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From the Survey: Encana Corporation
Encana Corporation (ECA) is an energy producer possessing a portfolio of natural gas, oil, and natural gas liquids (NGLs) assets. At the end of 2012, this Canadian entity had 13.4 trillion cubic feet of natural gas and 282.5 million barrels of oil and NGLs in reserves, respectively. The company focuses solely on North America, with operations comprised of Canadian and USA segments. Besides having a presence in a number of flush gas plays, its liquids profile continues to get more attention. This expansion is being pursued through joint ventures and/or co-development agreements, which are enabling production growth while maintaining financial flexibility.
The Canadian division holds an industry-leading 8.5 million acres of land in Alberta, of which, 4.4 million acres are undeveloped. Most prolific is Cutback Ridge, where horizontal drilling and hydraulic fracture techniques are generating attractive gas yields. In 2012, Encana entered into a $2.9 billion (Canadian) agreement with Mitsubishi to jointly develop certain parts of this resource. Under a $2.2 billion 50/50 partnership with PetroChina, work will commence to establish a production hub in the liquids rich Duvernay play. Another resource that is receiving substantial amounts of capital is Big Horn.
Encana’s USA division holds roughly 2.4 million acres (1.9 million acres being undeveloped). The Piceance Basin in Colorado remains the unit’s most significant source, and one which has secured several development agreements. Most significant is a joint venture in which steel maker Nucor (NUE) will cover half of all developments costs at certain sites for the next 20 years. The other play that is getting plenty of attention is the Jonah field in Wyoming, which is becoming a domestic energy hub. The company has finalized a transaction with Exaro, which has agreed to invest $380 million over the next five years for a 32.5% interest.
In 2013, management is looking for oil and NGL production to range between 50,000 and 60,000 barrels per day, and average annualized natural gas output of 2.8 billion to 3.0 billion cubic feet equivalent. With oil markets cooling and NGL prices searching for a bottom, investors appear to be disregarding the ongoing recovery in natural gas, Encana’s biggest source of sales.
United States gas prices increased 39% in 2012, and momentum has carried over into 2013. After averaging $3.48 per million british thermal units (mmbtu) during the 2013 March interim, the key source of energy is currently above $4.00 mmbtu. With domestic natural gas inventories below the five year average (1.7 trillion cubic feet) at the start of the 2013 refill season, gas producers are positioned to have a relatively good year.
Momentum may well continue. A growing number of domestic producers are seeking permission to sell natural gas overseas, in the form of liquid natural gas (LNG). The liquefaction of natural gas enables the transportation of massive amounts of fuel from areas where natural gas is abundant and relatively inexpensive to areas where production is insufficient or infrastructure (pipelines) is unable to meet demand.
While this key source of energy sells for approximately $4 per mmbtu in North America, its price tag is four to five times that in certain overseas markets. In particular, it fetches as much as $16 per mmbtu in Europe and $20 per mmbtu in Asia. Consumption of LNG is on pace to grow sharply in the years ahead in these markets, driven by a build-out of natural gas fired electric power generation capability in Asia; reduction in nuclear power generation in LNG importing regions, such as Japan and Europe; and conversion of coal- and oil-fired power generation to natural gas. In fact, North American exports will be pivotal to the global economy, as total LNG demand is expected to grow 30%-40% over the next several years, eclipsing projected supply deliveries. We expect increased competition for LNG to be a boon to domestic gas suppliers.
Oil is likely facing a challenging short term. Total domestic crude inventories are at 388.9 million barrels, which is 6.5% above year-earlier levels and 10.5% greater than the five year average. The market for black gold is being hampered by slack demand from Europe and a slower-than-anticipated recovery from China. Our 3- to 5-year outlook for oil is bullish, though, as development in emerging markets ought to drive up prices for one of the most indispensable products in the world.
Lastly, the immediate outlook for NGLs (ethane, propane, butane, isobutene, and natural gasoline) appears tepid. A side effect of heavy shale gas investments is a boom in NGL supplies, with average domestic production reaching a record 2.4 million barrels a day in 2012. We expect the glut of NGLs to persist in the short term, but exports and consumption (with several chemical companies in place to build plants stateside) should eventually lead to tighter fundamentals.
Meantime, this diversified explorer & producer has taken measures to shore up its balance sheet. Encana’s financial position weakened in 2012, following natural gas’s precipitous decline. In fact, cash flows were insufficient to fund dividends and capital spending requirements, which led management to raise capital. Non-core asset sales and joint ventures more than covered the shortfall, generating nearly $4.0 billion in proceeds. While this trend is apt to continue this year, the tide ought to gradually turn. For now, we expect Encana to have sufficient financial wherewithal to maintain its dividend, which currently yields approximately 3.0%.
Encana’s capital investment strategy is focused on transitioning into a diversified explorer and producer. In 2010, the company spun off its oil and NGL businesses into another publicly traded company, Cenovus. At that time, management was intent on focusing development efforts on the most promising shale-gas regions in North America, including Haynesville in the United States and Horn River in British Columbia, Canada. It was confident that hedging practices could mitigate the adverse effects of cooling natural gas prices had on profitability. This assumption proved to be presumptuous. Since then, Encana has been working to once again become a well-balanced energy supplier. In particular, expenditures are being allocated toward oil and liquids rich gas plays, minimizing spending in dry gas.
Investors have yet to embrace Encana’s transition back into a diversified energy player. With the company’s liquids profile growing nicely, and natural gas markets firming, Encana offers substantial recovery potential from the current quotation.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.