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Devon's North American Expansion Takes Long View on Prices

Devon Energy Corp. has a long "to-do" list of exploration activities planned in North America this year -- in the deepwater Gulf of Mexico, onshore in its core U.S. holdings and in emerging Canadian oilsands projects. The plans take into account rising service and labor costs, but "we'd have to see a fairly large reduction in prices" before pulling back on any planned exploration, President John Richels said. "We're taking the longer-term view, and we're very confident that we'll see higher prices this year on the gas and oil side."

Richels joined Devon's management team for a conference call Wednesday to discuss quarterly and year-end earnings. He detailed the 17% hike in Devon's operating costs last year over 2005, which followed "upward pressure on services and personnel costs." But those costs were "a recurrent theme in the exploration and production sector." And already, Devon has begun to see those costs coming down.

"We tend to review this on a fairly periodic basis," he said. "We keep pretty close ties on that, and we are making most of our decisions based on longer-term horizons that are more than a quarter or a half year." Devon is budgeting $4.9-5.3 billion for 2007 exploration; all-in capital costs are estimated at $5.3-5.7 billion. Devon invested around $5 billion in exploration projects last year.

As several of its peers have noted, Canadian costs are a problem. CEO C. Larry Nichols said some of Devon's competitors were "pulling back on investments" there, but their pull-back provides "opportunities in the market. It will return over time, and we'll watch to see how long that takes. We're prepared to ramp up the conventional side when that occurs."

Meanwhile, Devon has plenty of opportunity to grow its core U.S. onshore holdings and emerging deepwater development, said Nichols. Devon expects to increase total drillbit reserves this year by 350-370 MMboe, which would be two-thirds more than estimated production.

In addition to the drillbit reserves, oil and natural gas output from continuing operations (excluding West African assets for sale) is forecast to be 219-220 MMboe in 2007, 10% higher than in 2006. Full-year gas output is expected to climb to 841 Bcf from 815 Bcf in 2006. Devon drilled more than 2,400 wells in 2006, with a 98% success rate.

"This was one of the best years in Devon's history," said Nichols. "We had the highest earnings per share in Devon's history...We funded the largest exploration program in the company's history." Nichols said last year's successes had "set the stage for well into future," led by core U.S. onshore exploration. "We couldn't be more excited about Devon's outlook."

Using only 2006 full-year data for its retained properties, total U.S. gas production jumped 6% year-over-year, to 566.1 Bcf from 535.5 Bcf. Onshore, gas output rose 7% over 2005, to 487.5 Bcf from 455.2 Bcf. However, offshore gas output fell 2% to 78.6 Bcf from 80.3 Bcf. In Canada, total gas output fell 3% year-over-year, to 240.4 Bcf from 246.6 Bcf.

Devon's estimated proved reserves at year-end set a record at 2,376 MMboe, a 13% increase over 2005. Reserve additions from all sources before price revisions were 533 MMboe, more than double the company's annual oil and gas production of 214 MMboe. Also last year, Devon's reserve life index (proved reserves divided by annual production) increased to 11.1 years from 9.4.

The independent Devon added 427 MMboe organically last year through discoveries, extensions and performance revisions. The company also acquired 106 MMboe, mostly in the Barnett Shale, primarily through the $2.2 billion purchase of privately held Chief Oil & Gas. At the end of the year, Devon's proved developed reserves were 1,674 MMboe, or 70% of proved reserves, which were composed of 8.4 Tcf, 708 million bbl of crude and 275 million bbl of natural gas liquids.

Revisions, mostly related to the drop in year-end oil and gas prices, reduced 2006 proved reserves by 50 MMboe.

Going forward, Devon is counting on the Barnett to provide the lion's share of gas production. Its 2007 Barnett gas output is expected to top 800 MMcf/d. Devon produced 709 MMcf/d from the play in December.

In the deepwater, Devon will participate in a second delineation well at the Chevron Corp.-led Jack well later this year. A test on the No. 2 Jack well, located in the Lower Tertiary trend, proved successful last year, but more tests have to be conducted before development begins. The well is considered a bellwether for the Lower Tertiary, and Devon, which holds a 25% stake in the Jack, also holds stakes in several other discoveries in the trend.

For the final quarter, Devon blamed the slide in gas prices for lower earnings. It reported net profit fell to $582 million ($1.31/share), down from $970 million ($2.18) in 4Q2005. Overall revenue fell 18% to $2.61 billion from $3.19 billion a year ago. Thomson Financial analysts had expected Devon to average earnings of $1.36/share on $2.62 billion in revenues.

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