Devon Energy Corp (DVN)

ArmChairAnalyst (92.95) Submitted: 9/14/06 4:04 PM : Start Price: $64.74 DVN Score: 33.11

Devon in Deep Water

   We all understand what it means to be in hot water and many of us from first-hand experience. But what does it mean to be in deep water? Devon Energy Corporation (NYSE:DVN), one of the larger independent oil and gas producers headquartered in Oklahoma City, knows or should know very soon. Along with Chevron Corp. (NYSE:CVX) and Statoil ASA (NYSE:STO), they announced the discovery of the Jack oil field purportedly containing between 3 billion and 15 billion barrels or oil and natural gas.

   However, to us Fools that is old news. But what is interesting is that now we have been informed that several leases on a portion of this 300 square mile oil field appear to be exempt from federal royalty payments. Apparently, to encourage oil exploration in the 1990s congress exempted oil from royalty payments extracted from new exploratory wells when oil reached a certain price trigger. The price trigger is well below the per barrel price seen today. But, it now appears that oil leases written in 1998-1999 contained the royalty exemption but did not include the price trigger to re-apply the royalty. Devon Energy may now be on top of the largest oil find since Alaska?s Prudhoe Bay and may well soon be in Deep Water.

   So why should a Fool concern himself or herself with whether or not Devon?s tall, cold glass of iced Texas tea is running over. Well there are several reasons. Fellow Fool, Shannon Zimmerman, considers Devon Energy a defensive value stock best geared toward hedging against your more growth oriented portfolio. Normally, I would agree, but not anymore.

   In their 2006 second quarter report, Devon reported a 7% percent increase in revenue over the comparable period in 2005. Not to shabby, but not a stock one would expect to shoot to the moon. Also revenue for the first half of ?06 increased 11% over the revenue of ?05. Not really that spectacular considering their average price of domestic crude in ?05 was $40.18 and so far in ?06 it has been $66.05. But what is interesting is that revenue continued to increase despite a 2 million barrel decrease in domestic production and a 5 million barrel decrease overall.

   Now the point, it appears that with this new find Devon has found the production increase it has been hoping for. Further, if the federal government doesn?t renege on the wording of its leases it appears that there will be a large amount of royalty free oil to extract from the depths of the Gulf. Fool, Will Frankenhoff pulls back on our reins telling us that since this new well is so deep (28,175 feet) it could be at the very earliest 2010 before these new wells come online.

   However, I contend that with oil prices remaining above $60.00 per barrel. Iran just yesterday stated that OPEC should not allow oil to drop below the $60.00 price point. Also, with the governments focus on reducing our dependency on foreign oil and this new development of royalty free black gold, Devon Energy and its partners will be willing to pay a little more now, in the way of decreasing the set-up time for wells in the Jack field, to get a lot more later. With future earnings on the mind, Devon will definitely be in deep water with its Texas Tea runeth over much sooner than we first believed.

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