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Stick handling in tight spot Encana trims gas production growth in response to ‘unsustainably low’ commodity prices, shut-ins possible; uncertainty on JV talks Gary Park For Petroleum News
At first glance, you might think Encana has little to lose sleep over.
The North American natural gas power has brought shut-in gas back into production this year, is increasing 2010 spending at its Bighorn property in Alberta’s Deep basin to C$340 million where output is rising, is curbing costs at its British Columbia unconventional plays and is surging ahead at its overlooked Alberta coalbed methane operations.
Toss into the mix favorable progress at its farm-out agreement properties with Korea Gas Corp. in British Columbia and you have the ingredients for a successful brew — certainly enough for Encana to stick with its bold target of doubling per-share gas production over the next five years, a growth plan that drew a skeptical response when it was first unveiled six months ago.
So why would the big independent’s shares take a bruising in the wake of its third-quarter earnings report, giving Encana the worst performance on Oct. 20 of the 47 companies trading on the Toronto Stock Exchange energy index?
The answer is pretty simple. These are some of the worst of times in years for companies that are dependent on gas.
Cost inflation, price concerns In addition to facing cost inflation in its U.S. business where shale gas operations are experiencing equipment constraints and New York Mercantile Exchange contract prices for November of $3.50 per million British thermal units (the lowest November price since 2001), Encana is wary of what lies around the corner.
If the low prices persist, Chief Executive Officer Randy Eresman said his company may consider trimming capital spending next year (it has already deferred $200 million from 2010 to 201l because of completion delays at the Haynesville shale play in Louisiana and Texas).
The double-up production objective was based on capital expenditures of $6 billion a year and would have required an annual growth rate of about 15 percent, compared with the 12 percent it has achieved so far this year.
“However, our view right now is that in light of what could be an extended period of lower prices, it’s just not prudent for us to continue to develop production at that same pace in the short run,” he said, disclosing that Encana is close to the point where it is considering shut-ins.
At the same time, Eresman said, there are areas in British Columbia’s Horn River and Montney where Encana will have to continue expanding processing capacity to be ready for a rebound in later years.
To that end, the company is working with its advisers to assemble packages in both Canada and the United States that should be available within the next month for potential joint packages.
Executive Vice President Bob Grant said the goal is to “find third-party funding to help us accelerate the development of properties we wouldn’t be able to get to otherwise for 10-plus years.”
The farm-out arrangement with Kogas has been moving ahead, targeting seven well completions this year at Horn River. Mike Graham, president of Encana’s Canadian division, said there is now the prospect of building on the Kogas deal, which commits the Koreans to spend $565 million over three years at Horn River and Montney.
But there is a more subdued response to questions about the status of the plans to establish a joint venture with PetroChina-China National Petroleum Corp. to spend up to $2 billion a year.
“We’re not sure where things are going to go at this point in time,” said Eresman, backing away from his July comment that the talks were “developing very well.”
He indicated there is a variation in the Chinese calculation of the project’s long-term value and Encana’s own estimate of the value of its holdings.
‘Unsustainably low’ gas prices Eresman offered a candid outlook when he said North America’s continuing gas oversupply has driven prices to “unsustainably low” levels that could force his company to “adjust our growth rate to align with our capacity to generate cash flow.” In fact its target for 2010 has been trimmed by 50 million cubic feet per day to 3.315 billion cubic feet per day.
Analysts welcomed word that Encana will back off its aggressive growth strategy, with Andrew Potter of CIBC World Markets, noting that investors who have been concerned about “high-spending plans in a weak gas price environment” should have some of their fears alleviated.
Phil Skolnick, with New York-based Canaccord Genuity, said Encana, by spinning off its oil sands assets to create Cenovus Energy, has removed the “optionality that the oil sands provides and also the balance it provides … (and) now it’s showing.”
In what was interpreted as admitting to a mistake, Encana said it will look for opportunities within its portfolio to extract value from its oil and natural gas liquids, although, with current output of just 23,000 bpd, that isn’t viewed as potential for a windfall.
The more telling test is scheduled for December when Encana lays out its capital spending and production targets for 2011.
Skolnick said that will be a double-edged sword — if it fails to lower its 14 percent annual growth target, the market will accuse the company of “not being capital disciplined,” but if it takes drastic measures the market will question the economics of the company’s assets.
UBS Securities analyst George Toriola said Encana has little choice but to “moderate” its growth targets, but warned that the message now being offered may be “too little, too late.”
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