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Encana beats a retreat Weak economic recovery, low gas prices, force sidelining of aggressive production goals, restoring liquids to portfolio, JV hunt Gary Park For Petroleum News
A year of grumbling and sniping by analysts and investors at Encana’s high-risk strategy of doubling its per-share output by 2015 culminated April 19 when North America’s second largest natural gas producer took a sharp course correction.
Chief Executive Officer Randy Eresman reluctantly conceded that raising the company’s volumes to about 6 billion cubic feet per day was no longer feasible amid a grim outlook for gas prices in a market saturated with shale gas and a sluggish economic recovery.
The mood turned sour at Encana’s annual meeting later that day when a shareholder challenged Eresman’s compensation of $10.2 million in 2010, noting that Brian Ferguson, chief executive officer of Cenovus Energy, the pure oil sands player spun off from Encana in late 2009, pocketed just over half that amount.
Encana Chairman David O’Brien was left to make the case for the defense, arguing that Cenovus is simply a Canadian company, while Encana has more than 50 percent of its assets in the United States.
“So we compete on a North American basis and that’s a big change over the last several years,” he said. “And one of our challenges … is to compete with the best and brightest in the U.S. So we have to peg our compensation to what we describe as the 50th percentile across North America.”
Whatever the merits of O’Brien’s logic or the fact that holders of more than 90 percent of Encana shares endorsed the compensation policies, the exchange was an uncomfortable moment for a company accustomed to collecting plaudits.
Signs of trouble building The signs of trouble have been building over the past 18 months, forcing Encana to retreat from its production goal.
Eresman insisted the target stands. It’s just the timetable that has moved, although he wouldn’t say by how much.
When the plan was unveiled a year ago, Encana expected gas to trade at $6-$7 per thousand cubic feet on the New York Mercantile Exchange over the long-term. It is currently stuck around $4.
The per-share doubling of volumes was predicated on total production rising by 14.4 percent a year over the five years. That has now been adjusted to 10 percent, undercutting Eresman’s insistence that Encana’s industry-leading technologies and strategies resulted in lower operating costs than most analysts realized and that commodity prices would bounce back.
Instead, he now admits that a “full North American economic recovery did not occur as quickly as we expected and natural gas prices retreated further at a time when it was clear natural gas supply was growing rapidly.”
The result has been a “major impact on Encana’s near-term ability to generate cash flow (which in turn) has impacted our program economics and long-term development planning” — the same factors that hang menacingly over smaller gas-weighted companies and proposals for develop Arctic gas in Alaska and the Northwest Territories.
Full scramble mode The company is now in full scramble mode to find ways to accelerate development of its vast holdings, with contingent resources estimated at 56.5 trillion cubic feet, 7.5 million net acres and 23,000 drilling locations, by attracting third-party offshore investors, opening export routes to Asia and promoting gas as a transportation fuel in North America. Most surprising of all, it is turning the clock back to its days as a combined oil and gas producer.
Its first-quarter earnings were a dismal $78 million compared with $1.5 billion a year earlier and cash flow was down 19 percent, despite a 4 percent increase in production to 3.34 billion cubic feet equivalent per day.
The early signs of discontent surfaced late last year when RBC Dominion Securities analyst Greg Pardy recommended Encana should formally abandon its high-growth ambitions.
He said Encana should “return to a very successful game plan whereby it delivered an annual return of approximately 10 percent, consisting of a combination of single-digit production growth, dividend yield, and share buybacks as its free cash flow allowed.”
Pardy said RBC’s neutral stance towards Encana “has everything to do with a natural gas market that is likely to be structurally oversupplied for the next few years. Even in the absence of gas price risk, high-growth rate strategies tend to raise execution risk and are often not rewarded by the market as a result.”
Goldman Sachs urged investors to sell their shares and Macquarie Capital Markets forecast shareholders would be hard-pressed “warming up to (Encana’s) market strategy” if they saw profitability being squeezed.
More time and money into liquids Faced with oil prices heading in one direction and gas prices going the other way Encana has opted to put more time and money into crude oil and natural gas liquids, although it faces a long haul, given that liquids currently account for only 23,000 barrels per day, or 4 percent of its production.
However, it plans to transfer $1 billion, or about 21 percent of its 2011 capital budget, into liquids and is committed to “significantly increasing our liquids weighting over the next five years,” drawing on 1.7 million acres of liquids-rich lands in British Columbia, Alberta, Colorado and Michigan.
Laura Lau, an energy and resources fund manager at Sentry Select Capital in Toronto, said the diversification shows the risk Encana took in unloading oil assets and “putting all its eggs in one basket.” She said Encana has also been slow to follow its peers in exploiting the byproducts of gas production.
Encana has also hired RBC Capital Markets and Jefferies & Co. to seek joint-venture and divestiture deals for selected assets in British Columbia’s Horn River and Greater Sierra land as it steps up its efforts to divest unconventional shale gas holdings by attracting Asian capital.
JV, farm-out deals Movement on that front would model joint-venture and farm-out deals already negotiated with PetroChina and Korea Gas to develop its British Columbia and Alberta properties, which hinge on regulatory and corporate approval for the Apache-operated Kitimat LNG project, which could eventually export 1.4 billion cubic feet per day to Asia, with Encana as a 30 percent partner.
The PetroChina joint venture, which would see the stated-owned producer pay C$5.4 billion to develop 50 percent of Encana’s Cutbank Ridge assets, is waiting for a verdict by Canada’s foreign investment review agency.
Confident that the Canadian government will ratify the Chinese offer, Eresman said that if all of PetroChina’s investment was “reinvested in share purchases, there’s a big chunk of growth right there.”
To open new markets in North America, Encana is also making some headway in expanding the use of LNG and CNG as a transportation fuel.
It is introducing mobile LNG fueling stations for 150 of its fleet vehicles by the end of 2011 and for 200 heavy-duty trucks operated by California-based Heckmann Water Resources and also plans to build five plants over the next two years to produce LNG.
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