Hedging and Accounting at EnCana Corp.

It has been recently reported in the globeandmail.com and elsewhere how EnCana's (ECA) hedging strategy "backfired" as the company recently hedged 40% of its expected 2008 natural gas production at around $8 MMBtu, while prices for natural gas are currently near $11 MMBtu.

The impact of the hedging showed up in EnCana's first quarter results as profits fell to $93 million from $497 million a year earlier, with the decrease in the first quarter resulting from unrealized hedging losses. While EnCana's 2008 hedges have not expired, mark-to-market accounting generated the balance sheet adjustments of $737 million as natural gas prices moved above the original $8 MMBtu contract price. Also mentioned is how EnCana's executives are "looking on the bright side" as the higher prices have helped the 60% of their production that is not hedged.

As usual, it is interesting how hedging is considered to have backfired when it turns out that the company would have been better off being without a hedged position. Of course, if it had turned out that $8 MMBtu was the top for natural gas prices, and Encana was now selling the majority of its 2008 production for spot prices of $6 MMBtu, then some of the same authors and many shareholders might be wondering why the company did not lock in prices when they were so high.

Rather than seeing a "backfired" strategy, Encana's approach to managing its business appears sound and stable, and less risky and foolish than one might expect.

Disclosure: None

Comments

[User 42142]

For almost a decade the 'experts' have been wrong on energy. Any one else with that record would be ignored. Supposedly clever CEOs are apparently slow learners. as is this bean counter.

[Mmarrkk]

Have to disagree with you User. Hedging production is a form of insurance. Lock in a certain percentage of your production at a given price, eliminating some of the impact of volatility. Would you quit buying homeowner's insurance, because over the last 10 years I've bought it and never had to make a claim. Just reduces the volatility! Its a shame that accounting regulations force companies to show a "loss" on the books when they lock in prices at something less than the market price. Produce gas for $1/mmcf, sell it for $8, looks like a profit of $7/mcf, right? Not in the mind of the bean counting fools because you could have sold it for $11! So now you have to include a "loss" of $3 in the equation. Wall STreet analysts are the ruin of good operating companies.

[ACEMAN]

Keep your eye on the prize, y'all. ECA dominates the natural gas industry in North America; its deal with COP of 50%-50% Athabasca tar sands gre 26% from the prior year. ECA appears to be on track for an operating profit of $5.70 per share for 2008. And it has the largest land position in NA for future hydrocarbon production of 26 million acres, which makes ECA a long-life reserve company. So forget mark to market, keep your eye on the black gold and the gas, gas, gas.