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Devon to 'Stay in the Game' at Slower Pace

With "no reason" to accelerate North American natural gas production in a weak gas market, Devon Energy Corp. is dramatically cutting back capital spending this year and will drop its onshore rig count to 32 by the end of March. Devon's North American rig count peaked at 112 in 2008.

The sober forecast followed Devon's quarterly earnings report, which was issued early Wednesday. The Oklahoma City-based independent reported a 4Q2008 net loss of $6.8 billion (minus $15.42/share). Higher natural gas and liquids production and sales couldn't overcome a $7.1 billion noncash, after-tax loss in the carrying value of the company's oil and gas assets, whose value was based on year-end 2008 commodity prices.

By comparison, Devon's net profit in 4Q2007 topped $1.3 billion ($2.96/share). Without writedowns, Devon earned $297 million (67 cents/share) in 4Q2008 and earned $4.4 billion for the year.

"Three months ago Devon had the largest quarterly earnings in history...and this time we have the largest ever quarterly loss," CEO J. Larry Nichols told financial analysts during a conference call. The company "still owns the same assets...only the accounting has changed...The only constant is volatility."

Devon's "response to the current environment is to cut capital expenditures," Nichols said. The company this year now plans to spend $3.5-4.1 billion for exploration and development, compared with $8.4 billion in 2008.

Assuming a West Texas Intermediate crude oil price of $45/bbl and a Henry Hub gas price of $5.50, Devon's total capital expenditures (capex) are forecast to be $4.6-5.4 billion. If commodity prices fall below those marks, or if the economy deteriorates more than Devon now expects, the company could further cut its budget later in the year, Nichols noted.

"We can't keep spending without some improvement in prices," he told analysts. "To maintain the business and to take advantage" once conditions improve, Devon will "use its balance sheet strength" to fund $1 billion of the total capex. But to ensure it's able to continue to operate if conditions were to deteriorate more, "we are dramatically decreasing our activity" across nearly all of the North American regions. "We'll continue at a rate that will keep us in the game, but at a lower pace.

"There's no reason to accelerate gas production in a weak natural gas market," said Nichols. "We will continue our longer-term growth projects to position us when gas prices and demand recover."

The capex cuts will impact Devon's gas and oil output, but not much. Even with the cuts to spending, Devon is forecasting that full-year 2009 production will be "essentially flat with 2008," said the CEO. "We are fortunate that we will be able to withstand a downturn in the economy."

Devon is "really balancing two things this year," said Nichols. "On the one hand, we have a strong balance sheet. But we want to position ourselves so that when the recession does end, which it will, and gas prices increase, which they will, that Devon is in the best possible position to have fully evaluated the Haynesville [Shale] and other plays, and have all of the pulleys in place to take off...rather than maximize production now when gas prices are weak..."

Steve Hadden, who runs Devon's exploration and production arm, said Devon began "tapering back" its drilling program in the second half of 2008, and by the end of the year the company had 96 rigs in operation. "Now we are running 68 rigs and we'll be down to 32 by the end of the first quarter," he told analysts (see related story).

Devon last year made "significant acquisitions" in four North American gas and oil plays, Hadden noted. In the Haynesville Shale of northwestern Louisiana and the Horn River play in British Columbia Devon added to its leaseholds and continued its development. It also captured sizable positions in two new plays, which Hadden hinted may be world-class.

In the Midcontinent Devon is testing a shale play in west-central Oklahoma dubbed Cana. The company holds 112,000 net acres in the play.

Cana's shale is similar to the rock in the Woodford Shale of the Arkoma Basin, but Hadden noted that "there are some important differences." Cana's targets are at around 14,500 feet, which is about 5,000 feet deeper than in eastern Oklahoma's Woodford Shale. There also appears to be "greater storage capacity in the reservoir," which is "upwards of 200 Bcf per square mile."

Cana, he said, "is similar to the best shale plays in the country, with a net risked potential of 4 Tcfe."

"Devon drilled the first well 18 months ago and we've now completed 10 wells, including seven long lateral horizontal wells," Hadden said. The wells are said to average 6 MMcf/d each and some of the Devon wells are producing "in excess of 8 MMcf/d."

Now the company is looking for "repeatable, commercial results" in the Cana play. If development goes to plan, Devon would build a processing facility to "capture additional value," Hadden told analysts. This year the company plans to drill 27 operated wells in Cana and acquire more 3-D seismic information.

Cody, Devon's second emerging play, is located in south-central Montana. Devon has a leasehold of around 575,000 net acres, Hadden said. "Cody is in the early stages of evaluation." Devon has drilled seven wells and completed three to date with "encouraging results."

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