COMPANY NEWS

"As part of a much larger organization, our shareholders will benefit from the superior access to capital necessary to accelerate key exploration and development opportunities," said James T. Hackett, chairman, president, and CEO of Ocean Energy. "It also provides a commodity mix weighted positively toward North American natural gas and creates a better balance between exploration and exploitation, minimizing the risk associated with high-impact exploration."

Analysts voice doubts

Some financial analysts questioned whether the deal will be welcomed by the two companies' shareholders.

The merger agreement puts a value of $19.97/share on Ocean Energy stock, representing a 3.6% premium, based on the Feb. 21 closing price of $48.23/share for Devon stock, said John P. Herrlin Jr., first vice-president of Merrill Lynch Global Securities Research & Economics Group. However, he said Merrill Lynch previously put a net asset value of $22/share on Ocean Energy stock.

Herrlin said the proposed merger also provides Devon with Ocean Energy's proven reserves at a price of $1.49/ Mcfe.

"We believe most (Ocean Energy) shareholders held (that) stock hoping for a potential acquisition premium and the exploration upside, which is significantly diluted from aUshareholder's perspective," said Robert S. Morris, at Salomon Smith Barney Inc., New York, following the merger announcement. "Meanwhile, based on our very preliminary projections, the merger is expected to be roughly 3-5% dilutive to Devon's earnings and cash flow per share and essentially neutral on an enterprise value to cash flow multiple basis."

Devon shareholders also might react negatively "initially" to the proposal, said Herrlin, "given the series of large corporate acquisitions (by Devon) and paucity of information provided" in the merger announcement. With this latest deal, Devon "has taken on $13.3 billion in mergers (inclusive of acquired debt) over the last year," he said. "We were somewhat surprised by the acquisition, given the recent period of asset absorption and concomitant divestitures for (Devon) and given that (the company) has stated that generated cash flow would cover its growth goals."

However, both Nichols and Hackett expressed confidence that the proposed merger will be approved by both shareholders and regulatory officials.

Deal terms

Under terms of the merger agreement, Ocean Energy shareholders will get 0.414 share of Devon common stock for each common Ocean Energy share.

That exchange ratio is based on relative market prices for the two securities over the previous 30 trading days and will require Devon to issue 73.4 million new shares to Ocean Energy stockholders.

Based on the Feb. 21 closing price for Devon stock, company officials estimated the value of shares to be issued at $3.5 billion. Assumption of Ocean Energy's debt and other obligations is expected to increase the acquisition price to $5.3 billion. The transaction will be on a tax-free basis to shareholders of both companies, officials said.

In a Feb. 24 telephone conference, Hackett said the proposed merger would have no impact on Ocean Energy's deepwater joint venture with Kerr-McGee Corp., Oklahoma City, in the Gulf of Mexico, especially since Kerr-McGee owns part of Devon Energy.

Ocean Energy is a 50% partner with operator Kerr-McGee in a deepwater natural gas discovery at their Merganser prospect on Atwater Valley Block 37 in the gulf last year (OGJ Online, Apr. 10, 2002).

The 1 OCS 21826 No. 1 discovery well, drilled to 21,268 ft, encountered 150 ft of gas pay in 7,900 ft of water, with a gross estimated reserve potential of 200-400 bcfe.

Merganser was drilled under the deepwater exploratory drilling joint venture in which Kerr-McGee and Ocean Energy are to explore and develop oil and gas prospects on more than 1 million undeveloped acres in the deepwater gulf.

Ocean Energy's North American operations are focused on the shelf and deepwater areas of the Gulf of Mexico, the Rocky Mountains, the Permian basin, the Anadarko basin, East Texas, northern Louisiana, and US Gulf Coast region.

It also holds a leading position among US independents in West Africa, with activities in Equatorial Guinea, Angola, Nigeria, and the Ivory Coast. Ocean Energy also is active in Egypt, the Russian Republic of Tatarstan, Brazil, and Indonesia.

During 2002, Devon Energy discontinued its Indonesian, Argentine, and Egyptian operations in an effort to focus its operations on North America. Devon recognized a $31 million pretax gain ($31 million after tax) on these discontinued operations.

The company also recognized $23 million of pretax income ($14 million after tax) from operations prior to discontinuing these operations.

However, Nichols said, "The properties that we divested in the past were things that we had inherited (through earlier acquisitions) where there was not a critical mass. Egypt is a perfect example: What we had there before was very small. What Ocean has in Egypt is a much more enticing suite of properties."

The two companies still have "significant" overlap in their core areas, providing operational synergies, officials said. They expect general and administrative cost savings of at least $50 million/year.

Among other favorable aspects of the merger, said Morris, "First, the transaction reduces Devon's debt-to-book capitalization to 52% from 60%. Second, Ocean's high-impact international and deepwater exploration and development program increases Devon Energy's 'organic' growth profile.

"The combined company is expected to grow 'same-store' production 4-6% in 2003."

In a later webcast presentation to financial analysts, both Nichols and Hackett emphasized that neither company "had to do this deal. We wanted to do it."

Nichols said, "We could easily have fixed our debt ratio by letting time take us to where we want to be." But the merger provides a quicker fix, he said. Devon had debt with terms that would not allow the company to prepay it, said Nichols, "so we had this high cash flow that we had to sit on. But Ocean has debt we can pay off and bring our (combined) debt rate down."

The combined company will produce 2.4 bcfd of natural gas and 250,000 b/d of oil and NGLs, said company officials. It will have 2.2 billion boe of proved reserves, with 84% of that in North America.

In fact, 90% of the new Devon's total production will be in North America, of which 69% will be natural gas.

The combined company will hold 29 million net undeveloped acres. With interests in more than 500 deepwater Gulf of Mexico blocks, it also will be the largest independent deepwater leaseholder in the gulf, officials said.

Following the proposed merger, Nichols will retain his positions as chairman and CEO of Devon, while Hackett will become president and chief operating officer. The new board of directors will comprise nine members from Devon and four from Ocean Energy.

The boards of both companies have approved the merger, and dates for special meetings of shareholders are expected to be set soon. Completion of the deal is expected in the second or third quarters.

Analyst note

In a weekly report before the merger announcement, Morris noted Devon recently announced additional crude and natural gas price hedge positions.

"The company has now hedged approximately 54% of its projected 2003 worldwide crude oil volumes via costless collars with average floor and ceiling prices of $22.26/bbl and $28.14/ bbl, respectively," Morris said. "Devon has also hedged roughly 31% of its projected 2003 natural gas production via collars with average floor and ceiling prices of $3.34/MMbtu and $5.11/MMbtu.

In addition, Devon Energy has entered into fixed price collars and swaps covering nearly 7% of projected natural gas production at an average price of $2.94/MMbtu."

Earlier, Devon Energy officials had indicated that their 2003 exploration and development budget would remain essentially flat from 2002 levels at $1.5 billion. However, Ocean Energy had indicated a 43% increase in its exploration and development budget to $900 million from $630 million last year.

The oil field service industry will be watching to see if the combined company follows through with those spending projections.

IPR acquisition

IPR's purchase included the interests of Devon Energy Red Sea Inc. and Devon Energy Suez Inc., which owned interests in the North July and South West Gebel El-Zeit (SWGEZ) concessions, respectively.

IPR Red Sea is a subsidiary of IPR Transoil Corp. and a member of the privately held Improved Petroleum Recovery Group of Cos., Irving, Tex. The acquisition is IPR's first offshore foothold in Egypt, where it operates producing and exploration properties in the Western Desert.

Fanar Petroleum Co., the IPR-Egyptian General Petroleum Corp. joint venture, produces 1,500 b/d of 37° gravity crude and 700 Mcfd of gas from the North July-1 well. A second well is to spud in mid-March from the three-slot platform in 169 ft of water in the Gulf of Suez. BP PLC purchases the oil.

Ocean Energy operates SWGEZ, in which IPR holds 43.75% working interest. A discovery on the concession, in 86 ft of water, flowed on test at a rate of 6,700 b/d of oil and 2.4 MMcfd of gas, and Ocean Energy has submitted a development plan to EGPC.

Gross reserves in the two concessions are estimated at 10.6 million bbl proved and 129.6 million bbl proved and probable. Exploration prospects and leads have unrisked potential of 77-289 million bbl, says IPR.

IPR also operates Alamein, Yidma, and Tarfa fields in the Western Desert and operates and holds interests in the El-Hamra terminal near the Mediterranean Sea and a 40 km, 12-in. pipe- line, all acquired from Phillips Petroleum Co. in 1993. IPR also holds operatorship and interest in the North Ras Qattara, North Bahariya, and El-Diyur exploration concessions in the Western Desert.

Devon recognized a $10 million pretax loss ($11 million after tax) in fourth quarter 2002 on the Egyptian transaction, including the effects of operations during the quarter.

El Paso to sell line

Karrer added that the company would place its shares for sale as part of a strategy to "recycle investments" in Brazil. Karrer said that the "pipeline does not bring aggregate value to our operations here."

The pipeline, which cost $2 billion to construct, currently transports an average of 24 million cu m/day of gas. The pipeline's full capacity is 30 million cu m/day.

Slow demand for natural gas in Brazil has blocked plans to boost the pipeline to full capacity as plans to build new gas-fired plants have not progressed as expected.

The government—led by Luiz Inacio Lula da Silva of the Workers Party (PT) that took office Jan.1—is giving priority to hydroelectric plants and placing the construction of new power lines up for bids, with the government as a minority shareholder.

Hydroelectric plants generate about 90% of Brazil's electricity.

The construction of gas-fired plants was envisaged by the administration of former president Fernando Henrique Cardoso to avoid another electricity rationing like the one decreed during mid-2001.

Karrer said El Paso owns 9.67% of TBG, the Petroleo Brasileiro SA (Petrobras) subsidiary that owns the pipeline on the Brazilian side, and 2% of GTB, the company controlling the pipeline's Bolivian side.

El Paso is one of the few shareholders in the Bolivia-Brazil gas pipeline that doesn't own gas reserves in Bolivia.

Currently, El Paso Brasil will focus on natural gas and oil exploration, and is also more interested in producing cheaper gas locally to supply its five thermoelectric power plants, Karrer concluded.