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Devon Digging Deeper in STACK, Permian Delaware, Pledging to Return More Cash to Shareholders

Devon Energy Corp.’s management team on Wednesday promised to return more cash to shareholders and reduce debt following a fourth quarter report that failed to match analyst -- or internal -- guidance.

The Oklahoma City-based independent reported mixed results for the final three months of 2017, with overall capital spending above guidance and production of 545,000 boe/d below the low end of guidance (551,000-571,000 boe/d).

During a conference call to discuss results, CEO Dave Hager began by addressing the elephant in the room: why has no share repurchase program been authorized even with a huge stash of cash? Devon exited 2017 with $2.7 billion of cash on hand.

“Let me be clear,” Hager said. “As we generate more cash through our operations and asset divestiture programs, we will reward our shareholders through higher dividends and opportunistic share buybacks. However, our near-term priority is to use a significant portion of our large cash balance to reduce the debt associated with our upstream business.”

Reducing debt is the top near-term priority, he said, because the company is shifting to development mode in its two biggest onshore plays, the Permian Basin’s Delaware sub-basin and the STACK, i.e., the Sooner Trend of the Anadarko Basin, mostly in Canadian and Kingfisher counties.

“It is absolutely critical that we possess a top-tier balance sheet in order to maintain consistent activity levels through all cycles,” said the CEO. “Commodity prices go up and down, but our plan to execute on a steadier and more measured development program through all cycles will optimize returns and value associated with our development programs.”

Devon could have authorized “a $2 billion share repurchase program today and had our stock price positively respond to this type of announcement,” but “it is not the correct move for Devon right now. Our business is performing at a very high level. And with the continuation of current commodity prices, coupled with imminent asset sales during 2018, I am confident in stating that there will be increasing shareholder returns this year.”

Operational issues during the final three months of 2017 reduced output by around 9,000 boe/d in the STACK and 5,000 b/d from heavy oil operations at the Jackfish complex in Canada.

The STACK issues were resolved by the end of the year, Hager said, following well tie-in issues at nonoperated wells. Temporary steam plant problems also are being resolved.

Hager attempted to make lemonade from lemons, pointing to Devon’s broad exploration and production (E&P) portfolio.

“I do want to be clear on this,” he said. “We have no shortage of highly attractive growth opportunities within our portfolio and could definitely grow at much higher rates in 2018 if we chose to optimize top line production with our capital allocation.

“However, we are absolutely committed to doing business differently in the E&P space, and we are optimizing our capital allocation to maximize corporate-level returns while delivering capital-efficient cash flow growth.

“We fundamentally believe that a steadier and more measured investment program through all cycles is the correct strategy to efficiently expand our business and maximize Devon's valuation in the marketplace as opposed to pursuing maximum production growth in any one given year.”

He pointed to the Delaware and STACK, where Devon’s “top 30 wells” operated in 4Q2017  averaged initial 30-day production rates of more than 2,500 boe/d, 60% weighted to oil.

E&P capital investments this year are expected to be $2.2-2.4 billion, with nearly 90% earmarked for U.S. resource plays. The “vast majority” of domestic spend is geared to the Delaware and STACK.

“The 2018 program will deliver a step-change improvement in capital efficiency,” Hager said. At least 25% more wells are expected to be tied to sales in the STACK and in the Delaware this year from 2017. The capital program also should be “self-funded” at a $50/bbl West Texas Intermediate (WTI) oil price.

“Devon has no plans to increase activity levels with higher prices.”
To 2020, the compound annual growth rate from the combined STACK and Permian is set at 25%-plus.

“In 2018 and beyond, with our low-risk development programs focused in the economic core of the Delaware Basin and STACK plays, we expect to deliver a dramatic step change in capital efficiency, achieve attractive corporate-level returns and generate substantial amounts of free cash flow at prices above our base planning scenario of $50 WTI pricing.”

Devon should be able to achieve a 15%-plus rate of return to 2020, generating $2.5 billion of cumulative cash flow over the period. About $5 billion of assets also are set to be monetized in the next three years.

Management plans to “accelerate value creation through the pursuit of capital-efficient cash-flow growth and portfolio simplification, not top-line production growth,” Hager said. “Looking beyond our initial priority of reducing up to $1.5 billion of debt from our upstream business, we plan to return excess cash flow from operations or divestitures to shareholders through both opportunistic share buybacks and dividend growth.”

Exploration and development would remain centered around prospects in northwestern Oklahoma and in the Delaware. In 1Q2018, production should average 530,000-554,000 boe/d.

Full-year output now is estimated to average 552,000-576,000 boe/d, with U.S. oil production increasing about 14% year/year.

STACKing It Up

From the STACK and Permian combined, this year’s production should increase by about 25%.

Production from the top two fields since the start of this year already is averaging 195,00 boe/d, up 10% sequentially and 20% higher than the average for full-year 2017.

“The substantial increase in daily production is driven by higher operated completion activity in the Delaware Basin and tie-in of more than 50 nonoperated wells in the STACK around year end,” which resolved the loss of output in 4Q2017, said Hager. “In aggregate, these two high-growth assets remain on plan to increase oil production by greater than 35% in 2018 compared to 2017.”

Estimated proved reserves were 2.2 billion boe at the end of 2017, a 5% increase from 2016. Proved developed reserves accounted for 81%. At year’s end, liquids reserves advanced to 1.2 billion boe, driven by a 32% increase in U.S. oil reserves.

Last year’s reserves growth was “entirely” from U.S. resource plays, where proved reserves increased 11% to 1.7 billion boe.

In the fourth quarter, net earnings totaled $183 million (35 cents/share), down from year-ago profits of $207 million (41 cents). Full-year 2017 earnings reversed from 2016 to $898 million ($1.71/share) from a loss of $1.056 billion (minus $2.09).

Revenue in 4Q2017 climbed year/year to $3.98 billion from $2.81 billion. Full-year revenue totaled $13.9 billion, versus $10.3 million in 2016.

Devon’s midstream business generated $272 million in operating profits in the fourth quarter, increasing 35% year/year. This growth was driven entirely by its 64% ownership in EnLink Midstream. Overall, for 2017, midstream profits reached $912 million, the highest in company history.

Beginning in the fourth quarter Devon changed its method of accounting for oil and gas exploration and development activities to successful efforts from the full-cost method; all reported financial results reflected this accounting change.

The company currently has around half of its expected oil and gas production hedged for 2018. It also has secured Western Canadian Select (WCS) basis swaps on about 50% of its estimated Canadian oil production in 2018. The WCS basis swaps are locked-in at $15 off the WTI benchmark price and are currently valued at around $300 million.

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