Tuesday, December 16, 2014

Why Encana’s Gas-to-Oil Transition Isn't Threatened by Price Drop

This article was originally published by TheStreet on November 21, 2014. 
By Sarfaraz A. Khan. Research Asst. Omar E. 
NEW YORK (TheStreet) -- Two years ago, Encana (ECA) , which became Canada's largest gas producer by drilling wells in more than 25 different areas, said that it was going to focus on just five higher-margin oil and natural-gas-liquid-rich regions.
It has continued that transition and, despite double-digit drops in crude prices over the last three months, is not slowing down.
This year, the Calgary company purchased properties from Freeport-McMoRan Copper & Gold (FCX) for $3.1 billion and acquired Athlon Energy (ATHL) for $7.1 billion. Both of these purchases were revealed at a time when WTI crude oil prices were trading at over $90 a barrel, compared with current levels of around $76 a barrel.

In hindsight, the two acquisitions appear poorly timed. But Doug McIntyre, Encana's spokesman told TheStreet in an email interview that while the commodity price cycles are "very difficult to predict," the two acquisitions have allowed the company to add the "top two resource plays in Canada, the Montney and the Duvernay, and the top two resource plays in the U.S., the Eagle Ford and the Permian" in Texas to its portfolio. Due, in part, to these acquisitions, Encana will "achieve 75% of its operating cash flow from liquids production in 2015, which is two years ahead of plan."
With the sale of $9 billion of lower margin gas-focused assets, Encana has "more than adequate" cash to fund the acquisitions and pay dividends, despite cutting this year's cash flow guidance by 7% in its third-quarter results last week, said RBC Capital Market's analyst Matthew Kolodzie in a recent report.
Eventually, Encana seeks to have up to 50% of its total production in 2017 as liquids, as opposed to just 10% in 2013. While the possibility of prolonged weakness in crude prices in the $70-$80 a barrel window has prompted some oil and gas companies, like Continental Resources (CLR) and Halcon Resources (HK) to scale back their oil and gas drilling activity, Encana is not delaying its transition goals.
his is because, according to McIntyre, Encana sees the "current oil prices as an annoyance rather than a threat." The company's gas-to-oil transition plans are based on "economic thresholds that create returns well below current commodity prices."
Further, Encana is not completely abandoning natural gas, choosing to stick with some of lucrative properties. "This diversified commodity mix [of both oil and gas assets] has us well positioned to deliver sustainable, profitable growth in any price cycle," McIntyre added.
Encana has won over some analysts. The company's stock, at around $19, has fallen by around 17% over the last three months and is up only 4% for the year to date because of declining oil prices. But this decline offers "a good entry point" to investors, Kolodzie wrote.
Similarly, Sameer Uplenchwar, analyst at Global Hunter Securities said in a recent report that Encana "is moving in the right direction" by focusing on fewer core liquid rich areas that, at current price levels, generates "higher return than natural gas."
So far, Encana's quarterly results have been hit by asset sales and divestitures, which makes it difficult to measure its performance. Investors will have to wait until the first quarter of the next fiscal year to get, what Uplenchwar termed, the "first clean quarter."