While most of Devon Energy Corporation's (DVN) production growth in the second quarter was attributed to its Jackfish and Permian Basin operations, its operations in other plays remain stable, which is what is allowing Devon to pursue growth in these and other high value plays. In particular, Devon has been acquiring massive tracts of leasehold in the light oil Mississippian play, amounting to 545,000 net acres at the close of the second quarter. This could be the next big growth opportunity for Devon, even as it continues to focus on its current production leaders.
The Mississippian Leads the Way
The Mississippian is a promising area for Devon, since Devon's experience in unconventional shales like those in the play is deep. Its focus on the Mississippian is primarily within Oklahoma, where 400,000 net acres of its total Mississippian leasehold is located. Its risked resource potential in the play is estimated at above 800 mmboe, which explains why Devon wants to drill at least 50 wells total here in calendar year 2012. Its joint venture with Sinopec, in which Sinopec claims a 33% stake in the Mississippian among other fields, awarded Devon a generous drilling carry that will allow it to complete drilling without massive expenditures from its own exploration budget.
Chesapeake Energy Corporation (CHK) was no doubt disappointed at Devon's joint venture announcement, since it is seeking a joint venture partner of its own on the Mississippian, or failing that, a buyer for its leasehold. Chesapeake is struggling to raise capital against its massive debt, which is siphoning the cash it needs to drill its leasehold efficiently on its own. Chesapeake's Mississippian holdings are attractive, encompassing 2 million net acres with steadily rising production, 39% comprised of oil, 12% in natural gas liquids, and 49% in natural gas. Despite its cash struggles, Chesapeake is operating 18 rigs on the play, most likely because of the low cost to drill and relatively generous oil production compared to the other plays the company is struggling to hold on to.
These trends have many benefits for unconventional drillers, not least of which being that the shales match the ideal profile for unconventional drilling. Porosity in the Mississippi Lime is up to 15%, when 8% is generally considered an indication of profitable drilling. Between this and the relatively shallow depths of the target, drilling costs on the Mississippi Lime can fall below $2.5 million per well while returning production that is frequently between 52 and 55% oil.
Future Plans for the Woodford
Long term, Devon plans to explore not just the Mississippian lime, but the underlying Woodford Shale, which is present beneath much of Devon's Oklahoma acreage. The Woodford is natural gas heavy, located at depths between 6,000 and 12,000 feet. This is well below Devon's current target depths of 4,500 to 6,500 feet for the Mississippian Lime, but potentially profitable once natural gas prices rebound. This is especially true since Devon's joint venture with Sinopec does not grant Sinopec an interest in the Woodford, although if the initial venture is successful, I would not be surprised if the companies announced a second venture for Woodford exploration.
Competitor Apache Corporation (APA) is also targeting the Woodford Shale, as part of an exploration strategy that is considerably more expansive than that of Devon. Range Resources Corporation (RRC) is also a player on the Woodford, though its focus is primarily on the Anadarko Woodford and growth through the drillbit, rather than through acquisitions.
Exxon Mobil Corporation (XOM), though, is one of the most aggressive drillers on the Woodford, with 12 rigs on the play exploiting the liquids-rich Anadarko Woodford, as well as the wet mix natural gas that the Arkoma Woodford trend tends to produce. These rigs are operating through Exxon Mobil subsidiary XTO Energy. XTO Woodford regional production supervisor Guy Haykus indicates, "We're stepping things up here; right now this is a limelight area."
The Woodford may well be a limelight area for Exxon Mobil. Its excitement over the Woodford is evident, since it recently acquired 58,400 acres from Chesapeake for $590 million in cash, or about $101 an acre. This was an excellent deal for Exxon Mobil, though it helps explain why Chesapeake is having trouble finding a joint venture partner. I think its willingness to let go of properties that might not be profitable now, but are sure to become profitable in the future, is an indicator to others that Chesapeake is willing to part with acreage at rock bottom prices, making a joint venture with a long-term drilling carry unpalatable.
Devon is currently trading around $58 per share, with a price to book of 1.1 and a forward price to earnings of 9.8. Chesapeake is trading around $19 per share, with a price to book of 0.9 and a forward price to earnings of 10.6. Apache is trading around $86 per share, with a price to book of 1.1 and a forward price to earnings of 7.6. Range is trading around $65 per share, with a price to book of 4.4 and a forward price to earnings of 69.6, which is very high and skewed by its natural gas heavy portfolio, with lower earnings forecasts as a result. Exxon Mobil is trading around $87 per share, with a price to book of 2.5 and a forward price to earnings of 10.0, an excellent multiple for this stable large value.
A month after its second quarter earnings release, Devon is seeing a slide from its earnings bounce that might be deeper than some expected. I think that this is due in part to continued softness in the natural gas markets, since Devon does have considerable natural gas exposure. But, there are many reasons to be bullish on natural gas long term, in which case Devon occupies an enviable position in natural gas heavy plays, in some cases with equipment in place. This being the case, Devon is a good long-term stock for growth, especially at its current price.