Devon Energy (DVN) recently closed its $1.4 billion joint venture with Sumitomo Corporation, which will help Devon finance its development of the Cline Shale and the Midland-Wolfcamp Shale. The $980 million drilling carry paid by Sumitomo after the initial payments made at closing will finance these efforts through mid-2014. This will allow Devon to pull ahead on these competitive plays, which are currently underrated given the focus on the Bakken and the Niobrara.
As part of the Permian Basin, the Cline Shale underlies the Wolfcamp. Devon allocated $1.4 billion to the Permian in 2012, which it expects to result in 30% oil growth from the play by year end; the $1.4 billion from the Sumitomo joint venture that it expects to spend through the next two years will result in even further growth, even as wells spudded in 2012 continue to produce. Laredo Petroleum Holdings (LPI) Chairman and CEO Randy Foutch also believes in the Cline's potential, recently calling it "a world class shale based on what we know today." That leaves the door open fairly wide, since the Cline is relatively underexplored.
In addition to the well known Cline, Wolfberry, Bone Spring, and Wolfcamp opportunities, Devon is maintaining a long term target on stacked pays within the Permian, notably the Tubb, Wichita-Albany, and Strawn formations. These are interesting pays that can be exploited using similar methods to other pays within the Permian. The vertically commingled Tubb, for example, is believed to be coeval with the lower Spraberry in the Midland Basin and the Dean of the Delaware Basin. This correlation makes it simpler for producers with experience in either of the other pays to exploit, especially since the Tubb is located as shallow as 2,000 feet.
Devon does not seem to be ruling out the deepest reaches of the Permian, either, such as the Pennsylvania Atoka, at vertical depths between 8,000 and 10,500 feet and still within the oil window. other firms operating on the Permian are already targeting this deep objective. However, at present it appears Devon will substantially explore and develop its other targets within the Permian before moving on to these more challenging pays, which I think is a good strategy given its need to further develop its oil resources.
Keeping the Mississippian Active
Devon is also partnering with smaller US based operators in its Mississippian leasehold. The firm recently started drilling with partner Osage Exploration and Development, a privately held firm, in Logan County, located in the north central portion of Oklahoma in the middle of the Mississippian fairway. Although the deal between Osage and Devon is small, comprising at present only one well and a working interest for Osage of less than 20%, Osage's Chairman and CEO Kim Bradford remarked that Osage is "delighted to be participating in a well operated by Devon Energy, who we believe is one of the best in the business, as well as drilling alongside them." The opportunity to drill with and learn from Devon is certainly beneficial to Osage, but it is also beneficial to Devon.
Perhaps seeing the traps that competitors like Chesapeake Energy (CHK) and Encana (ECA) laid for themselves as natural gas prices plummeted, Devon is following a strategy that sees it pursuing not only less risky ventures, but making deals in such a way that even in these stable investments the risk is divided among other partners, even comparatively tiny ones like Osage. This has echoes of Range Resource's (RRC) deal with private AusTex Oil Limited, which like Devon's deal with Osage allows AusTex a working interest in some of the much larger Range's Mississippian wells.
Devon's early focus on the Mississippian is also beneficial, since the play is already showing signs of a consolidation wave. Midstates Petroleum (MPO) recently agreed to purchase private Eagle Energy in a deal valued at $650 million. As a tight oil play with targeted formations relatively close to the surface, the Mississippian allows producers to experiment with new technology for improved recovery, as well as standards such as downspacing. In some areas, producers are downspacing wells as close as 160 acres.
Devon is currently trading around $61 per share, giving it a price to book of 1.1 and a forward price to earnings of 11.7. Chesapeake is trading around $19, with a price to book of 0.9 and a forward price to earnings of 10.9. Encana is trading around $22 with a price to book of 2.4 and a forward price to earnings of 40.6, which reflects the company's own struggles with low natural gas prices and strategy that will see it taking on more debt than many investors are comfortable with.
For further comparison, Midstates Petroleum is trading around $9, with a price to book of 1.6 and a forward price to earnings of 10.4. Range Resources is trading around $71, with a price to book of 4.8 and a forward price to earnings of 69.1, thanks to its incredible trajectory since mid-summer. Finally, Laredo Petroleum is trading around $22, with a price to book of 3.5 and a forward price to earnings of 15.6.
Although it is making strides into improving its oil production, Devon is still significantly exposed to dry gas, which makes up 63% of its production mix. However, with $7 billion in cash and short term investments, Devon has the resources to continue exploration and development and see it through until prices improve, which gives it a definite advantage over its more gas dependent peers. Moreover, its unrisked resources at 31.8 bboe are nearly double its proved and risked resources at 16.2 bboe, giving the firm a healthy inventory of exploration and development opportunities, many in oil. This will help the firm overcome its natural gas exposure, and with its smart financing moves, will not lead to accumulation of significant debt in the near term.