Encana Should Grow After Reshuffling Its Assets

| About: Encana Corporation (ECA)


The volatility in the natural gas prices have forced the company to focus more on liquids.

The addition of high-margin assets will enhance the profitability of the company.

Encana's focus on liquids will bring stability to the revenues as well as cash flows.

Tuscaloosa Marine Shale has a massive growth potential due to its massive oil reserves and it can add 50,000 Bbls/d to Encana's production.

Encana Corporation (NYSE:ECA) has collected a strong portfolio of assets, which can be categorized into two categories: growth assets, and base assets - both of these categories hold high yielding liquids and gas rich plays. Encana made its reputation as a natural gas E&P company; however, the decreasing natural gas prices at the start of the year prompted the company to shift its focus towards high yielding oil assets. In order to move towards a liquids-heavy portfolio, the company has been acquiring assets from other companies, and it has also been making acquisitions. Recently, Encana acquired Athlon Energy (NYSE:ATHL), an independent exploration and production company focused in the Midland basin. Let's see how the company has been reshuffling its assets base.

The Reason for Change and Expected Benefit

Encana has a natural gas heavy assets portfolio - the company has a total proved plus probable [2P] natural gas reserves of around 14,555 Bcf gross and 12,551 Bcf net - the total developed producing reserves stand at 6,125 Bcf gross and 5,360 Bcf net. Encana recently increased its natural gas prices as the commodity prices showed a favorable trend during the last year. However, by the end of the year, commodity prices again started to show weakness, which resulted in declining revenues for the company. The image below shows the trend in revenues for the fourth quarter in the last two years - fourth quarter is usually good for energy companies as the winter season usually results in increased demand for natural gas and strong commodity prices. However, even in the fourth quarter, the company has been seeing declining revenues.

Source: Earnings Supplement, Investor Relations.

As a result of this uncertainty, the company has planned to balance its liquids and natural gas assets by 2017, and the management wants the liquids to account for approximately 75% of the company's operating cash flows. Encana has targeted five oil-rich core growth assets in the U.S., which are estimated to give more than 40% return in the future. By acquiring these assets in Montney, Duvernay, DJ Basin, San Juan and Tuscaloosa Marine Shale, the company is focusing on growing value, not the volumes. Also, these assets have strong growth potential with output capability of approximately 50,000 Boe/d.

Source: CIBC 17th Annual Whistler International Conference, January 2014.

With the addition of these assets, the company is looking to increase the margins - Encana is expecting these assets to take its margin from $1.90/Mcfe to $4.20/Mcfe. If the company is successful, then we can expect a strong trend in the earnings. We are looking at a growth of over 120% in margins due to the addition of these five assets.

Crude will Take the Center Stage

The first step Encana took during the current year was the acquisition of the liquid-rich plays in Eagle Ford for $3.1 billion. The acquired assets include 45,500 net acres in Karnes, Wilson and Atascosa counties - these assets produced around 53,000 Boe/d in the first quarter with over 400 future drilling locations. Also, the company managed to acquire the highest yielding acreage in the Eagle Ford basin, with Estimated Ultimate Recovery [EUR] of more than 600 Mbbl in the region.

Source: Investor Presentation, Company Website.

Encana has also acquired Athlon Energy to establish a premier oil position in the Permian basin. The $7.1 billion acquisition of Athlon has enabled Encana to explore 140,000 net acres of Permian acreage with approximately 3 billion Boe resource potential and around 5,000 potential future drilling locations. However, with the acquisition, the company has jeopardized its entire cash position, which could limit its capital spending to pursue its growth strategy. Nonetheless, the acquisition has increased its acreage in an extremely attractive, high quality, and high yielding area. Permian basin has an estimated production of more than 1.7 MMbbls/d with more than 30 Bbls of cumulative oil production. This will increase the operational productivity of Encana by around 50,000 Boe/d by the next year with increased estimated operating cash flows of $4 billion by 2019.

Source: Investor Presentation, Company Website.

Furthermore, the Tuscaloosa Marine Shale [TMS] has real future growth potential. TMS is a massive oil resource with strong upside potential of producing more than 50,000 Bbls/d. The company holds more than 300,000 net acres in the region and more than 60% of the acreage is located in the liquid-rich land with massive oil and condensate reserves. The image below shows the details of the TMS assets.

Source: Investor Presentation, Company Website.


We have seen this strategy from other E&P companies as well - the natural gas prices have forced a number of E&P companies to focus on liquids. Some of these companies have taken heavy write downs as some assets are not economically viable anymore - oil or gas assets become economically unviable when the extraction costs exceed the prevailing market price. At the start of the decade, natural gas prices were close to the all time lows and the natural gas heavy companies were taking write downs as the cost to extract natural gas was more than the prevailing price - Encana also wrote down assets during this time as it was an industry wide problem - the company wrote down $1.7 billion worth of assets in the second quarter of 2012 alone. However, recovering natural gas prices during the next year gave these companies some breathing space and the industry started to see natural gas heavy companies moving towards liquids so that they do not have to face the same problem again. These companies are now trying to achieve a balance in their assets mix so that the risks can be hedged. We believe Encana is reshuffling its assets portfolio well and it will not be exposed heavily to the natural gas commodity price risk in the future.

Additional Disclosure: This article is for informational purposes only and it should not be taken as an investment recommendation. Investing in stock markets involves a number of risks and readers/investors are encouraged to do their own due diligence and familiarize themselves with the risks involved.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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