Adjusted cash flow from operations (cash flow from operations before changes in assets and liabilities, a non-GAAP measure) for the fourth quarter of 2004 was $48.6 million, slightly higher than fourth quarter 2003 adjusted cash flow from operations of $47.8 million. Net cash flow provided by operations, the GAAP measure, totaled $17.7 million during the fourth quarter of 2004, as compared to $51.8 million during the fourth quarter of 2003. The difference between fourth quarter 2004 adjusted cash flow and cash flow from operations is due to the significant reduction of accounts payables and accrued liabilities during the quarter. (Please see the accompanying schedules for a reconciliation of net cash flow provided by operations, as defined by generally accepted accounting principles (GAAP), which is the GAAP measure, as opposed to adjusted cash flow from operations, which is the non-GAAP measure).
Review of Financial Results
Denbury's fourth quarter 2004 production averaged 19,644 Bbls/d and 56.0 MMcf/d, or 28,977 BOE/d, a 4% increase over third quarter 2004 levels and a 4% increase over fourth quarter 2003 production levels, all after adjusting for the sale of offshore properties. Production from the Company's tertiary recovery operations set another quarterly record in the fourth quarter of 2004, averaging 7,242 BOE/d, a 4% increase over third quarter 2004 levels, and a 30% increase over the fourth quarter of 2003 average of 5,579 BOE/d. During the month of January 2005, production from these tertiary operations continued to increase, averaging over 8,300 BOE/d (approximately 27% of the Company's total production). Production from the Barnett Shale averaged 5.8 MMcf/d (962 BOE/d) during the fourth quarter of 2004, an almost threefold increase over the 1.6 MMcf/d (268 BOE/d) average production during the fourth quarter of 2003. Production during the fourth quarter of 2004 was 68% oil as compared to 55% oil for the comparable quarter of 2003, primarily as a result of the sale of Denbury's offshore properties in July 2004.
Despite an overall lower production level as a result of this offshore sale, total revenues in the fourth quarter of 2004 increased $7.7 million (9%), as compared to revenues in the fourth quarter of 2003, primarily as a result of higher commodity prices, partially offset by higher hedging payments and lower production levels. In the fourth quarter of 2004, NYMEX oil prices averaged approximately $48.34 per Bbl, and natural gas NYMEX prices averaged approximately $7.25 per Mcf, as compared to NYMEX averages of approximately $31.20 per Bbl and $5.40 per Mcf in the fourth quarter of 2003. Denbury's weighted average price received per BOE was $13.82 higher per BOE (excluding hedges) in the fourth quarter of 2004 than in the comparable period of 2003. However, the Company paid $8.31 more per BOE on hedges during the 2004 quarterly period than payments a year earlier, reducing the net realized per BOE price increase between the respective fourth quarters to $5.51 per BOE.
Oil price differentials (Denbury's net oil price received as compared to NYMEX prices) deteriorated during 2004, particularly in the last quarter, as the price of heavy, sour crude produced primarily in the Company's East Mississippi properties dropped significantly relative to NYMEX prices. The Company's average NYMEX differential increased from $3.54 per Bbl during the fourth quarter of 2003 to $6.48 per Bbl during the fourth quarter of 2004, a $2.94 per Bbl decrease in the price the Company received relative to NYMEX prices. For the full year periods, the average oil price differential was $3.60 per Bbl during 2003 as compared to $4.91 per Bbl during 2004.
Overall, expenses were lower in the fourth quarter of 2004 than in the prior year's comparable quarter. Lease operating expenses were $1.3 million less on a gross basis as a result of the offshore sale, but increased from $6.78 per BOE in the fourth quarter of 2003 to $7.60 per BOE in the fourth quarter of 2004. The primary reasons for the higher cost per BOE were continued expansion of CO2 tertiary projects, which typically have a higher operating cost per BOE than conventional oil operations, higher lease fuel costs to inject and recycle CO2 due to high natural gas prices, and the cost of leased recycling facilities. Production taxes and marketing expenses also increased primarily as a result of the higher commodity prices.
General and administrative expenses increased $1.8 million (38%) between the fourth quarter of 2003 and 2004, averaging $2.38 per BOE in the fourth quarter of 2004, up from $1.44 per BOE in the comparable quarter of 2003. The biggest portion of the increase relates to higher bonus levels for employees in 2004 as a result of the Company's strong performance during the year, non-cash amortization of the deferred compensation related to restricted stock issued to the officers and directors during the last half of 2004, increased litigation expenses, and incremental costs related to the Sarbanes-Oxley Act.
Interest expense decreased 12% in the fourth quarter of 2004 as compared to the fourth quarter 2003, due to lower overall debt levels following the Company's $50 million debt reduction during 2003 and $75 million debt reduction during 2004. At Dec. 31, 2004, the Company had approximately $140 million of net debt (long-term debt less working capital), one of the lowest leverage positions in the Company's history.
Depletion, depreciation and amortization ("DD&A") expenses decreased $4.2 million (16%) in the fourth quarter of 2004 as compared to DD&A in the prior year fourth quarter. The DD&A rate in the fourth quarter of 2004 was $7.98 per BOE, about the same as the $8.00 per BOE in the prior year fourth quarter. DD&A expense on a per BOE basis decreased due to the sale of the Company's offshore properties in July 2004, which was partially offset by increasing estimates of future development costs due to rising industry costs.
During 2004, the Company paid out $84.6 million on its hedges and incurred a net expense of $1.3 million primarily related to hedging transactions surrounding the Company's sale of its offshore properties. The total of $85.9 million is reflected in the income statement as $70.5 million of payments on the Company's effective hedges and $15.4 million of expenses on the Company's ineffective hedges. This compares to total payments during 2003 of $62.2 million and $3.6 million of other non-cash income relating to hedging. The hedge payments are expected to be substantially less in 2005 as most of the Company's existing hedges are price floors, which means the Company will retain any commodity price increases. Effective Jan. 1, 2005, the Company plans to no longer use hedge accounting, which means that any changes in the fair value (i.e. mark-to-market) of the Company's derivative contracts will be charged to earnings each quarter rather than being charged to other comprehensive income.
Denbury's 2005 development and exploration budget (excluding acquisitions) is currently set at $305 million, including $45 million to build the Company's CO2 pipeline to East Mississippi which the Company may finance on a long-term basis upon completion. Over 60% of the combined 2005 capital budget is related to tertiary operations, as compared to approximately 43% of 2004 capital expenditures. The Company has adjusted its 2005 forecasted average production to approximately 31,000 BOE/d, an increase of approximately 500 BOE/d to adjust for the anticipated production from its High Island A-6 well, a well excluded from the offshore sale package that should commence production late in the first quarter. The adjusted production target represents an 11% increase in production over the Company's 2004 production levels, excluding 2004 offshore production. Production from the Company's tertiary operations is expected to increase from a 2004 average of 6,784 BOE/d to a projected 2005 average of almost 10,000 BOE/d, a 47% increase.
Gareth Roberts, Chief Executive Officer, said: "2004 was one of our best years ever. During the year we (i) sold our offshore division for a good price, which also allowed us to further reduce debt, (ii) added approximately 1 Tcf of additional proven CO2 reserves, (iii) initiated Phase II (East Mississippi phase) of our CO2 program by commencing the construction of a CO2 pipeline to East Mississippi, (iv) accelerated our Phase I (Southwest Mississippi phase) CO2 program, (v) drilled five successful horizontal wells in the Barnett Shale with plans to accelerate this program during 2005, (vi) saw most of our out-of-the-money hedges expire, and (vii) completed a dramatic improvement in our float over the last two years with the final sale of stock by our former largest shareholder, the Texas Pacific Group. All of these factors, combined with high commodity prices, helped our stock reach new highs during 2004.
"Our decision to focus on tertiary operations continues to be a winning strategy and the backbone of our Company. Tertiary oil production continues to grow and we added almost 19 million barrels of proved tertiary oil reserves at Brookhaven Field this past year, and we expect our growth in tertiary oil production and reserves to continue. We are enthusiastic about the inventory of assets we have compiled, while continuing to look for additional tertiary opportunities for a future Phase III and IV program. With the proceeds from the offshore sale, we have reduced our debt to minimal levels and historically low leverage ratios, giving us the ultimate financial flexibility for the future. We expect to grow our tertiary oil production almost 50% during 2005 and our total corporate production by approximately 11%, all from internal organic growth. We are bullish on oil prices even though we still use much lower oil prices for our internal economic evaluations. With our significant inventory of oil projects, we believe we have ideally positioned Denbury as any price increase will enhance the value of both our current proved reserves and our future potential reserves."
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