The oil market has gone from bad to worse over the past couple of months, with the price of crude slumping 17% during the fourth-quarter. That is going to have an impact on Devon Energy's (NYSE:DVN) fourth-quarter earnings report, which is expected to be released this Tuesday. The question that the report will answer is what actions Devon Energy took in response to worsening crude prices. That response is one of the things investors will want to be on the lookout for when reviewing that report.
First, let's review
Before we ponder what lies ahead, let's briefly be reminded of the recent past. In the third-quarter Devon Energy reported a pretty decent quarter all things considered. Core earnings of $316 million, or $0.76 per, share were only slightly less than the $320 million, or $0.78 per share, Devon earned in the second-quarter. Cash flow from operations was even stronger at $1.6 billion, which was 41% higher than the prior quarter. Devon accomplished this thanks to three factors:
- The company had strong oil hedges during the quarter, adding a full $10 per barrel of oil equivalent, or BOE, to its realized price.
- Its operating expenses dropped 18% year-over-year and were below its own guidance.
- Production averaged 680,000 BOE/d during the quarter, which was 4,000 BOE/d head of its guidance.
Neediness to say, the company is going to need to repeat its out performance in order to overcome even weaker oil prices.
Keep an eye on how Devon Energy performed vs. its own guidance
Devon Energy has several cost reduction initiatives in process, which are what drove the big year-over-year drop in operating expenses last quarter. The company expects to see some follow through in the fourth quarter, which should reduce its full-year operating costs down to $13.80 per BOE:
Ideally, we'd like to see Devon Energy beat that guidance in order to offset some of the oil price weakness during the quarter.
The other big guidance item for Devon Energy is oil production, which it sees growing by roughly 32% in 2015 to an average of 276,000 barrels per day. That's 6,000 barrels per day ahead of its prior guidance due to stronger-than-expected production growth in prior quarters. What investors should keep an eye on is if Devon Energy once again exceeds its production guidance, which it has done in the previous five quarters, or if it hit the brakes on growth in response to persistently weak oil prices. Pushing production higher than guidance will help the company make up some of what was lost in price with volumes, but given the persistent supply glut, such a move would have only exacerbated the market's problems.
Look at its plans for 2016
Despite a deteriorating oil market in 2015, Devon Energy chose to grow its oil production sharply. That's something rival EOG Resources (NYSE:EOG) refused to do because growing production into an oversupplied market only makes the problem worse. Instead, EOG Resources chose to keep its production flat and save its growth for when conditions improved. That proved to be the prudent move considering that oil prices have only grown weaker as the supply glut has gotten worse.
Despite restraint being the far more prudent move, Devon Energy's initial plan for 2016 is to continue to pursue production growth, with the company guiding at the end of the third-quarter for low single-digit oil production growth in 2016. However, the caveat was that it assumed current pricing, which is no longer what we have. That leaves Devon Energy with a dilemma, either it can continue on its course and push production higher or join EOG Resources in showing restraint. Investors need to keep a close eye on the company's plans to make sure it isn't planing to grow for the sake of growth in 2016.
With oil prices continuing to slump, Devon Energy was up against a pretty steep headwind in the fourth-quarter. It will need to have pushed its operating costs lower and its production higher than guidance in order to overcome some of the sting of lower prices. That said, pushing its production higher wouldn't have been the best idea given the glut of oil on the market. Instead, the company really should have pulled back on production growth in the quarter and should plan to do that again in 2016, at least until conditions improve.