Devon Energy Corp (NYSE: DVN ) has made a dramatic shift from natural gas to oil over the past few years. That has sent its stock up more than 30% in the past year. While there are reasons for continued bullishness, investors also have to be aware of the risks. Here are three reasons Devon Energy's stock could fall, and that might just open up a buying opportunity for bullish long-term investors.
Focus on oil could backfire
Over the past year, Devon Energy has grown its U.S. oil production by 79%. The company combined both organic production growth in the Permian Basin with its acquisition of a position in the Eagle Ford shale to give its oil production that big boost. Looking ahead, it expects its combined oil production in the U.S. and Canada to grow by another 20% next year. This growth is expected to produce better profit margins for the company.
However, North America is quickly becoming saturated in oil. This is causing growing price discounts to the global oil benchmark. Currently, U.S. benchmarked crude oil, WTI, is selling for $95 per barrel, while the global benchmark, Brent, sells for around $102 a barrel. There is a concern that oil prices in the U.S. will trade at an even greater discount in the future because of surging shale production. We've already seen this play out in Canada, where Devon Energy realized just under $70 per barrel for its oil last quarter as the country lacks pipeline capacity to get the oil to refineries.
Because a greater portion of Devon Energy's production is coming from oil, its stock price could fall if oil prices in the U.S. and Canada keep heading lower.
Emerging oil plays might never emerge
Devon Energy's future is built on a mixture of core growth assets that include the Eagle Ford, Permian Basin, Anadarko Basin, Barnett Shale, and the Canadian oil sands. While these assets will drive its growth in the near term, Devon Energy needs to continue to find new supplies of oil and gas to keep growing in the future. Currently, two assets are beginning to emerge that the company hopes will fuel that future growth: The Rockies and Mississippian-Woodford.
Devon Energy needs at least one of these two assets to emerge as an additional core area. That's no small task as the company has had issues in the past with early-stage exploration plays. The company's Utica shale position, for example, turned in poor results, and the company has since given up on pursuing that once-promising shale play. Its acreage simply was located in a weaker spot of the play. There is nothing to say that won't happen again in either the Rockies or Mississippian-Woodford, and while initial results have been more promising, either play could end up being a dud, or at least not economical enough to move the needle.
Canadaian oil sands' image doesn't improve
In addition to its U.S. oil production, Devon Energy has a large position in the Canadian oil sands, as noted on the following slide.
The problem here is the fact that environmentalists are firmly opposed to the oil sands because the oil is 17% more carbon intense to produce than conventional oil in the U.S. Further, it uses a lot of fresh water, disturbs a large surface area, and is harder to clean up. This is why environmentalists continue to oppose pipeline projects like the Keystone XL, which has had a noticeable impact on the price of oil in Canada. This has forced producers to ship more oil by rail, which eats into their profits. Further, with oil prices low, it limits growth opportunities as the economics of the oil sands aren't as compelling.
Looking ahead, Devon Energy expects its Canadian oil sands operations to begin pumping out over a billion dollars per year in free cash flow starting in 2016. However, that outlook could be affected by falling oil prices. Further, its future growth in the Jackfish area as well as in the Pike project area could be put on hold for a long time if oil prices fall, or even if the Canadian government bows to environmentalists and slows down project approvals.
No company is without risk, so investors shouldn't be surprised that Devon Energy has a number of them that could impact the stock price. The biggest risk is oil prices, because that could impact both its emerging oil projects as well as its Canadian operations. While Devon Energy does a good job at hedging oil in the near-term, no company is immune to oil price volatility over the long term. That being said, the longer-term outlook for oil continues to be bright, which suggests that any weaknesses in Devon Energy's stock prices just might be an opportunity for long-term investors to add to their position.
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