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Devon Dumping Natural Gas-Heavy Assets in Turn to Oil

The once and former king of unconventional natural gas production in the United States, Devon Energy Corp., is selling close to one-third of its gas reserves to give it more leverage in a bid to become a top North American oil producer, CEO John Richels said Wednesday.

The Oklahoma City-based operator on Wednesday announced its makeover on the news that it is spending $6 billion cash to acquire Eagle Ford Shale property from GeoSouthern Energy Corp., a pioneering operator in the play. The transaction, the biggest to date this year in the U.S. onshore, includes about 82,000 net acres that currently produce 53,000 boe/d.

Richels and his management team spent about an hour discussing the GeoSouthern transaction, and the portfolio redo, during a conference call.

The "catalyst" of the call was the acquisition, "but that's really just the first part of the story," said Richels. In addition to acquiring the principal arm of the privately held producer, "we're also announcing a plan to sharpen our focus and monetize assets that lack scale or that are not competitive within our portfolio…

"The result will be a company that looks and performs very differently in the future."

Richels said he's confident the assets for sale will prove attractive. The properties now set for divestiture hold about 30% of Devon's natural gas reserves, 12% of the natural gas liquids and 8% of the oil. All of the Canada conventional resources would be sold.

Devon cut its teeth in unconventional drilling beginning in 2002 when it paid $3.1 billion to buy George Mitchell's Mitchell Energy & Development Corp., an acquisition that not only gave it prime acreage in the emerging Barnett Shale, but access to proprietary technology to unlock tight gas reserves (see Daily GPI, Nov. 19, 2002). Devon paid Mitchell about half of what it paid for the GeoSouthern properties, $3.1 billion.

So what does the transformation mean for Devon? Simple answer: a lot less natural gas production and potentially a lot more crude oil output across North America. Details were scarce about exactly what's to be sold off, but the primary focus heading into 2014 will be to extract crude from the Eagle Ford and Barnett shales, the Permian Basin and the Anadarko Basin's Cana-Woodford formation. Also in the mix is growth from Canada heavy oil production.

In the Eagle Ford alone, Devon plans to spend around $1.3 billion in 2014, said the CEO. Most of the near-term capital will be focused only on the Eagle Ford and Canada oil.

"The new Devon is a significant North American oil producer capable of delivering high rates of growth in high-margin oil production while generating free cash flow," Richels said. "This deal represents a major milestone in our disciplined plan to enhance our balanced returns-focused portfolio, further shifting production to our highest margin product, which of course is U.S. light, sweet crude."

Between July and September, Devon's average production was 691,000 boe/d, up from 678,000 in 3Q2012 -- mostly all from oil growth. Oil output averaged 165,000 b/d in 3Q2013, 16% higher year/year, with a 29% increase in the Permian Basin and 34% higher in the Rocky Mountain operations. Light oil production, which nearly doubled from a year ago to reach 81,000 b/d, should top 90,000 by year's end, Richels said last month.

GeoSouthern's 82,000 net acres in the South Texas counties of DeWitt and Lavaca produce an estimated 53,000 boe/d, 56% light crude, 20% natural gas liquids. Devon also gains about 1,200 undrilled locations. The risked resource potential is estimated at 400 million boe, mostly proved reserves. Development is concentrated in the Black Hawk field, where GeoSouthern has partnered with BHP Billiton plc. They split ownership and costs evenly across the 173,000 gross acres; Devon would continue to partner with BHP once the transaction is completed, Richels said.

GeoSouthern pumped up its rig count to 18 from five in 2011. Average estimated ultimate recoveries in DeWitt County have exceeded 800,000 boe per well, said COO Dave Hager. The rig count should be steady through 2014. By entering the play in full development mode, Devon plans to expand production in the near term while generating free cash flow.

Production from the new oil assets, and from the ones already held, should overcome any downturn in output, said Hager.

"The acquired assets are expected to grow at a compound annual growth rate of 25% over the next several years, reaching a peak production rate of approximately 140,000 boe/d." The development drilling program already is self-funding and should generate an estimated annual cash flow of $800 million beginning in 2015.

The GeoSouthern purchase "leverages our core competencies," said Hager. "The technical expertise and project management experience developed in our other large-scale, unconventional development plays provide us the skillset to efficiently develop these assets and optimize the value through improved recoveries and reduced costs."

The Blackstone Group LP, GeoSouthern's private equity partner in the Eagle Ford, is expected to take a $1.54 billion payday on the sale. Although it's selling its principal subsidiary, GeoSouthern will continue to explore and develop onshore properties. It owns and operates about 68,000 net acres in the Austin Chalk formation and Brookshire Dome Field in Texas.

Energy analysts appeared enthusiastic about Devon's new direction. The $6 billion purchase price suggests Devon is paying around $113,000/bbl, or about $73,000 net, according to Wells Fargo.

"We view the possible acquisition of GeoSouthern Energy very positively, since it would give DVN added running room to grow its oil volumes from a new position in the Eagle Ford Shale," said Canaccord Genuity's Robert Christensen. "A deal would bolster the already solid U.S. oil production growth it is getting from its emerging Permian and Mississippi-Woodford plays." More oil growth and a "higher mix of oil as a share of total output are key elements" for Devon to receive a higher valuation for its "deeply undervalued" exploration assets.

"We believe this is a positive move for the company, as the Street and investors have been questioning Devon's remaining inventory levels," said Wells Fargo analysts. GeoSouthern "adds tier-1 acreage in a high profile play, and unlike prior Devon acquisitions, provides immediate production visibility."

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