Encana Corporation (NYSE:ECA) is in a transition phase. The leading North American energy producer is focused on strengthening its portfolio of resource plays producing natural gas, oil, and NGLs. The company has a history of entering in to highly potential plays and strengthening the productive capacity at a low cost. In the past, the company struggled with lower natural gas prices primarily due to a boom in shale gas production. Therefore, the company decided to bring about certain changes in its asset portfolio and to make focused and disciplined capital allocation to growth assets.
Moreover, during the second quarter of 2014, the company seemed to make faster than expected progress in executing its strategy. With the recently taken steps, the company endorsed its plan to focus on growing its oil and natural gas liquids production. During the past year, Encana has accelerated its acquisition and divestment activities as part of its strategy to sharpen its focus on high-margin liquids. Consequently, with the new asset base the company is now ahead of its 2017 production target.
The company delivered strong operational results in the second quarter backed by increased liquid growth. It delivered oil production of 34,200 barrels per day reflecting an increase of 49 percent compared to the figure reported in the previous year. Moreover, the natural gas liquids production also increased by 38 percent year-over-year to 34,000 barrels per day. In addition, given the strong operating performance, the company also revised its 2014 guidance from the previously projected production of target of 68,000 to 73,000 barrels per day to 86,000 to 91,000 barrels per day. The revision of the 2014 guidance is primarily due to the company's latest acquisition of acreage in the Eagle Ford shale. The liquid production growth can be seen in the figure below.
Source: Encana's Corporate Presentation
The acquisition of the sixth growth area in the Eagle Ford shale is expected to accelerate Encana's liquids production growth as the play is expected to double the company's current oil production in the long term. At the time of the acquisition, there were 2 rigs running in the play. However, going forward the company plans to increase the total rig count to 4 by the end of the current year which will result in $200 - $250 million free cash flow in the second half of 2014. To do so the company has also increased its upstream capital investment guidance from the previous guidance of $2.3-$2.4 billion to the current allocation of $2.6-$2.7 billion. A major portion of the planned capital expenditure was allocated to the newly acquired acreage position in the Eagle Ford shale.
Risks Attributed to the Strategy
Currently, natural gas makes up a big part of production at approximately 86 percent, reflecting a decrease of 4% from last year's 90 percent. However, the sale of natural gas assets coupled with increasing focus on liquid assets will cause the percentage to continue to decrease. Some analysts believe that it is a risky strategy. The problem is that the company is selling its assets at a time when natural gas is trading at lower levels; therefore the assets are being sold for less than what they are actually worth. On the other hand, oil is trading at highs. So the problem is twofold. Although, in the short term the decision seems to be the right move to strengthen its financial performance, the negative effects could hit the company in the long term.
Encana has been pursuing the strategy to strengthen its portfolio of resource plays and is focused on growing its oil and natural gas liquids production. To do so, the company has divested assets worth $121 million in Canada and $2170 million worth of assets in the U.S. during the first six months of 2014. Going forward, the company is determined to close the remaining balance of the East Texas transaction in the third quarter of the current year. Similarly, the company has acquired $2 million worth of assets in Canada and $2944 million worth of assets in the U.S. The acquisition includes 45,500 net acres in the Eagle Ford shale and is expected to replace the natural gas weighted production from the Jonah and East Texas divestitures.
The company believes that the accelerated acquisition and divestment activity has allowed it to sharpen its focus on high-margin liquid production. However, there are certain analysts who tend to believe otherwise. They argue that the strategy might boost the financial performance in the short term but it is better to make decisions that are counter-cyclical in the long term. Therefore, investors are advised to consider both arguments before making any investment decisions.
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