Encana is looking well beyond its blockbuster US$5.4 billion deal with PetroChina to fast track development of vast shale gas deposits in British Columbia and open up export markets in Asia.
In the process, it is testing the limits of the Canadian government’s foreign investment rules and national security concerns.
A “cooperation agreement” announced Feb. 10 culminated nine months of negotiations between the two companies, which sources believe grew rapidly from an initial US$1.5 billion-US$2 billion.
The prize for PetroChina is 50 percent of Encana’s prolific Cutbank Ridge shale and conventional gas formation, which the Calgary-based company started acquiring in 2003 when it paid a bargain-basement C$700 per acre for 500,000 acres.
But Encana’s success on the land acquisition front, combined with its rapidly advancing “gas factory” approach to developing unconventional resources, have created a new set of challenges.
By trailblazing the way into North America’s shale and tight gas plays, Encana has established proven reserves of 14.3 trillion cubic feet, up 3.1 tcf from 2009; built an inventory of 23,000 drilling locations; and has significantly lowered its operating costs last year to US$1.09 per thousand cubic feet per day in Canada and a mere US56 cents in the United States.
Saturated North American marketThe added problem in British Columbia is the distance from major gas-consuming centers, combined with Encana’s decision a year ago to double per-share production to about 6 billion cubic feet per day by mid-2015 in a saturated North American market.
Short of embarking on massive production shut-ins or drastic spending cuts, it turned last year to the only obvious alternative — attracting foreign investment in joint-ventures — by opening talks with PetroChina parent, China National Petroleum Corp. (the world’s second largest company by market value).
The resulting deal, assuming it gains regulatory and government approval in Canada and China by mid-2011, will give PetroChina a share of 1 tcf equivalent of proven gas reserves, 635,000 net acres, 510 million cubic feet per day of production, 700 million cubic feet per day of processing capacity, 2,050 miles of pipelines and gas storage in Alberta.
Encana Chief Executive Officer Randy Eresman said joint-venture activity is “an important part of how we conduct business” in an environment of “unsustainably low” gas prices that he doubts will rise above US$6-US$7 per million British thermal units over the long-term.
He said the strategy accelerates “our development timeline (and) allows us to focus that development in a highly efficient and cost-effective manner. We foresee significant multiyear transactions that could give us the ability to grow at a faster rate and a lower cost.”
To date, Encana’s joint ventures are valued at about US$10 billion and include a farm-out deal with Korea Gas Corp., which has pledged to i
Joint ventures worth US$10 billionnvest US$1.1 billion over five years in British Columbia’s Horn River and Montney formations, and its joint venture with Shell in the Hayneville shale of Louisiana and Texas.
However, nothing more is likely on the joint-venture front until the PetroChina deal clears the regulatory hurdles and gains approval from the Canadian and Chinese governments — likely about mid-2011.
Although the two companies are still discussing their operating details, Eresman said Encana will market the gas for no longer than five years, after which PetroChina will be responsible for its own sales arrangements.
Gas to Asia as LNGBut the most significant aspect to surface so far is an apparent tacit agreement by Encana and PetroChina to pursue markets in Asia.
Eresman said Encana thinks it “makes a tremendous amount of sense from a proximity point of view (to link LNG from North America with Asia), so we look forward to supporting that in any way we can.”
Having disclosed for the first time that Asia is on Encana’s radar screen, Eresman said “there is obviously an opportunity to supply natural gas to the (planned) Kitimat LNG project” — a joint venture by Apache (which is an upstream partner with Encana) and EOG Resources, which has filed an application with Canada’s National Energy Board to export an average 1.28 billion cubic feet per day over 30 years, starting in 2015.
He said Encana has started thinking about LNG exports since recognizing the “abundant supplies of natural gas in North America and acknowledging that we have multiple points for imports, but no real export points.”
“To make the market more fluid and functional, we think North America needs both,” specifically to provide an opportunity for “Asian players who demand more natural gas in their energy portfolios.”
Kitimat may have driven PetroChinaAndrew Bradford, an analyst with Raymond James, said in a research note it is “fair to assume” that PetroChina entered the joint venture “based on some strategic premises and we suspect that recent progress at the Kitimat LNG project was likely an enabling factor in this transaction.”
The Kitimat partners also advanced their plans Feb. 7 by agreeing to pay C$50 million for the 50 percent of Pacific Trail Pipelines they do not already own. The proposed 280-mile pipeline would serve the planned Kitimat liquefaction terminal, with Apache owning 51 percent and EOG 49 percent — the same split they already have for the US$3.4 billion terminal.
Roy Dyce, CEO of Pacific Trail owner Pacific Northern Gas, said there is now an “increased likelihood that the (Kitimat pipeline and terminal) will move forward.”
The PetroChina deal is the largest by a Chinese company in Canada’s energy sector, putting the spotlight on the Canadian government and its foreign investment review agency to decide whether partnerships, rather than outright takeovers, meet its economic and national security tests.
Under the Investment Canada Act, reviews are mandatory for foreign companies acquiring controlling interests in Canadian companies with assets worth more than C$600 million, or investing more than C$299 million. The vetting requires buyers to demonstrate a net benefit to Canada.
An amendment in 2009 also allows a review if there are “reasonable grounds to believe an investment by a non-Canadian could be injurious to national security,” but the statute does not define what is meant by “national security.”
Last year, Industry Minister Tony Clement approved two Chinese-initiated energy deals — PetroChina’s C$1.9 billion offer for 60 percent stakes in two oil sands leases held by Athabasca Oil Sands Corp. and Sinopec’s $4.65 billion acquisition of ConocoPhillips’ 9.03 percent stake in the Syncrude Canada oil sands consortium.
But Clement turned down a bid last October of C$39 billion by Australia’s BHP Billiton for fertilizer giant Potash, declaring the Saskatchewan company was a “strategic resource” and BHP’s proposal would not generate a net economic benefit.
That stunning decision builds some uncertainty around the Encana-PetroChina deal, which Clement said will trigger a “thorough” review, including consultations with affected provincial and territorial governments as well as other federal government departments.
Once an application is filed, Clement will have 45 days, with the option of adding 30 days, to make a ruling.