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Will Hurricane Harvey Slow Down Devon Energy Corp.'s Growth Engine?

By Matthew DiLallo - Oct 30, 2017 at 10:00AM

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The shale driller’s diversification should help, but it’s not immune to the storm’s impact.

Devon Energy's (DVN 0.00%) drilling operations have been firing on all cylinders this year. Consequently, the diversified shale driller exceeded the high end of its production guidance during the first two quarters of the year, which helped fuel expectation-beating financial results. Furthermore, as a result of the company's top-end production, it's now on pace to increase its U.S. oil output 18% to 23% by the end of the fourth quarter, which is better than its initial estimate that it would rise 13% to 17% by year-end.

That said, the company faced an unexpected headwind during the third quarter in the form of Hurricane Harvey, which might impact those results and could disappoint the market when it reports earnings on Tuesday after markets close. This little bump in the road, however, still shouldn't derail Devon Energy's growth potential. 

An oil pump with the sun setting in the background after the rain.

Image source: Getty Images.

Expect oil to be a little light

Heading into the third quarter, Devon Energy estimated that companywide oil production would range between 234,000 to 244,000 barrels of oil per day (BPD). At the midpoint, that's only about 1,000 BPD ahead of last quarter. That's primarily because the company needed to do some maintenance work on its Jackfish 2 oil sands complex in Canada, which would force it to hold back 15,000 BPD during the quarter.

However, it doesn't look like output will meet the low end of that range in the third quarter because Devon temporarily suspended operations and shut-in production across its entire Eagle Ford shale position in south Texas in preparation for Hurricane Harvey. The company noted that the storm's impact would cause it to produce about 15,000 barrels of oil equivalent per day (BOE/D) less than anticipated from these assets, two-thirds of which is oil. Thus, it seems likely that Devon's oil output will decline in the third quarter, which could take earnings with it. 

An oil drilling rig near some oil pump jacks.

Image source: Getty Images.

Just a little bump in the road

That said, while Hurricane Harvey appears that it will have a noticeable impact on Devon's third-quarter oil production and earnings, it shouldn't slow down the company's overall momentum. That's because it doesn't expect the production impact to last past the third quarter. Also, while the Eagle Ford provides a meaningful amount of current output, it's no longer a major growth driver for the company.

Instead, Devon's relies on the Delaware Basin in western Texas and southeast New Mexico and the STACK play of Oklahoma to drive growth, neither of which Harvey touched during the quarter. Overall, 90% of the company's drilling activities this year will be in those two regions, enabling it to deliver more than 30% production growth compared to last year.

The reason Devon focuses on those two plays is that they deliver excellent drilling returns in the current market environment. These wells tend to provide an immediate boost to production as well because they can be quite prolific. For example, last quarter the company delivered expectation-beating production growth due in part to the fact that it drilled nine gushers across those two plays, with each averaging 30-day initial production rates of nearly 2,000 BOE/D.

To put that size into perspective, we'll contrast them with the wells Whiting Petroleum (WLL) completed in the Niobrara shale of Colorado during the third quarter. Whiting stated that it brought 58 wells on line last quarter, which helped fuel a 78% increase in output from that play. However, that surge only boosted its production in the Niobrara up to 11,750 BOE/D, implying that the wells produced just a few hundred BOE/D apiece. One reason for that is that wells in this region don't hit their peak for 60 to 90 days, though even at their pinnacle, they aren't as productive and therefore don't generate the high returns that wells in the Delaware and STACK plays achieve. That's why Devon focuses on those regions to fuel growth. 

The quarter might be a washout, but that shouldn't rain on expectations for 2017

It looks like Hurricane Harvey will put a dent in Devon's oil production and earnings in the third quarter. However, that shouldn't have an impact on its full-year projections since the company quickly brought that production back on line and the storm didn't touch either of its growth engines. So, if Devon sells off after earnings, it could be an opportunity for long-term investors to consider buying more stock since Hurricane Harvey appears unlikely to have slowed its growth momentum, which is what should fuel returns for long-term investors.

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