Devon: Ready to Climb in Q3
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As revealed in its second quarter earnings report, Devon is making great strides towards diversifying its production base, increasing its oil production by 26% in the second quarter over the same quarter a year ago, to 149,000 barrels per day. As expected, maintenance downtime at its North Texas Bridgeport facility had a measurable impact on Devon’s natural gas production, cutting natural gas liquids production by 10,000 barrels per day for most of the quarter.
Though the natural gas liquids price environment is less than favorable as more producers pile into natural gas liquids as a cheaper alternative than oil growth, most natural gas liquids are still bringing a profit to producers, so the downtime was not a positive factor for Devon. Devon also struggled with disruptions and downtime at third party facilities in other regions, though the firm believes that the issues prompting the disruptions are now resolved as it heads into the third quarter. Though CEO John Richels is indicating that Devon will meet its forecasts for the year, he is warning that production will fall on the low end of previously released guidance due to these disruptions.
Active on the Mid-Continent
Devon’s Permian Basin acreage is bringing needed oil into its sale mix, with almost 60% of its 59,000 boe daily production for the region based in oil. Its two phase Canadian Jackfish oil sands project is also ramping up production, which measured 51,000 barrels per day in the second quarter, an appreciable 63% increase over year ago production at the same facilities.
After entering the Mississippian Lime earlier this year, Devon must like what it sees since it is now holding 545,000 net acres in the play. This is a major position in any play and puts Devon among the largest leaseholders on the Mississippian, all the more impressive considering that during the same quarter a year ago Devon did not have a presence here. These moves may be making other firms such as SandRidge Energy (NYSE: SD) skittish; SandRidge in particular is recognized as the first mover on the Mississippian, and as large independents and majors edge in SandRidge will have a hard time acquiring the acreage it needs to stay in the lead at reasonable prices.
Could See a Premature Exit on the Utica
Devon is indicating that its results on the Utica shale in eastern Ohio disappointed the company and fell short of expectations. Though Devon continues to drill in select areas on the Utica, I think that unless its next wells make up for the disappointment its Utica holdings could be up for sale. This is in contrast to plans by Chesapeake Energy (NYSE: CHK) to increase drilling on the Utica, despite not having adequate cash to do so meaningfully without detracting from its much needed oil production activities. Ever given to exaggerated language, CEO Aubrey McClendon recently called the Utica “the biggest thing to hit Ohio since the plow,” showing that he lost none of his exuberance since his job landed in serious jeopardy. According to its latest guidance Chesapeake plans to operate sixteen rigs by the end of 2012 on the Utica, mostly in areas where reserves are unproven.
So far, Devon is the only major independent with significant acreage on the Utica to report such disappointing results. In April of this year, Anadarko Petroleum (NYSE: APC) reported on its first three producing wells, including well Brookfield A-3H, which delivered over 9,500 barrels of light gravity oil and 12 mmcf of high btu natural gas during its first twenty days on line. The second two wells, Spencer A-1H and Spencer A-5H, together produced 20,000 barrels of light gravity oil and 37 mmcf of liquids rich natural gas in slightly under sixty days on line. Clearly, Devon’s initial efforts did not approach these numbers.
Hess (NYSE: HES), which built its Utica position on the acquisition of Marquette Exploration and a joint venture with Consol Energy (NYSE: CNX), plans to complete ten wells on the Utica with three rigs running by the end of the year. The first well drilled in its Consol joint venture was successful, yielding “commercial amounts of light crude oil” and 1,440 btu during initial flow back.
Outlook
Devon is currently trading around $61 per share, with a price to book of 1.1 and a forward price to earnings of 8.7. For a company of Devon’s size with a clear growth strategy and measurable success over the last few quarters, I think this puts Devon at a discount to its peers. As its oil production continues to ramp up, Devon is set to pull ahead of most of its former natural gas peers. Chesapeake is at the bottom of that list despite the intervention of Carl Icahn; though Chesapeake is up since June, currently around $20 with a price to book of 1.0 and a forward price to earnings of 9.8, the firm has a long way to go towards ensuring its future survival.
Anadarko is trading around $70 with a price to book of 1.7 and a forward price to earnings of 15.2, rebounding nicely from a summer slump. For its part, Hess is looking like a true value, trading around $51 with a price to book of 0.9 and a forward price to earnings of 7.5. Of the four, Hess and Devon have the best chances for growth financed through revenues, as both show a history of keeping debt to equity down.
Devon’s third quarter should see better results, as no serious downtime at any of its production facilities is forecast and the price environment for natural gas is incrementally improving. Devon will also see a small boost from its joint venture with Japanese giant Sumitomo, which will result in a further advantage since after the deal closes Sumitomo will bear a drilling carry amounting to 70% of Devon’s drilling and completion costs on the Cline and Midland-Wolfcamp shales through mid-year 2014.
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