DBRS Confirms Devon Energy at BBB (high), R-2 (high), Stable Trend

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 trends are Stable. The Devon Finance debt rating is based on the guarantee of the Company. The ratings confirmation reflects Devon’s strong asset base, substantial growth prospects and sound financial profile. Key challenges are its significant exposure to low natural gas prices (natural gas accounted for 67% of the total production mix in the first half of 2011) in North America, potential balance sheet pressure from continued substantial capital investments and share repurchases, and rising production and reserve replacement costs.

The Company has recently completed its major divestiture program of higher-risk assets including its Gulf of Mexico (GOM) and international business segments. With $6.7 billion of cash and short-term investments on the balance sheet (largely resulted by proceeds from the divestitures), the Company has strong financial flexibility in deploying more capital to accelerate growth for its onshore resource plays, while completing its planned $3.5 billion share repurchase program ($2.5 billion repurchased as of June 30, 2011) in the near term. The ratings are based on DBRS’s expectation that the Company will maintain adequate credit metrics within the rating category by funding its growth plans, dividends and share repurchases mostly through internally generated cash flow once the divestiture proceeds become largely used.

In May 2011, Devon closed a $3.2 billion (before tax) sale of its Brazilian assets to BP p.l.c., (BP, rated “A”), which essentially completed the strategic repositioning of Devon to a company focused entirely onshore in North America. Proceeds from the divestitures over the past 18 months totaled approximately $10 billion, half of which has been used for a combination of share repurchases ($2.5 billion) and growth capital programs ($3 billion). The remaining proceeds are expected to be used for additional share repurchases ($1 billion) in 2011, growth capital programs ($3 billion) over the next two years, and tax repatriation payments ($1 billion). DBRS expects the Company to maintain its financial profile within the rating category. If the Company continues to pursue aggressive share repurchases and capital programs after the divestiture proceeds are largely used, credit metrics could deteriorate significantly and trigger negative rating implications.

Devon has maintained a solid balance sheet and financial flexibility. The Company had a conservative total debt-to-capital ratio of 27% as of June 30, 2011, and strong cash flow to support a total debt-to-cash flow of 1.25 times for the 12 months ended June 30, 2011. These ratios compare favourably with its peers. Devon maintained relatively strong financial metrics even in 2009, one of the most challenging years faced by the oil and gas industry. Net debt-to-capital was very low at 5.4% as of June 30, 2011 due to significant cash and short-term investments stemming from the divestiture proceeds.

Devon has a strong reserve profile with above-average production growth. The Company has a large portfolio of upstream exploration and development growth prospects in diversified mature and developing regions in North America. Annual production replaced through the drill bit of 204% and reserve life of 12.9 years in 2010 were above-average levels for the industry. A substantial portion of the divestiture proceeds have been allocated to enhance future production growth. As a result, production volume is expected to grow by 6% to 8% in 2011, and reserve replacement is expected to remain high at around 160%. The Company continues to bolster it natural gas hedge position to secure a measure of cash flow stability to support its growth projects. In the second half of 2011, the Company has a combination of swap and collar contracts, covering approximately 35% of forecast oil and gas production (45,000 barrels per day (b/d) collared: $75 per barrel floor and $109 per barrel ceiling for crude oil; 980 million cubic feet per day with an average protected price of $5.28).

Devon’s three key development plays are the Barnett, Cana Woodford and Jackfish. Unconventional natural gas developments in the Barnett Shale formation remain the backbone of Devon’s steady reserve and production, accounting for 39% of total proved reserves and 31% of total production volume in 2010. Jackfish provides another avenue for significant and more predictable growth. Jackfish 1 continues to deliver industry-leading performance with average net production of 31,000 b/d. Jackfish 2 (similar design capacity at 35,000 b/d of gross bitumen production) achieved initial production in June 2011 and is expected to reach peak facility production by late 2012. Devon plans to continue investment within the oil sands to grow total oil sands production volume to between 150,000 and 175,000 b/d by 2020. Cana Woodford’s shale, despite the damages on its Cana gas processing plant by a tornado in May, net production increased 17% over the first quarter to a record 32,000 per barrel of oil equivalent (boe) per day. Other potential high-growth areas include liquids-rich Wolfberry, Avalon and Bond Springs plays in the Permian 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. Finding and development costs (F&D) (three-year average) in 2010 was competitive at $13.87 boe. As a result, the Company’s reserve recycle ratio was relatively strong at 1.56 times compared with other gas-focused players.

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.