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Devon Energy's Fortuitous Timing

|Includes: BP, Devon Energy Corporation (DVN), RIG

Devon Energy's announcement last November, that it was selling off all of its non-North American assets, including its Gulf of Mexico holdings, briefly sent DVN stock sharply lower. The thinking on the street was that Devon was not only selling its crown jewels, but might be cutting the 'E' out of its E&P designation. At the time, Devon estimated that its asset sale might fetch as much as $7.5 billion on the open market. Fast forward to the present, and announced asset sales to-date total in the neighborhood of $10 billion with still more  assets on the market and expected to sell by year-end.

 

While the market reacted negatively to Devon's plan, understandably, investors failed to focus on the then hard to foresee positives. Recent events are reminding investors that Gulf assets are expensive to insure and entail a fair amount of risk, and while there was no significant hurricane activity in the Gulf Area last year, climatologists have been warning that global weather patterns suggest that the 2010 hurricane  season could  be far worse than 2009. To be certain, there is no way of knowing what kind of hurricane season will unfold. What is certain is that deep water drilling requires massive amounts of capital and when deep water discoveries are made, the investment required to bring the found resources to market involves not only monumental costs, but in many cases take years to bring online. Add to that the variety of risks that exploration companies face in drilling around the world, I cite Nigeria, Argentina, and Peru as the more obvious examples, and Devon's success in ramping up production in its substantial North American shale play portfolio demonstrates either prescience or old fashioned good luck. Either way, the decision was timely.

 

The catastrophic impact of the explosion and sinking of Transocean's Deepwater Horizon drilling rig is a huge setback to offshore drilling interests in North America. While the economic cost directly attributable to  the spill will not be known for years, clearly, there will likely be a slowdown in exploration and possible  increase in the costs for deep water drilling going forward. Given the magnitude of the BP spill, it is unlikely that the US Government will go forward with plans to open up new areas for development offshore. As a result, onshore assets become all the more appealing.

 

For Devon, the timing was perfect. It will receive far more than expected for its offshore assets and given the current news in the Gulf, undeveloped asset values will likely drop going forward. While it is not entirely clear how Devon will spend the $10 billion it receives for its offshore assets, the most likely scenario is that Devon will shore up its balance sheet and put itself in excellent position to make opportunistic acquisitions in and around the various shale plays it is involved in going forward. Add to this the fact that assessing the risk and value of a pure play land based North American energy producer is far less complex than attempting to assign valuations to producers with far flung assets and Devon becomes a much easier to evaluate acquisition target should the North American natural gas industry continue to consolidate.

 

The company is well positioned to ride out the current environment of low natural gas prices and to benefit from an eventual uptick in natural gas prices. It is unlikely that the spread between the energy equivalent between natural gas and crude oil will be sustained. Either crude oil prices will come down or natural gas prices will rise. Either way, Devon is well positioned for a turnaround.


Disclosure: Long Devon Energy