Devon Reaches Shale Deal With Sinopec

01 03, 2012 by The Wall Street Journal

China Petrochemical Corp. struck a multibillion-dollar deal with Devon Energy Corp. (DVN) for a one-third stake in five U.S. shale oil and gas fields, in another move by a Chinese state-owned firm eager to play a bigger role in the global rush to tap unconventional fossil fuels.

Under the deal, expected to close in the current quarter, Devon will serve as the operator. Sinopec, as the Chinese oil giant is known, will pay Devon $900 million at closing. That payment includes $300 million in reimbursements for money Devon already spent on acreage and drilling acquisition, according to a Devon spokesman. In addition, it will pay $1.6 billion to Devon in the form of a drilling carry expected to be realized by the end of 2014.

Sinopec is making its first foray into the U.S. oil patch through the deal with Devon, one of the first companies to successfully tap shale fields. But it follows a path already trod by Cnooc Ltd. (CEO), which in 2010 and 2011 bought stakes in Chesapeake Energy Corp.'s (CHK) operations in south Texas's oil-rich Eagle Ford shale and in shale assets in Colorado and Wyoming.

The deals give Chinese state oil giants a front-row seat to one of the most dynamic oil regions in the world, where production is rising dramatically, thanks to fracking technology applied in the past decade. Learning and adapting fracking methods to shale plays in China could unlock massive new oil and gas reserves for the emerging superpower, just as it is changing the energy landscape of the U.S.

In addition to buying stakes in U.S. shale, Cnooc and Sinopec are competing to buy a 30% stake in FTS International, an oilfield services company specializing in fracking technology, the Wall Street Journal reported in December. Saudi Arabian Oil Co., known as Saudi Aramco, is also bidding, the Journal reported.

The U.S. Energy Information Administration estimates that China's technically recoverable shale gas reserves at nearly 1.28 quadrillion cubic feet, by far the most in the world and more than the agency's combined estimates for the volumes in the U.S. and Canada, which amount to 1.25 quadrillion cubic feet.

For Devon, the agreement helps cover operating expenses at a time when natural gas prices are low. "This arrangement improves Devon's capital efficiency by recovering our land and drilling costs to date and by significantly reducing our future capital commitments," said Devon Chief Executive John Richels. Devon shares recently were up 5.5% at $65.41.

Sinopec emerged from bidding that included U.S. independent oil producers, domestic majors and other international firms, Devon spokesman Chip Minty said.

The deal includes positions across five shale regions: the Tuscaloosa Marine Shale in Louisiana, the Niobrara in the U.S. mid-continent, the Mississippian in Oklahoma, Ohio's Utica Shale and the Michigan Basin.

Typically U.S. firms have brought in one partner per oil field. Devon chose to bring in a single partner for five so that it wasn't contractually obligated to spend money drilling in any field where the economics were unfavorable, Minty said. If one of the plays doesn't pan out, Devon and Sinopec can move rigs and funding to those that are more profitable, an approach praised by some analysts ahead of the Tuesday's announcement. "We greatly prefer Devon's approach to this potential transaction over those of some peers," Argus Research analyst Phil Weiss wrote in a research note.

The drilling carry is expected to fund 70% of Devon's capital requirements, which will result in Sinopec paying 80% of the overall development cost. The companies expect to drill 125 wells by the year's end across the five areas.

Devon in November reported third-quarter earnings fell 50% from a year-earlier period that included a $1.5 billion divestiture gain, as its hedging losses continued to mask its revenue growth.

Devon's deal is the third billion-dollar-plus investment in U.S. oil fields by a foreign oil company in the last three weeks. Spain's Repsol YPF (REP.MC) on Dec. 22 agreed to a $1 billion pact with SandRidge Energy Inc. (SD) to jointly develop oil fields in Kansas and Oklahoma, while Chesapeake on Tuesday said France's Total SA (TOT) paid $2.32 billion for a stake in some of its Ohio shale discovery.

John Ale, a partner with Skadden, Arps, Slate, Meagher & Flom LLP who has represented both foreign buyers and domestic sellers of shale assets, said that while national oil companies are pursuing such deals for strategic purposes, including learning the techniques needed to exploit shale, others are simply looking for a good trade. "This is a market that is stable, and people want to invest in it," Ale said.

For companies, such as sovereign wealth funds, power producers and private equity firms that have pumped money into shale, the deals are a hedge against rising energy prices. "Countries need access to the commodities somewhere around the globe so they're not killed every time the price spikes," Ale said.