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Big Profits for Big Oil Continues with Devon

Posted on: November 5, 2008 - Email Article - Printable Version

Chris Barrella

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The Oklahoma City based oil and gas giant Devon Energy Corp. [DVN: 70.98, 0.00 (0.00%)] reported a 256% increase in net earnings this morning, continuing the trend of large U.S. oil companies posting record profits amid a recession-fearing market. As much of the stock market continues to shed market value and the lowering of earnings estimates becomes common place, the likes of Devon, Exxon Mobil [XOM: 81.63, 0.00 (0.00%)], and Chevron [CVX: 76.66, 0.00 (0.00%)] are flying high.Profits for Devon spiked to $2.6 billion, or $5.87 per diluted common share, up from third-quarter 2007 profits of $735 million, or $1.63 per diluted common share. Excluding an unrealized gain on oil and natural gas derivative instruments of $1.8 billion pre-tax, earnings rose to $1.4 billion, or $3.09 per share. Analysts were looking for $3.06 per share. As of September 30th, Devon held cash and short-term investments of $1.2 billion.

Hurricanes Gustav and Ike wrecked havoc throughout the Gulf of Mexico over the summer and had a profound effect on Devon’s operations in the region. Due to the suspending of operations during the quarter, output was reduced by 1.5 million BOE. Also in Azerbaijan, their ACG unit with net production of 13 MMBOE was reduced by 400,000 barrels due to transportation interruptions and a sub sea gas leak. These issues aside, Devon was able to blow past analysts sales estimates of $4 billion as a 62% rise in oil and natural gas sales drove revenues of $5.98 billion. Total production was up 3% for the quarter to 58.6 MBOE, but came in under managements projections.

Operations Overview:

Devon primarily operates its exploration and production business in the United States and Canada with 91% of their oil and gas production accounted for from North America. During the quarter, Devon continued to add to their assets with the drilling of 636 new wells, at an overall success rate of 97 percent. They also completed construction of their Northridge gas processing plant in the Woodford Shale field in eastern Oklahoma. The plant can process up to 200 million cubic feet of natural gas per day. In Wyoming, natural gas production hit an all-time high in the Powder River Basin, where Devon has pioneered a move to coal bed natural gas production, a lower risk and cost alternative to conventional natural gas drilling. In Canada, the first phase of Devon’s wholly-owned Jackfish Canadian oil sands project has been completed and once phase two has been completed, Devon hopes to produce an expected capacity of 70,000 bpd in 2012. Devon has also begun expanding into South America with positive early evaluations from their offshore oil drilling in Brazil.

Expenses and Debt

As mentioned earlier, the 2008 hurricane season did limit production in the Gulf of Mexico, and higher costs were a byproduct. Unit lease operating expense (LOE) for the third quarter was $10.09 per Boe compared with $8.04 per Boe in the third quarter of 2007. This included $14 million of costs associated with post-hurricane inspections and repairs.

The company used free cash flow and cash on hand to redeem $983 million of exchangeable debentures, which helped lower interest expense in the third quarter of 2008 by 36% percent.

Where Next?

Even as profits hit record heights, it is hard to look past the beating oil prices have taken in the last three months and how oil companies have followed the trend down: Devon is down over 35% from its all-time high back in May, Exxon down 20% from its peak in early summer, and Chevron suffering over a 26% decline. They are all off their worst levels of the last couple weeks, helped by strong earnings reports from the sector and short covering, but I would remain cautious going forward. With such a strong correlation between profits and prices, I expect numerous oil drillers and producers like Devon to lower estimates in the coming weeks and months as oil prices remain low. The big questions that will affect prices in the near term are if OPEC announces any new output reductions, how will the commodities markets react to the elections, and how will global demand react to $60 oil? Barring a surge past $100 oil, even with exploration and drilling at all-time capacity levels and new projects popping in exotic locations, continued “cheap” oil will take its toll on profits. Only time will tell.