Fed by the success of its U.S. onshore natural gas operations, Devon Energy Corp. posted a 4.3% gain in quarterly profits and raised its year-end production guidance. The producer reported a 10% jump in quarterly oil and gas output -- most of it through the drillbit -- and it now expects to hit a 1 Bcf/d production rate by early 2009 in its core holding, the Barnett Shale.

Domestically, Devon's winning strategy onshore was evident, with average daily production jumping to 1,567 MMcf/d from 1,382 MMcf/d a year earlier. Total U.S. gas output climbed to 164.1 Bcf from 149.4 Bcf in 3Q2006. Including its overseas operations, Devon's gas production rose to 222.5 Bcf from 210.6 Bcf. Worldwide, oil and gas production from continuing operations rose to 56.8 million boe from 51.8 million boe a year ago.

"We had another exceptional quarter," said CEO J. Larry Nichols during a conference call last week. "We exceeded all of our expectations."

Onshore, U.S. gas output rose to 144.2 Bcf from 127.2 Bcf. Offshore, U.S. gas output fell to 19.9 Bcf from 22.2 Bcf; Canadian gas production declined to 57.9 Bcf from 60.9 Bcf.

The Barnett Shale dominated the news for most of the conference call, and for good reason. The company began drilling its thousandth operated horizontal well there during the quarter. Horizontal drilling has been a hallmark of Devon's work in the shale, unlocking more of the potential for the company's 735,000 net acres. Net production in the one play alone averaged 856 MMcfe/d in the quarter, which was 32% higher than a year ago and 7% higher than in 2Q2007.

Stephen J. Hadden, executive vice president of exploration and production, told energy analysts and investors during a conference call that the Barnett growth was allowing Devon to be "well on our way to hit our goal." Surprisingly, he noted that Devon managed to keep its costs flat to lower in the play while other operators struggled with rising service costs.

"All of the major operators in the play have the same completion data available; they know the impact IPs [initial production] per wells, the recoveries per well. Devon's goal is not to have the maximum well recovery or the maximum reserves, but to focus on optimizing returns," Hadden said. "We will drill 500 wells [in Barnett] this year, by far the largest in the play. That scale gives us in-depth knowledge of the reservoir," and he said it also gives Devon another advantage: long-term relationships with the drilling contractors and oilfield services companies.

"We're asked a lot about why we don't buy service companies," as some of its competitors have done, Hadden said. "It's always been our view to let the professionals who know how to do the services to do what they do best, and let us focus on what we do. These relationships allow Devon to hold well costs flat despite well cost escalation."

Devon drilled 385 wells in the Barnett in 2006. Now with its production data in hand, the operator drilled 127 wells there in 3Q2007, and Hadden said there's no slowing down.

Another growing focus for the company is East Texas, where its Carthage and Cotton Valley plays are showing promise. Devon had five rigs running in that part of the state for most of the quarter, and one well in the Cotton Valley produced at a rate of 6.6 MMcf/d "for the first 30 days of production," Hadden said. Carthage production jumped 5% sequentially from 2Q2007, and it was up 8% from a year ago, averaging 260 MMcfe/d. Based on its success with both vertical and horizontal wells, Devon increased its rig count in Carthage to 13.

"We've got a lot of running room, and we'll continue to grow Carthage production," Hadden said.

Offshore, Devon in August ramped up its 50%-owned deepwater Merganser field in the Gulf of Mexico, which it operates. Combined initial production rates from two wells was about 150 MMcf/d, both which feed into the Independence Hub. It also sanctioned development of its deepwater Cascade project, which is located in the emerging Lower Tertiary trend. Cascade is expected to be the first of two development projects to establish production in the trend, where Devon holds multiple prospects.

Devon drilled 599 wells in the quarter with an overall success rate of 98%. Sales of oil, natural gas and natural gas liquids were $2.3 billion, up 12% from a year ago. The average realized price for natural gas decreased 6% to $5.31/Mcf from $5.63 in 3Q2006. Based on its rising production rates, Devon increased its year-end guidance to 223 million boe, which tops a forecast set just a few months ago of 219-221 million boe.

In other news, Nichols said Devon has shelved its plans to form a publicly traded master limited partnership (MLP), something that was expected to launch before the end of the year. The MLP was to own a minority interest in Devon's considerable U.S. onshore marketing and midstream businesses. The "markets today are just less receptive than when we announced our plan, so we're putting it on hold," Nichols said. "Devon's midstream generated more than $450 million in profit, and we are prudent to be cautious. This is a strategic part of our business. We have no firm time line, but we will reconsider it in the future if markets change."

Net income for the quarter rose to $735 million ($1.63/share), from $705 million ($1.57) a year ago. Excluding one-time items of 8 cents/share, earnings would have been $1.55/share, which topped a forecast of $1.40 in a survey of energy analysts by Thomson Financial. Revenue for the quarter rose 10% to $2.76 billion from $2.5 billion.

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