Maintaining Bearish View on Devon Energy Amid Frothy Commodity Environment

When we published our initial take on Devon's third-quarter financial and operating results, we argued that the firm is executing well on its development plan, maintaining impressive capital discipline, and benefiting from a second-to-none cost advantage in the U.S. upstream space that supports its narrow economic moat rating. However, we also suggested that the market has gotten carried away with the current commodity environment and is expecting favorable conditions to persist. In contrast, we do not expect oil and natural gas prices to remain indefinitely above marginal supply costs ($55 for WTI and $3.30/mcf for U.S. natural gas). Exploration and production, or E&P, stocks currently appear to be discounting a long-term WTI price of about $65-$70, making the whole sector look richly valued.