DBRS Confirms Devon Energy at BBB (high) and R-2 (high)

DBRS has today confirmed the Senior Unsecured Debt ratings of Devon Energy Corporation (Devon or the Company) and its subsidiary, Devon Finance Corporation (Devon Finance), at BBB (high) and the Company’s Commercial Paper at R-2 (high), all with Stable trends. The Devon Finance debt rating is based on the guarantee of the Company. Devon’s ratings reflect its continued strong operational performance and solid financial profile, despite the sharp drop in commodity prices since Q3 2008, and its substantial growth prospects.

The Company has recently made a strategic move to divest all of its higher-risk Gulf of Mexico and international businesses (GOM/International) by year-end 2010, which should improve its business risk profile on completion. It has also redefined its growth strategy based on unconventional natural gas developments, mostly in the United States, and in-situ oil sands in the Jackfish Project (Jackfish) in Alberta, Canada. Its North America onshore (Onshore) focus will likely strengthen its already strong production and reserve profiles achieved since 2003. The estimated proceeds of $7.5 billion to $8.3 billion (after-tax) (up from $4.5 billion to $7.5 billion projected in November 2009) to be deployed mainly for debt reduction and capital programs should further strengthen Devon’s balance sheet and provide funding to accelerate growth for its Onshore resource plays. The planned divestitures complement its exit from Africa completed in 2008, with net proceeds (approximately $2.2 billion) used for paying down debt and modest share repurchases. DBRS does not expect any material share buyback in the near term. Offsetting the positive attributes of focusing on Onshore are such challenges as the increased exposure to North American gas markets and the loss of the higher impact and higher returns associated with the Company’s deepwater GOM assets, which will be disposed of by year-end.

The Company has recently closed a $1.1 billion (after tax) sale of its Lower Tertiary development projects to Maersk Oil. The recently announced proposed sale to BP p.l.c. (BP, rated AA (high)) of all of its assets in the deepwater GOM, Brazil and Azerbaijan for $7.0 billion should largely complete the Company’s divestiture program. Further proceeds are expected from the remaining GOM/International assets to be divested by year-end (estimated proceeds of $1.3 billion to $2 billion by Devon). Additionally, BP will assume Devon’s two deepwater drilling rig commitments, saving approximately $1.5 billion in leasing costs over the next three years. The Company’s proposed 50/50 joint venture with BP to develop BP’s Kirby oil sands (Kirby) leases in Alberta through a $500 million investment, plus a $150 million carry for the first three years of the project, should add substantially to its potential oil sands bitumen resources as estimated by the Company (first oil potentially by 2016). Kirby is adjacent to Devon’s Jackfish developments.

Devon strives to maintain a balanced portfolio and sufficient financial flexibility to better manage the volatile commodity pricing environment. Post-divestitures, the oil and gas product mix will remain virtually unchanged, with a continued focus on natural gas (68% versus the current 69%). Capital efficiency will likely improve as the disposed assets have a higher cost base and are less scalable, representing in 2009 approximately 11% of production and 7% of proved reserves, but 28% of capex. Re-organization costs are estimated at $200 million to $275 million versus $100 million of annual cost savings. Following the sharp drop in commodity prices and the financial meltdown in late 2008, the Company substantially curtailed capex and shored up liquidity through additional credit lines. It maintained approximately $2.0 billion of unused credit facilities and $1.0 billion of cash balances (including $365 million for discontinued operations) at year-end 2009. Given its intention to fund all growth projects internally, going forward, the Company will pursue more aggressive hedging (to cover about 50% of production at all times) to secure a measure of cash flow stability to support its growth projects. Close to 60% of forecast production in 2010 is hedged (55%/71% for gas/oil volumes). No material share repurchases or major acquisitions are contemplated in view of its substantial drilling inventory, although potential tucked-in or acreage acquisitions are likely. Credit metrics remained solid in 2009, although weakened from the very strong levels achieved in 2008. The key contributor is substantially lower commodity prices, which resulted in after-tax extraordinary charges of approximately $4.1 billion to net income and a similar reduction in asset values, depressing the equity base. Debt-to-cash flow of 1.57 times (1.43 times net of cash) and debt-to-capital of 32% at year-end 2009 remain satisfactory for the current credit ratings.

Based on strip prices with WTI of $83/barrel (bbl) and Nymex of $5/mcf in 2010, rising to $89/bbl and $6.5/mcf in 2014, Devon expects to grow production at 6% per annum. DBRS expects incremental growth based on a lower crude price of $70/bbl in 2010 and substantial hedges in place. About 82% of the Company’s 2010 upstream capex of $5.7 billion to $6.3 billion is focused on Onshore for the continuing operations ($4.7 billion to $5.1 billion including $500 million for Kirby) with the remaining 18% for GOM/International developments until these assets are sold. Shale gas and Jackfish/Kirby resource plays represent close to 65% of Onshore capex. Additional capex of about $0.9 to $1.0 billion is projected for the Company’s midstream, corporate and other capital spending for an aggregate estimated by DBRS at approximately $6.5 billion to $7.3 billion for 2010, which should mostly be funded by internally generated cash flow and divestiture proceeds.

Unconventional natural gas developments in the Barnett Shale formation (Barnett) remain the backbone of Devon’s steady reserve and production growth, contributing 40% of total reserves additions from 2006 to 2008 (totaling about 514 million barrels), and about 28% of output in 2009. Jackfish provides another avenue for significant and more predictable growth. Production from Jackfish 1 ramped up to peak capacity of 35,000 barrels per day (b/d) during Q1 2010, with start-up for Jackfish 2 (currently under construction) of similar design capacity targeted by 2012. Devon plans to apply for regulatory approval for Jackfish 3 in 2010, which could add another 35,000 b/d of bitumen production in 2014. Other potential high-growth areas include Haynesville Shale, Cana Woodford Shale and Horn River Basin.

Reflecting the repeatable nature of most of its North American onshore assets, Devon’s operational performance continues to improve, which sets it apart from most of its peers. For the continuing operations of North America Onshore, annual production replaced through the drill bit of 189% and reserve life of 12.0 years on a three-year average basis are above-average levels for the industry. The Company added about 444 million barrels of oil equivalent (boe) of reserves through the drill bit in 2009 (including 117 million barrels from Jackfish 2). This resulted in lower finding and development costs (F&D) in 2009 of $8.58/boe adjusted to exclude crude oil price-related revisions ($4.69/boe unadjusted) and $11.69/boe on a three-year average basis for continuing operations (excluding GOM to be sold), which is considerably lower than replacement costs for the assets to be sold.

Note:
All figures are in U.S. dollars unless otherwise noted.

The rating of Devon Finance Corporation is based on the irrevocable guarantee of Devon Energy Corporation.

The applicable methodology is Rating Oil and Gas Companies, which can be found on our website under Methodologies.

This is a Corporate rating.