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While weak oil prices continue to weigh down Devon Energy's (DVN +1.26%) financial results, the company's underlying operations are delivering robust returns. In fact, during the third quarter Devon recorded the best drilling results in the company's 45-year history. That is after the 20 wells it brought online during the quarter averaged an initial 30-day production rate of 2,000 barrels of oil equivalent per day (BOE/d). Those robust wells allowed the company to stay on pace with its full-year guidance as it gets ready to ramp up heading into 2017.
Drilling down into the numbers that matter
In many ways, the third quarter was a transitional one for Devon Energy. That's because the company closed $1.8 billion of non-core asset sales, which weighed on companywide production. Overall, total production averaged 577,000 BOE/d, which was down 10.4% from just last quarter. However, production from its retained asset base rose slightly less than 1% to 550,000 BOE/d.
Two factors drove that uptick from its core assets. First, production at the company's Jackfish complex in Canada was up 13.2% over last quarter after the company completed scheduled maintenance. That improvement, along with the remarkable results of the shale wells the company did bring on during the quarter, more than offset a 2.1% decline in production from the company's U.S. resource plays as a result of underinvestment.
Aside from the production numbers, there were a few other metrics worth noting. First, the company continues to push down expenses. Overall, operating expenses are now down 37% from the peak, while Devon Energy's total costs are on pace to be $1 billion less than last year. That was key to the company's ability to generate $726 million of operating cash flow last quarter (up 117% from the prior quarter), and lift core earnings to $47 million, or $0.09 per share. Meanwhile, the company's assets sales have pushed its cash balance up to $3.5 billion and its debt balance down by $1.2 billion. The net result is a $45 million annual interest savings and tremendous financial flexibility going forward.
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Getting ready to pivot
While the third quarter was transitional as Devon Energy jettisoned non-core assets, the fourth quarter will mark the restart of a return to growth mode. That is after the company said that it plans to double its rig count from five to 10 by the end of this year. Those rigs will not add much production next quarter, which is why the company expects its oil production to be relatively flat. However, they will enable Devon to get a jump on 2017 when it anticipates delivering double-digit U.S. oil production growth. That puts it on pace to match leading shale driller EOG Resources (EOG +1.84%), which is aiming to grow its oil output by 10% next year as long as oil stays above $50 a barrel.
While Devon has ample cash resources to fuel that growth, it does not believe that it will need to tap its balance sheet to fund its plans. Instead, the company sees its cash flow soaring next year to as much as $2.5 billion under the assumption that oil and gas average $55 and $3, respectively. That assumption would yield a substantial improvement in the company's cash flow, which is on pace to tally $1.1 billion this year. Furthermore, it is ample capital to allow the company to add the five to 10 rigs necessary to boost output by double-digits while remaining within cash flow. Meanwhile, Devon Energy believes that its cash flow could rise to $3.5 billion in 2018 assuming $60 oil and $3.25 gas, which is what would give it the fuel to generate even stronger oil growth that year. In one sense it is similar to EOG Resources' plan, which can ramp up its oil growth rate to 20% if crude averages $60 a barrel.
Investor takeaway
Devon Energy has completed its repositioning and is now ready to resume growth next year from a much stronger position. More importantly, it can deliver that growth while living within its cash thanks to its dramatic cost reductions and robust production results from new wells.
