For Devon Energy Corp, It's Texas or Bust

With a focus on oil, Devon Energy (NYSE: DVN  ) is laying the groundwork for high returns. In Devon Energy's latest quarterly report, its oil production in the United States grew by 56% year over year. As its oil production soared upwards, so did its EPS, which grew by 103% versus the same quarter of last year. Devon Energy's update was strong enough to catch the attention of several analysts, with the likes of RBC Capital and Morgan Stanley raising their price targets to $81 and $88 respectively.  

Texas or bust
Texas has been very kind to numerous oil and gas producers, including Devon Energy. Year over year, the company boosted its production from the Permian Basin by 36% to 91,000 boe/d, 60% of which was light oil. 

According to management, "The most significant contributor to the company's Permian oil growth was once again the Bone Spring oil play in the Delaware Basin. Devon added 35 new Bone Spring wells to production in the first quarter, with initial 30-day rates averaging nearly 700 Boe per day, of which 80 percent was light oil."

With 12 rigs up and running in the Delaware Basin, Devon Energy will be able to capitalize on its 25 years of drilling inventory in the area. The company has more than 5,000 potential drilling locations in the Delaware Basin, with 3,500 of those locations in the very oily Bone Springs play. To continue its focus on oil, Devon Energy plans on ramping up drilling activity in the Permian next year to churn out even more crude. 

The Permian Basin offers Devon Energy a long runway of oil production growth, but that isn't the only play it's banking on for oil production growth. Recently, the company completed it purchase of 82,000 net acres in the DeWitt and Lavaca counties, which house part of the Eagle Ford shale. 

A new, oil rich play for Devon
In March (its first full month of ownership), Devon Energy averaged 49,000 boe/d from its liquids-rich Eagle Ford assets; this was depressed due to issues with gathering systems being down and the timing of well tie-ins. Now that those issues have been resolved, the company is currently averaging 64,000 boe/d from the Eagle Ford. This is just the beginning, as Devon Energy sees its Eagle Ford operations averaging 100,000 boe/d next year. To get there, it is going to utilize its 1,200 drilling locations and 400 million BOE of potential reserves in the area. 

Part of Devon Energy's ambitions lay in its 32,000 net acre position in the Lavaca county, which will see its first well come online this quarter. If its Lavaca county acreage can yield similar results as seen in its DeWitt operations, then the company would be able to revise its potential drilling locations and reserve estimates much higher. 

Proof as to why that could quite possibly happen can be found in Penn Virginia's (NYSE: PVA  ) results from its Lavaca and Gonzales operations. Penn Virginia owns 80,000 net acres in those two countries (as of February 2014), with its 75.6 million BOE of proven reserves being 89% liquids (oil and natural gas liquids.) 

Penn Virginia's management sees 190 million BOE in potential reserves within its acreage in the Eagle Ford. To grow oil output while trying to turn the additional 114.4 million BOE of potential reserves into proven reserves, the company is going to operate six rigs in the Eagle Ford this year. 

Foolish conclusion
Oil plays offer very high rates of return, which is why Devon Energy spent a whooping $6 billion to get a foothold in the Eagle Ford. While some criticized the company for such a large purchase, management's guidance can put those worries to rest. According to Devon Energy, by 2015 its Eagle Ford assets will be churning out $1 billion in free cash flow; this is very impressive and would allow the company to easily manage its debt load. 

Investors should not only pay attention to Devon Energy's results down in Texas, but also to the results of companies like Penn Virginia that operate right next to Devon. This way investors can get the big picture, and see what their investments might turn up based on the results of previous E&P efforts. 

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9/15/2014 4:00 PM
DVN $70.27 Up +0.32 +0.46%
Devon Energy CAPS Rating: ****
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Penn Virginia Corp CAPS Rating: **

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