Devon Energy, (NYSE: DVN), announced a deal with Delfin Midstream (privately held) on Monday September, 5th, to buy into a Floating Liquefied Natural Gas-FLNG vessel, yet to be FID'd and constructed. The financial terms were not released, but this certainly involves a major cash commitment from Devon. In what amounts to a delayed reaction, in the absence of other news, the market didn't seem to like it at first in Friday’s trading, and Devon stock sagged for much of the day. A day when other E&P stocks were rising on what turned into a good day for WTI (up $3.00+) in the oil markets. DVN managed to stage a late-day rally Friday, of modest proportions, rising 1.71% as the market closed. Suggesting that investors were taking a longer view of this transaction and realizing why it might pay out for the company a few years hence. Any story that doesn't involve debt pay down, stock buybacks, or dividend news is unwelcome conceptually, as investors grow used to huddling around the mailbox at dividend distribution time. A sentiment that surely accounts for the temporary softness in the company’s shares last week.
In this article, we will look a little deeper than the trading response, from which shares have since recovered, and look at the strategy behind this decision on the part of Devon management.
The LNG market
As I have noted in past OilPrice articles, and what has been relentlessly documented over the last couple of years, is that the world is having an energy crisis. Short-sighted, climate-related decisions by EU and UK policy makers over the last couple of decades have put the energy security of the continent at risk. What this has meant as renewable energy sources have been unable to meet demand, is that new and unanticipated demand is coming simultaneously from Asia and the EU, and pushing up prices for LNG. As recently as a couple of weeks ago natural gas was trading at the equivalent of $410 per barrel.
An Offshore article describes how one aspect of the FLNG market is developing.
“Delfin LNG is a brownfield deepwater port requiring minimal additional infrastructure investment to support up to four FLNG vessels producing up to 13 million tonnes of LNG per annum. Delfin purchased the UTOS pipeline, the largest natural gas pipeline in the Gulf of Mexico, in 2014 and submitted its deepwater port license application in 2015. The port will be located approximately 40 nautical miles off the coast of Cameron Parish, Louisiana.
As a modular project requiring only 2.0 to 2.5 MTPA of long-term contracts to begin construction, Delfin says that it is on schedule to make the FID on the first FLNG vessel by the end of this year.
Delfin says that it has completed front-end engineering and design with Samsung Heavy Industries and Black & Veatch, which puts it on pace to execute the project this year and to commence operations in 2026.”
The beauty of the FLNG vessel concept is it moves the liquefaction process onto a mobile platform that can be moved at will on a global basis. As practical matter the few FLNG vessels that have been deployed to date, GLNG’s Hilli Episeyo, and Gimi have been contracted for long term assignments with Perenco in Cameroon-West Africa, and in BP’s Senegal and Mauritania project, Greater Tortue-Ahmeyim. This will likely be the case with the yet unnamed vessel that will be owned in-part by Devon.
That 2026 start-up date happens to coincide with a severe projected supply gap in LNG on a global basis. The EU countries are frantically building import infrastructure-Regasification terminals, to receive these supplies, as they spurn Russian gas.
The world's demand for LNG is durable and growing.
What's DVN's interest in fractionally owning an FLNG vessel?
Devon produces about 610K BOEPD, of which 51% is gas. So gas has a big impact on their profitability. Two years ago gas was selling for <$2.00 mmbtu, now look at it, selling above $8.00 mmbtu. The NYMEX strip isn't as encouraging though, showing pricing in the mid-$5's by this time next year. Right now DVN's domestic future gas sales realizations are controlled by sales points in West Texas-WAHA, and Henry Hub, and by buying derivatives contracts-something they are doing less of in 2023.
I think making this move to get export pricing is a smart one, and justifies the risk in taking on a project like an FLNG vessel. The volatility of the domestic market makes it hard to forecast, and while there is no guarantee, the extreme pricing now being paid by the EU will last...there is always that demand shortfall that will set the pricing in the end. By having this output exposed to EU pricing for LNG, Devon in-effect is “hedging” future production to a price several multiples above current and anticipated domestic pricing with its investment in the Delfin project. There are risks to this thesis though.
Delays could poke a hole in this thesis, and FLNG vessels are notorious for them. As noted in linked article above, there is a window for new LNG projects to gain traction beginning in the mid-2020’s. Delays in construction could result in all the choices contracts being snapped up on the European side. According to the press release, this project appears to be "shovel-ready" with no permitting hang ups to run the meter up whilst waiting on some government agency to stamp an application. From the press release it appears that with Devon on board, this project will meet FID sanction later this year.
“As a modular project requiring only 2.0 to 2.5 MTPA of long-term contracts to begin construction, and with all necessary permits in hand, Delfin is on schedule to make FID on its first Floating LNG vessel by the end of this year.”
Still, things can go wrong and this is a new era of risk for Devon. Hopefully, they are hiring experienced people who can oversee their interests in this project.
If DVN does begin exporting 1 mpta to the EU the upside could be huge. 1 mpta = about 48.7 BCF. At today's pricing that would equate to $500 million per year for just six weeks of their current annual production.
That would certainly seem to justify the gamble to me. With costs running around a billion USD for an FLNG vessel, Devon’s contribution of a few hundred million USD (guessing) is a well-managed risk that managers of an already risky business are well positioned to take. With the cash flow-$10 bn on an annualized basis, it is risk they can certainly afford.
It should also be noted that Delfin is currently the “prettiest girl” at the dance with recent contracts signed by Vitol for a 15-year SPA, and Centrica, (OTCPK:CPYYY) for a 1 mpta HOA, similar to Devon's.
Nor is Devon alone in shale players wishing for exposure to export LNG pricing. Shale giant, EOG Resources, (NYSE:EOG) noted their plans for this exposure in their Second Quarter, 2022 filing, detailing a 15-year modular pricing agreement with Cheniere Energy, (NYSE:LNG)
In my view, this is a move that will be viewed as accretive to shares of Devon Energy, and should provide further lift to shares as it becomes properly recognized by the market.
By David Messler for Oilprice.com
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