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Thursday, September 21, 2006

Catalysts That Make Devon Energy (DVN) A Buy

By Yaser Anwar, CSC of Equity Investment Ideas

A new discovery of oil in the Gulf of Mexico have boosted Devon shares of late. DVN has a 20% working interest in the Kaskida deepwater prospect 250 miles southwest of New Orleans- Anadarko has a 25% interest and BP, which operates the well, has a 55% interest.

This is Devon's fourth significant discovery in the lower Tertiary trend in the Gulf of Mexico, and management believes it is the company’s “largest to date." Kaskida, says Devon, has about 800 feet of hydrocarbon-bearing sands more than a mile below the water’s surface. Wells into the ocean floor go more than 30,000 feet deep.

Last year’s exploration drilling success rate was 86%, up from 84% in 2004, and Devon’s success rate for the first half of this year is even better at 90%. On the development side, success rates have been at 98% to 99%.

I like DVN’s drilling prospects, and the fact that Devon grew earnings per share by 39% to $1.92 in the second quarter. Also, its average realized oil price increased 71% due to the termination of its hedging program. In last year’s third quarter, the company only received $43.45 per barrel on average.

DVN's announcement of the largest domestic hydrocarbon find in a generation should allow the shares to trade at a premium to its large capitalization peers.

DVN is susceptible to substantial and sustained declines in oil and gas prices, and a hurricane can could damage its production facilities. However, this is offset by DVN's sizable operations, which are primarily located in NA, thus minimizing political risk, and its production, which is about evenly split between oil and gas. Also, Devon’s assets are diversified, including a lot of onshore production in the Texas Barnett Shale region, and so last year’s severe hurricanes caused limited stoppage

The International Energy Agency has revised its 06 global demand growth projection down 20% since March, to 1.2 mill barrels per day. Mild weather in NA and the removal of consumer subsidies in Southeast Asia were contributing factors too.

At year-end 05, DVN had proved reserves of about 2.11 billion barrels of oil 58% natural gas, 42% liquids, with 24% of reserves proved undeveloped.

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