changes contributed $26 million to our cash flow from operations during the quarter. On a pre-hedge basis, our cash operating margin increased to over $32.50 per BOE in the third quarter.

Financial liquidity at the end of the third quarter increased to $565 million, and we exited the third quarter with no borrowings on our credit facility. Our only outstanding debt at the end of the quarter was the final $17 million payment obligation on our NEJD pipeline financing, which was made last month. During the quarter, we closed on the sale of some additional Houston area nonproductive surface acreage that was outside of the company's planned development area for total proceeds of $12 million. Looking forward, I anticipate we will exit the year with $25 million to $50 million of bank borrowings as we wrap up the capital spend for the Greencore CO2 pipeline expansion to CCA in the fourth quarter. Based on current oil pricing, we project being debt free in the first half of next year.

Our strong balance sheet provides us great flexibility and is extremely valuable as we assess the massive growth potential ahead of us with CCUS, including pipeline expansion, EOR and non-EOR storage development and various new opportunities to create even more value in CCUS.

Sales volumes averaged approximately 49,700 barrels of oil equivalent per day in the third quarter as expected, a slight increase from the second quarter. Differentials in the third quarter were consistent with our guidance widening primarily with respect to the Gulf Coast crudes, which were weaker relative to WTI prices. For Q3, the differentials for our Gulf Coast and Rockies regions were essentially the same, whereas historically, our Gulf Coast crude received higher prices. This is reflective of the supply and demand balances in the various regions with the tight supply of Cushing driving strength into our Rockies pricing. It's always difficult to guide on differentials, but for now, we continue to expect differentials in the near term to be similar to our third quarter results.

Our cash outflow on hedges during Q3 was $78 million compared to $63 million last quarter as WTI oil prices continued to strengthen during the third quarter. You will recall that most of our hedge positions were put in place in the fourth quarter of last year as required under our bank credit facility. We have no additional hedging requirements under our bank credit facility. And as we move into 2022, we have less of our expected production hedged, and we are hedged at more favorable prices and with a greater mix of collars, which provides for more upside. Needless to say, we are looking forward to the roll-off of the 2021 hedges.

Lease operating expenses for the quarter totaled $25.50 per BOE, in line with our expectations considering the amount of seasonal work-over activity that we typically have in the third quarter as well as the impact on our operating costs from rising commodity prices, including the natural gas price impact on power and utility costs. All other items are right down the fairway of expectations.

For the fourth quarter, we expect that DD&A will increase by $5 million to $7 million as we consider the impact of the potential booking of initial proved tertiary reserves at CCA. It's too early to provide specifics on 2022 capital or cash flow plans as we are still working through our planning process. However, to provide a framework, I think it's reasonable for you to expect our focus to be on holding our base business relatively flat from a volume perspective and maximizing our cash flow generation as we progress CCA towards first tertiary production with ongoing evaluation of our capital needs in 2022 as we continue to grow our CCUS business.

Before I turn it over to David, I want to reemphasize what a great place we are in financially, with essentially no debt on the balance sheet, a strong base oil business that can generate significant free cash and hedges that are rolling off in our favor as we move into 2022. It gives us a lot of confidence in executing our long-term strategy and great optionality for funding our growing CCUS business.

David?

Thanks, Mark. Good morning, everyone. It's certainly an exciting time at Denbury as activity levels have been increasing throughout the year as we have built great momentum with our near- and long-term development projects. I will focus most of my discussion this morning on the CCA project and our recent Oyster Bayou development before wrapping up with some comments on volumes and expenses as we progress towards closing out 2021.

I always want to start with safety, which is core to our operational performance. Effective and efficient operations have to be safe operations, and our teams are doing a great job on that front. Year-to-date, we are continuing to track at a record-low total recordable incident rate, and the third quarter was our best quarter.

One accomplishment I want to share with you that is just outstanding. On the CCA project, we have accumulated 550,000 man hours of activity between Denbury company employees and contractors this year with no recordable safety incidents. I acknowledge the tremendous effort and focus by the project development and operations teams for a job well done.

Moving on to an update on project execution. During the third quarter, we finalized the A1 development project at our Oyster Bayou field in Southeast Texas. The initial A1 expansion included the drilling of 1 new producer while converting 2 wells to producers and 2 additional wells to injectors in a pattern designed to optimize resource recovery in a previously under-swept area of the A1 reservoir. Late in September, we began seeing the first well respond and is currently producing above plan. We expect the 2 additional producers to respond before the end of the year. This positive early result is very encouraging as we consider 2 additional development patterns for future expansion in the A1 reservoir.

Continuing with Oyster Bayou, you will recall the deeper A2 development that was executed in 2020 where we also expanded our facility compression and injection capacity. Results from the A2 have continued to show strong response, therefore, we are evaluating a potential A2 expansion. At the end of the third quarter, Oyster Bayou was producing approximately 4,200 barrels per day net to Denbury, the highest level seen in the field since the fourth quarter of 2019.

Approximately 60% of our third quarter capital spend went towards our CCA tertiary project, which is progressing ahead of plan. As of today, we have installed all 105 miles with a 16-inch Greencore CO2 pipeline extension, the final testing underway and mechanical completion expected within the next 2 weeks. This is the only significant CO2 pipeline project installation in the United States this year. And with this extension, I believe Denbury will become the largest mileage operator of CO2 pipelines in the U.S.

The first phase of tertiary development at CCA is targeting the East Lookout Butte and Cedar Hills South units, where our teams have multiple workover rigs operating in the field converting 74 water injector wells to CO2 injectors. CO2 line fill the Greencore pipeline extension, should begin by the end of this month and is expected to be completed by the end of the year. First subsurface CO2 injection has now accelerated into the first quarter of 2022, and Phase 1 production response is expected in the second half of 2023.

With the pipeline installed, we have put the key infrastructure in place that will benefit all future phases of CCA tertiary development. The 3 things that really stand out to me about the CCA development are: number one, the total recoverable resource potential of 400 million to 500 million barrels equivalent makes CCA the largest EOR resource development we've ever undertaken. Phase 1 is targeting less than 10% of the total potential, which means we have a multi-decade-long development opportunity. Two, CCA will drive down our operating cost per BOE. We estimate LOE per incremental BOE at $10 to $15, thereby increasing our margins with every barrel produced. And three, this is a fully carbon negative development as they will inject more industrial-sourced CO2 into the ground and the production and combustion of the oil will ever admit. CCA will significantly increase the scale of our blue oil operations.

Now to give some near-term thoughts for fourth quarter guidance on volumes, capital and operating costs. We anticipate fourth quarter sales volumes being nearly 50,000 barrels equivalent per day. Oyster Bayou is anticipated to increase from the third quarter as we will see additional contribution from the A1 development. This should offset anticipated lower volumes from our CCA field where we are temporarily shutting in wells to convert from water to CO2 injection.

In addition, at certain fields in CCA, a third party holds a net profit interest which negatively impacts our sales volumes as oil prices rise and the fields are more profitable.

On the capital front, we remain on plan at to slightly below the $260 million midpoint of our full year guidance range. And accordingly, the fourth quarter will come down some from the third quarter peak spend level. The vast majority of 4Q spend will again be related to the Greencore CO2 pipeline completion and CCA field activities.

Fourth quarter LOE per BOE should be relatively consistent with the third quarter as fewer workovers and preventative maintenance projects are offsetting some of the impact from the increased commodity prices, both oil and natural gas on our variable costs such as CO2, power and utilities. As we are seeing some incremental cost inflation pressures on certain goods and services, our operations teams along with planning and supply chain are proactively working with our suppliers to get the things we need, when and where we need them at fair prices.

Wrapping up, I just want to comment how pleased I am with the performance of our assets but even more so the execution by our teams. With our near- and long-term developments, we are strengthening the foundation on which Denbury stands and positioning ourselves for a tremendous future.

I'll now hand it off to Nik for an update on the CCUS business.

Thanks, David. It's great to be on the call today to share some of the team's exciting progress.

Over the past quarter, the Denbury Carbon Solutions team's momentum continued to increase, and we are laser-focused on moving deals to final agreement stages. In last quarter's call, we discussed our ongoing negotiations with industrial partners to transport and store more than 15 million metric tons of CO2 per year as well as negotiations with multiple floor space owners, representing more than 1 billion metric tons of CO2 sequestration potential.

We are thrilled with the 2 agreements that we disclosed since that call: the long-term offtake agreement for Mitsubishi's new build Gulf Coast ammonia project as well as the MOU with Mitsui to work together to jointly evaluate EOR opportunities to produce carbon-negative blue oil. This morning, we're excited to announce 2 new agreements. The first is a significant storage site development in Texas, and the second is a new CO2 transportation and storage agreement. I'll spend most of my time on the call today talking about these new agreements.

We reached a significant milestone with our first dedicated storage site that we plan to jointly develop with Gulf Coast Midstream Partners. The project site is located on the Western edge of our infrastructure in Southeast Texas with the potential to inject up to 9 million metric tons of CO2 per year and ultimately store up to 400 million metric tons. Development planning is already underway with preparations for the permitting of Class 6 injection wells in progress, with the expected readiness for first injection by early 2025. We believe this site will be a very competitive storage option for our customers.

Denbury intends to participate in equity of the storage project with up to 50% ownership. Proximity of this site to our infrastructure is ideal, located just 25 miles from our green pipeline. Also, by extending our pipeline infrastructure to the site, we will improve offtake access for significant additional industrial emissions in the Southwest Houston area. This will be the first of several storage sites as we expect to continue to build a portfolio of dedicated storage options across our infrastructure footprint. They'll provide significant storage capacity in the right locations, ensuring that our industrial partners achieve the most benefit from their captured CO2 emissions.

Separately, we've also signed a 25-year agreement for the exclusive rights to transport and store CO2 from a planned renewable biofuel plant on the Gulf Coast. At the request of the plant owner, we are limited on what we can share about this deal for now, but we are looking forward to sharing more at the appropriate time. We continue to be encouraged by the scale of plans for new-build activity in the area, which I think further validates the Gulf Coast unmatched combination of ideal geology for storage, strong regulatory and policy support, access to deepwater ports and extensive existing CO2 infrastructure.

I'll wrap up with a few key thoughts. First, we believe EOR is vital to accelerating the success of CCUS especially in the early innings. The certainty EOR provides under the existing permits and regulations allows industrial partners to make capture investment decisions today knowing that there is an offtake solution that is not subject to the uncertain timing of new permit approvals. Ultimately, we believe that dedicated storage will provide the bulk of CO2 storage primarily because the capacity we see is orders of magnitude greater than an EOR.

The Gulf Coast region in particular has an abundance of safe, long-term CO2 storage opportunities that can serve the industry's needs for decades. To put this abundance in perspective, Denbury's extensive pipeline footprint provides access to over 30 million acres of potential floor space within 25 miles of our infrastructure.

I'm proud of the great progress the team has made advancing Denbury Carbon Solutions strategic priorities. The current 45Q tax credit has opened up a large market, and we have great momentum from our initial engagements. I'm optimistic that the potential enhancements to the 45Q that we see in the reconciliation package will substantially increase the scale of the addressable CCUS market.

Our extensive currently operating pipeline network provides flexibility and reliability to our customers today. When combined with our strategy to build a portfolio of diverse storage options, we have a superior solution that will provide a secure, near-term, economic storage solution to the front gate of any capture project.

Operator, we'd now like to open the call for questions.

(Operator Instructions) Our first questions come from the line of Charles Meade with Johnson Rice.

Chris, I'd like to ask a first question about the -- I'd like you to actually give us some perspective on the CCUS business from your -- the arc of the last 6 months. If we -- if you were to go back and look -- if you were to go back 6 months ago and think about what you guys have accomplished with these 3 or maybe even 4 deals you've signed now, how would you characterize your progress versus your expectations? Are you kind of on track? Are you -- are the big fish still out there to land? So kind of give us that sense. And then also if you could share, is there anything that surprised you? Or maybe is there any way that opportunities are evolving in a way that you would not have anticipated 6 months ago?

Yes, that's a great question, Charles. And so actually, the 2 parts are kind of linked. And certainly, when I think about where we are today and I think about the great progress that Nik's team has made, both the parts of that, that we've disclosed but other parts that are yet to come, I actually think that we're ahead of where I imagine we'd be at the beginning of this. It's -- there's just so much activity, so much enthusiasm and tailwinds of where society is going, where companies are going and the recognition that carbon capture plays a huge role in what needs to happen here. So I feel great about that.

What I think is interesting is your second question, if anything that surprised me. And what I would say is the great surprise is not just the take-ups that we've seen, not just the regulatory support or the policy support that we saw in the last administration and that's only accelerating in the current administration, but it is what energy transition will really mean in terms of new build.

We know about emitters on the ground, and we have great relationships there, and we're offtaking CO2 already from several of them. What's more surprising was the ideas around, for example, blue ammonia and the new developments that will be associated with that or biofuels. And the way that any of these new developments can use the breadth of the system that we have to connect and have access to all of those benefits and really optimize their costs and optimize the whole system. So it continues to meet with positive to the upside.

We talked a little bit about some of the works to enhance 45Q. We were excited about this in the first place when we had $35 and $50 at 45Q, I think that the potential expansion there just makes it that much better. So we feel great about it. And I think that it's really coming into its own as a technique that is recognized and is going to be a big business.

That's really interesting, Chris. I think I was -- likewise, I wasn't looking for a new build blue ammonia plant as your first (inaudible).

Exactly. Exactly.

You caught me -- or you kind of aptly described me there. Second, if I could ask a question about the CCA pipeline. It's remarkable. We've been talking about this project for so many years, and here we are literally a couple of weeks from all the pipe being in the ground. Can you talk about what are the steps and if there's any really meaningful obstacles between getting the pipe in the ground and actually getting the first CO2 injected in the first couple of months of next year? I mean I saw a line fill and field distribution, but is that it?

Charles, this is David Sheppard. I'll take that question. I'll just tell you, it's been really tremendous progress by our teams in the field, just the execution that has gone on and not just the execution, it is how we've executed safely. And I really think that, that's a core tenet to note to our success right now. Just for clarity, the pipe is completely in the ground. We have one final segment that we're hydro testing -- but at this point, that work will be complete this week. The final mechanical completion of the pipeline will be finished within the next 2 weeks. We have work ongoing on the pump station that too as well that will wrap up here soon, probably in the first to second week of January.

Line fill will start prior to that, the pump station, being completed here by the end of the month. We expect to get that pipe filled and progress ahead. So no, to answer your question very short and direct, I do not see any impediment to CO2 distribution occurring in the first quarter of 2022.

Our next questions come from the line of Leo Mariani with KeyBanc Capital Markets.

I just wanted to ask a handful of questions here on the deal that you guys announced this morning with Gulf Coast. I just wanted to get a sense, is this deal kind of completely locked down at this point by the Gulf Coast guys? Is this a project they've already fully secured and you guys are in the process of "kind of farming' into this for some type of equity interest here? And I guess just additionally, would this be sort of kind of heads-up economics with those guys? Would there be any kind of upfront payments you got to make? Or is it more just sharing in the capital to kind of build this out over the next couple of years?

You bet, Leo. I'll take the first part of that, and then I'll ask Nik to go into it a little bit more. And certainly, at this point, we -- there are going to be some details of the agreements that I'm sure you can understand we can't go into. But I think we can talk generally about it and might just ask Nik to share your thoughts on the nature of where the GCMP team was when we met up with them and where we are.

Great. Great. Thank you, Leo. Thank you for the question. So I'll jump into the first part of the question around the lockdown of the storage side aspect. And what I'd like to, I guess, state here is that as we entered into negotiations with GCMP, they already progressed a lot of the steps necessary to get a store site in Texas past the hurdles that are in Texas around floor space ownership. And so getting that acreage prepared for development was something that they had already put in place. And so being able to get a site where it's at on our infrastructure, close to emitters there in Texas was a great win for both parties. And so we look forward to getting past that and starting the definitive agreement and working through that over the course of the coming months.

And just what I'd add to that is that we think we bring a lot to the story with the Gulf Coast Midstream team. And we think that, that team brings a lot to the story particularly for the storage area Southwest of Houston. And so we'll continue working through that and share more details at the right time.

Okay. And I guess maybe just from a high-level perspective, could you talk a little about kind of what you all's role would be in this project versus GCMP role? I don't know those particular -- that particular group, but obviously, you guys both have midstream capability, but clearly, you have the giant chunk line to move lots of volumes around. So maybe you can get into that a little bit more, it would be helpful.

Great. This is Nik again, Leo. And so just to address kind of the nature of the partnership, it will be a JV, and the exact interest percentage that either party will own in that JV will be figured out over time. But generally, we look forward to jointly developing this together. GCMP will take on a lot of the steps that are ongoing on the acreage they already secured. Denbury will be working a lot on the pipeline connection that we're bringing the CO2 to that site and working a lot with the emitters that will actually be bringing the revenue to that site.

Okay. Helpful for sure. And I guess, potentially, would this be a site that you would just fold in to other deals that you guys signed? So as you guys are signing deals with emitters, this would be part of their kind of offering package with these folks? Or is GCMP also kind of pursuing emitter deals on their side as well? Just trying to get a sense of that dynamic.

Yes. No, the way we think about it is that this is the first piece in the puzzle that we talked about for some time. Our vision is that this great pipeline network that we have, the existing EOR fields that are great targets for CO2 right now needed to be supplemented with a number of dedicated storage sites from one end to the other. And so this is on one end. And what I picture is that the storage sites will -- and we're working on many of them, as Nik mentioned earlier, that they will steadily be folded into the entire package to really give us this breadth of an offering that we can provide to the industrial partners where they know that if their storage needs can't be met for whatever reason, whether it's storms or technical or operational, that we have other options along the way. So we see it as part of a bigger story that we're building in real time right now.

Our next questions come from the line of Doug Leggate with Bank of America.

I don't know who's best to answer this one, but Class 6 permitting, where does that stand on the JV you announced this morning? Because our understanding is there's only a couple of those active currently in the country.

All right. Doug, this is Nik again. So what I'd like to say there is that GCMP has been progressing interactions with the EPA to get the Class 6 permitting underway. And -- but the actual Class 6 permit application hasn't exactly been submitted yet.

Can you offer any economics around the project as it relates to specific to your potential 50% interest?

So Doug, we haven't shared any of that yet purposefully. What I would say is, kind of echoing Nik's comments a few minutes earlier, is that we think that this storage will be competitive with anything that will be out there when we just look at what it will take to develop it, where it will be and what emissions it can access.

I have one last one, and I know, Chris, you and I have talked to this before, but I just wanted -- I want to ask this publicly, so everyone can hear what's on our mind on this particular topic. In the release, the utilization of your infrastructure and the replacement cost of that infrastructure and how you think about getting the market to recognize the value of that infrastructure. Is there anything structural that you might think in the context of how the ownership of your pipes might evolve over time? If not, how do you think about how you can get maximum recognition of the value of those already in the ground?

Yes, that's a great question, Doug. And we think about that quite a bit. Obviously, we think that the value of our infrastructure network is incredible and what it can provide. And not just the replacement value but the fact that it is in the ground and operating today, and it's touching all of these key industrial emissions areas, so it's in the right place. It has the right capacity. It has the right expandability. And so we think it's incredible. Obviously, we want to continue to grow that value, and we think about the system effects. You'll hear us repeatedly talk about that we think that the most efficient and reliable and flexible type of system that can exist is what we have, that presents the industrial customers the flexibility to move their CO2.

The underlying question of how do we really ultimately get that value realized, I think along the way, right now, what we want to do is just build this business as well and as large as we can. And as you see, we're in the process of doing that.

Ultimately, I think there could be some different structures, ways to think about providing opportunities for investors to invest in different parts of what Denbury does. And we'd like to get a bit further down the road on that and have that look like a business that truly does stand on its own. So yet to come, but it's certainly something that we're thinking about.

Intriguing comments, Chris.

Our next questions come from the line of Michael Scialla with Stifel.

I understand that you're not ready or able to discuss the economics of the storage side, but I was just wondering if you could give an idea of maybe initial capital costs or at least what are the early steps. You mentioned getting Class 6 permit, obviously, but I'm just wondering if you can give any sense on what the next steps would be there. Is there any remediation work that's required? Are there critical wells in the area that need to be worried about, I guess, anything along those lines.

Yes, you bet, Mike. So we're not yet at the point we're ready to jump into the capital cost. I mean, obviously, you see that we're about 25 miles off of the Western extent of the Green Pipeline, so we'll have a pipeline interconnect that we work on, that you could apply some of the typical pipeline CapEx to. Otherwise, we've got some work to do before we're ready to disclose any of that publicly.

What I'd just say is, when I think about it and I think about storage costs that we've talked about publicly, how they've been laid out in the National Petroleum Council's report on CCUS, it all fits very well with that. And so we feel good about it, just a little bit premature to talk any more details.

In terms of any vertical wells in the area that you need to do remediation work on? Or is there a seismic that needs to be acquired over the year?

Yes. And so to that, I'm not aware of any remediation that's needed on this site, and so nothing that's extensive or costly that we're aware of from that point. Seismic, I think in all of these sites, as you work towards the Class 6 permit and the MRV, there will be expenses like that, that are baked into our planning not just for this site but for any others that we're working on as we're wanting to make sure that we can provide just the most -- the highest level of confidence most of the regulators and to the public that we're putting CO2 into very secure places.

Got it. Okay. And with the proposed legislation, if we do go to $85.60 per ton, Chris, you mentioned that opens the door for more industrial companies to contemplate carbon capture. Are you seeing any new companies come to the table? And have your discussions changed at all in terms of the potential tolling fee may charge those customers? And I guess, same goes for now that you've secured a permanent storage site, does that open the door for more potential customers and changed any of your negotiations?

You bet, Mike. And so what's interesting, and when we look at where these credits could go,compared to where they are today, first of all, the excitement that we've had about this business was based on where the credits were and the number of different partners we're talking to, that were incentivized at those levels. And so what I'd say first is that, that's the primary set of conversations that we've been having. And I know that there are others that have been -- that have known that they were outside of the money on 45Q. Great examples are the hard-to-abate industries like cement or steel or, honestly, even start to get up into electricity-generating plants that are natural gas-fired, for example.

So I think that as we get to these higher levels, it opens that door. It also starts to move you towards a part of the cost of capture curve that flattens out some more. And so I think that just every dollar that you gain gives you an outsized improvement in the total amount of emissions that can be captured. So excited about that. I think that it just really underscores the bipartisan support that we see here on CCUS. Whether it comes through this reconciliation package or whether it comes from the Catch Act, plenty of pathways that this can be achieved. At least right now, the highest likelihood we see is in the reconciliation package. But it's exciting.

To your question on the negotiations and economics, I mean, to me, the biggest win for us and for the CCUS industry in general, I think, is building scale. And this allows a significant building of scale. I do think that there will be some improvements in what Denbury is able to realize. But primarily, what you want to do is you want to attract those higher cost of capture industries to build that huge scale that we think is the long-term win here.

(Operator Instructions) Our next questions come from the line of Richard Tullis with Capital One Securities.

I was wondering if maybe you can give us just an overview of any negotiations you may have had or just how aggressively you may have approached the Air Products, the hydrogen project that was announced recently in South Louisiana. It looks like a big project and a lot of CO2 likely to be moved there eventually. Just maybe let us know, did you have a shot at that project or were they just trying to keep almost all of it for themselves? And just any potential to participate in any way going forward.

So Richard, thinking about Air Products, first, they're a great partner of ours. They are together with us with their hydrogen plant in Port Arthur, we're taking about 700,000 tons a year of industrial source CO2 off of that plant into our system and have been doing so for many years. So we have a great relationship.

And I would say along the course of the last year, we have known that their product was working on this project and that it was something that, at least at this point, they wanted to keep to themselves, as you mentioned. Any number that we provided in terms of volumes that we've been considering to be in play, we actually carved those out because of what we knew from Air Products.

Having said all that, I firmly believe that in the long run, the network effect is a more reliable, more effective just a lower-risk choice for any emitter to move their CO2 into when you compare it to shipments of CO2 to a single destination. And we think, ultimately, that carries a day. And we'll keep working on that, and there could be possibilities along the way as we see their products project move forward and as we continue to develop out our network.

That's helpful, Chris. And looking at the Green Pipeline in place, I know it was brought up a little bit earlier in a caller's question. Looking at the backlog of projects, you're in discussions with any potential to look at expanding the capacity of the system. I know you're -- you have the ability to look both ways but just even in one direction to expand it maybe to 50 million tons per year if the 45 -- particularly at the 45Q tax credit is increased to $85 a ton.

Yes. No, absolutely, Richard. And I think of multiple ways that we can expand or extend this pipeline infrastructure. In the past, we've talked about expanding the in-place portion up to 50 million tons a year of overall capacity either by adding pump stations or line loops at high-traffic areas, and we see a good pathway of doing that.

Along the way, we see other ways of growing this system. Some of them are even associated with reaching the pipeline to the Gulf Coast Midstream site. There are other emissions in that area that we're that much closer to, and so that's an area we think about.

We think about moving segments into Lake Charles,or down towards Baton Rouge in New Orleans, again, areas of high emissions that would just make a lot of sense and really tie this integrated system into that much more of an emissions base.

So we're continuing to work that. And what I love about it is that we are starting from a base system that's already moving 10 million tons a year through it. We have a right of way that we're working within. We have a great base to start from that we can incrementally build as that demand comes and provide essentially real-time solutions as we go.

And then I guess just lastly for me, if you could recap the comments made during the opening remarks related to the 25-year contract that Nik was mentioning. I didn't catch all of that.

Yes. So we have a new agreement with a new-build biofuel plant there in the Gulf Coast, that we have that agreement, it's a long-term agreement, for 25 years.

Yes. And beyond that, Richard, we have been asked for several reasons by the partner there to not disclose anything further. We're excited about it, but it's going to be a bit of time before we can go into more detail. To me, it's just one more element that's out here of the types of new investments and new opportunities that 45Q combined with our system and the great situation that you have really across our infrastructure opens up. And as I mentioned to Charles earlier, these are ideas that weren't even evident to us a year ago, but we see them coming together now.

Yes. No, that's helpful. And just lastly, related to that, is it both transportation and storage? Or are you not able to say at this time?

Yes, it would be transportation and storage.

Okay. All right. Very good.

Our next questions come from the line of Michael Scialla with Stifel.

Yes, just had a couple of follow-ups. Mark, you mentioned you expect to be debt free in the first half of next year. You haven't given formal '22 guidance yet, but I'm assuming that you're thinking you -- well, I guess I don't know, I'm asking, I guess, are you anticipating generating free cash flow or just spending to be kind of equal free cash flow? What was that comment based on?

Sure. At this point, the guidance or the kind of the overarching comment that we've made was, as you think about next year, maybe think about us holding production kind of flattish from a volume standpoint, which we've kind of guided to before in terms of from a capital standpoint, what that might require close to $200 million or so just on an average basis. But knowing that we're continuing to build up CCA here for production in the next couple of years.

But beyond that, I would say that if you look at our hedge position alone, we're targeting probably paying out somewhere in the neighborhood of $280 million this year plus based on recent prices. As we look at our hedge book next year, it's definitely less than half of that based on current prices or recent prices. So that alone obviously puts us in a significant free cash flow position and not -- and we'll have more of our production that's able to benefit from the higher prices.

So we do anticipate generating a significant amount of free cash. And what we said is we want to remain opportunistic with our cash today as we think about building out the CCUS business and what that might entail here over the next couple of years, making sure that we have good line of sight to fund that before we start considering some kind of distribution program at this point.

So that's how we see it right now, and we'll -- as we continue to work through the planning process and hopefully share this a little bit more early next year once -- as we normally do, that's kind of some broad-brush comments that I would say for now.

Yes. And if I'm reading you right, Mark, it sounds like you're anticipating funding all the CCUS requirements for at least the next couple of years with internal cash flow. You're not thinking about external funding at this point?

Yes. I think that's definitely an option we want to have in front of us. I'd say to the extent that things move faster and it requires more capital, that's a great thing because it means CCUS is moving faster. And we don't believe there would be any issues or obstacles to also raising some money toward this if that became necessary. But having the flexibility to deploy our free cash into that growth vehicle, we think, gives us the best opportunities today, and we'll consider other options as we need to.

Yes. Okay. And just one last one. You mentioned in the press release a horizontal development well at that Coral Creek unit. I'm just wondering, was that just a kind of a one-off exploitation well? Or could that have any bearing on how that unit gets developed with CO2?

Michael, this is David. I'll take that question. Yes, that was just an extension of our Mission Canyon program that we've executed throughout the previous 2 to 3 years, we'll drill an occasional well there. Had a nice well to add to the inventory with a rig of opportunity. And we elected to do that good solid producing outcome.

Thank you. There are no further questions at this time. I would like to turn the call back over to Brad Whitmarsh for any closing remarks.

Thanks, Daryl, for helping us today. I want to thank all the analysts and investors for joining us. Susan and I are around all afternoon. Should you have some follow-up questions, we'd to speak with you. I hope everyone has a great day. Thank you.

Thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time. Have a great day.