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Summary

  • Encana's Tuscaloosa Marine Shale (TMS) asset has an upside potential to increase the total liquid production going forward, which will mitigate small decline expected in total natural gas production.
  • Encana is expected to capitalize on Canadian condensate market with its increased liquid production including condensate, which is now in high demand in sand oil producing companies.
  • The pricing advantage in TMS will help the company realize higher margin on per barrel of oil, which in turn will help the company sustain its financial performance going forward.

Encana (NYSE:ECA) in the fourth-quarter generated total cash flow of $677 million, lower than $809 million year over year, due to the lower price and realized margin of natural gas. As a result, the company decreased its total natural gas production by 7% year over year. However, it reported an impressive hike in total liquids production average to 66,000 barrels per day (bpd), which rose by 82% year over year. This helped the company to report total liquid production growth of around 74% for 2013 compared to 2012.

However, the company realized a better price margin of around 0.5% per barrel of oil year over year during the fourth quarter of last year. This helped in partially offsetting the effect of low natural-gas-realized price. I expect the company will continue increasing its total oil production to meet its estimated 30% growth this year with the following key takeaways:

Tuscaloosa Marine Shale worth a look

While Encana is poised for improving its financial performance through higher liquid production, the TMS asset of the company could be a game changer. TMS is a sedimentary rock formation and spread across portions of Mississippi and Louisiana. Encana holds more than 300,000 net acres in this play, and more than 60% of the acreages are positioned in the liquid-rich land with massive oil and field condensate resource. It is estimated that it has total resources of about eight billion barrels of oil equivalent (bboe) and potential to produce more than 50,000 bpd.

Condensate, an ultra-light oil, is used as a diluent that is mixed into the heavy oil to reduce the viscosity or thickness and ease heavy oil transportation through the pipelines. Thirth percent of condensate typically mixed with the bitumen to ease transport through the pipeline. Condensate is in high demand in North America as oil-sand production is growing. Total oil-sand production in Canada is expected to increase to three million barrels per day by 2015 from 1.8 million barrels per day in 2012. So the significant growth in total oil-sand production will lead total condensate demand.

Last year the total consumption of condensate by oil-sand producers in western Canada was reported at around 350,000 barrels per day; however, the total condensate production was much lower, at around 145,000 barrels per day. So, there is a gap between the total demand and supply of condensate for oil sand, made up mostly by U.S. producers currently.

Encana has a better opportunity in the condensate market. With more than 300,000 acres in TMS and a significant amount of expected capital expenditure between $125 million and $150 million, the company is expected to experience upside in coming quarters. With the potential, it planned to drill nine to 12 net wells this year by using around one to three drilling rigs. Encana holds 75% of working interest in these wells and will use its Resource Play Hub (RPH) model to drill. This resource play hub model helps reduce operating and capital costs while increasing efficiency. Encana has implemented this model for its entire North American operation and reduced cost, which in turn helped the company lower total capital expenditure by around $400 million during fourth quarter compared to its original guidance in 2013.

The company has total inventory of around 1,300 gross wells and is expected to achieve a production rate between 2,000 bpd and 2,500 bpd this year. Earlier Encana drilled 11 producing wells in TMS of which eight are in Mississippi and three are in Louisiana. As per the last record, the company achieved initial production of 976 barrels of oil per day from one of its wells in Louisiana. So, I expect with the higher number of wells and significant capital expenditure, this shale will enable the company to meet its planned production growth of liquid by 30% this year. This will also help the company to meet its target of generating cash flow per share with a compounded annual growth rate (OTCPK:CAGR) of more than 10% from 2013 through 2017.

Pricing advantage in TMS

In TMS, the oil is primarily priced on the basis of Light Louisiana Sweet (LLS). As this crude type trades with premium to West Texas Intermediate (NYSE:WTI) benchmark in the U.S., it is an advantage for the company. In February, LLS crude traded with a premium of $10 per barrel to WTI. It will continue to be traded with a premium of $5.50 per barrel to WTI and expected to be around $3.31 per barrel in December 2014. Moreover, the condensate traded in Western Canada at around $10 to $15 more than the U.S.-produced condensate. So increasing production of condensate in TMS could help Encana to achieve a higher margin, which will strengthen its top line in the coming quarters. Encana also has hedged around 9,500 barrels of oil per day in 2014 expected production, using a fixed WTI price contract at the average price of $94.19 per barrel. So the effective pricing in TMS and the company's hedged price of oil will enable it to improve results.

Conclusion

Encana, with a focus on increasing liquid production, is moving toward sustainable financial performance. As the demand of condensate in Canadian oil-sand-producing companies is growing, Encana expects a strong quarterly performance ahead.

Source: Encana: Accelerating Growth With Liquid