The third quarter was a rocky one for the oil industry, after oil prices did a head fake. Prices rebounded in the second quarter to around $60 a barrel, before plunging in the third quarter to less than $40 a barrel at one point.

WTI Crude Oil Spot Price Chart

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Overall, oil was down more than 20% for the quarter, which probably had a big impact on oil company cash flows, including those from Devon Energy (NYSE:DVN). With that backdrop, here's what investors need to keep an eye on when Devon reports its third-quarter results on Tuesday, after markets close.

First, let's review
Before we look ahead, let's take a quick look back at last quarter. It was surprisingly strong, as the company crushed expectations after reporting earnings that were more than double what was expected. Two factors played a key role in the company's stronger-than-expected quarter. First, operating costs fell by 8% year over year to $11.05 per BOE while general and administrative costs, or G&A, fell by 16% sequentially to $3.45 per BOE. In addition, Devon Energy's production grew by 9% to 674,000 barrels of oil equivalent per day, or BOE/d. That result was 5,000 BOE/d higher than guidance, marking the fourth straight quarter the company exceeded its own production guidance.

Can Devon Energy replicate its success?
The key to the third quarter will be Devon Energy's ability to repeat that success by pushing costs even lower while pushing production higher than its guidance. On the cost side, Devon Energy will again need to push its operating and general and administrative costs lower on a per-BOE basis. That's what the company is expecting to deliver, after it revised its guidance for full-year field-level operating costs and G&A from $16.10 per BOE to $14.50 last quarter, which is where its costs stood at the end of last quarter, suggesting more downside to come. However, in an ideal world, investors want to see the company revise its full-year costs lower again, which is a possibility given the persistent weakness in oil prices.

The other side of the equation here is production, which Devon Energy expects to grow by 5% to 10% over last year's rate, with even stronger oil production growth of 25% to 35%. Investors want to see that outperformance trend continued this quarter, because it suggests that it's drilling wells that are exceeding its expectations.

Is it pulling back the reins on capex spending?
Having said that, growing oil production into an oversupplied oil market isn't exactly helping oil prices recover. So given the downdraft in oil prices last quarter, it's possible that Devon Energy will rethink its spending plans for the balance of the year. To date, the company already shaved $350 million off its $4.96 billion capex plan. However, despite that cut, it has actually accelerated its production growth guidance since the start of the year.

Investors will want to keep an eye on the potential for Devon Energy to scale back its capex plans, resulting in its tapping the brakes on production growth. That's something rival EOG Resources (NYSE:EOG) has done all year long, as the company chooses "to refrain from growing oil production into an oversupplied market." That was quite evident last quarter, when EOG Resources reduced its capex budget by $200 million, choosing instead to pocket its captured capex savings instead of using them to accelerate oil production growth the way Devon did.

Investor takeaway
With oil resuming its fall during the quarter, Devon Energy isn't likely to report a robust quarter. The company needs to operate exceptionally well, which would be evident by beating both its cost and production guidance. It also needs to continue to make prudent moves financially, and given the persistent weakness in oil, Devon really should reconsider its robust oil growth plan and join rival EOG Resources in sitting out growth until the oil market rebalances and oil prices improve.

 

Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy and EOG Resources,. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.