Will Devon Energy Corp (DVN)’s Midstream Spinoff Boost the Company’s Performance?

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In early June 2013, struggling oil explorer and producer Devon Energy Corp (NYSE:DVN) announced that it would spin off a portion of its pipelines and storage facilities, otherwise known as its midstream assets. These would be used to form a publicly traded midstream master limited partnership. This proposal forms an important part of the company’s strategy to unlock value for share holders, through divesting itself of non-core assets.

Devon Energy CorpIn theory, this move allows Devon Energy Corp (NYSE:DVN) to free up capital and minimize risk, while retaining ownership of its midstream assets. But in some ways, it smacks of an opportunistic move to cash in on the newfound popularity of MLPs, with investors increasingly hungry for yield in a zero-interest-rate environment. Yet it has the potential to revitalize Devon Energy Corp (NYSE:DVN)’s operations and its share price, making it more attractive to investors.

What does it mean for Devon?

Over the last five years, Devon Energy Corp (NYSE:DVN)’s share price has continued to languish, down by almost 42% over that period. Yet the share prices of other oil explorers and producers such as Anadarko Petroleum Corporation (NYSE:APC) and EOG Resources Inc (NYSE:EOG) have continued to grow. A key driver of Devon Energy Corp (NYSE:DVN)’s poor performance has been a lack of strategic direction and an overconcentration on natural gas, in a market where natural gas prices have softened significantly.

This has seen Devon Energy Corp (NYSE:DVN) focus on shifting its production to higher-margin and more profitable oil production. But in order to do this, the company has had to focus on acquiring and developing oil production assets through an extensive capital expenditure program. For the first quarter of 2013 alone Devon had capital expenditures of almost $2 billion. Still, this was marginally lower year over year by 8%.

Despite Devon focusing on building its oil production, the company still has some way to go. For the first quarter of 2013, only 41% of its total production was made up of oil, with the remainder being natural gas. Devon also reported a net loss for the same period of $1.3 billion, on the back of a non-cash asset impairment charge related to lower oil and natural gas liquids prices.

But Devon’s investment in oil-producing assets is starting to pay dividends. Its Permian Basin oil production in the first quarter of 2013 grew by 24% year over year. This contributed to Devon’s 14% year over year increase in total oil production for the same period. All of which emphasizes that if Devon is to resurrect its fortunes as an energy explorer and producer, it must continue developing its oil assets.

How Will Devon Grow its Oil Producing Assets?

A key plank in Devon’s business development strategy is to unlock value for shareholders by spinning off its midstream assets into a publicly listed MLP. This will allow Devon to free up additional capital that it can use to further develop its onshore U.S. oil-producing assets, thereby boosting oil production. It will also see Devon retain majority ownership of those midstream assets. The MLP will only have a minority interest in the company’s U.S. midstream assets, including its natural gas gathering and processing assets located in Texas, Oklahoma and Wyoming.

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