Encana Shifts Focus from Natural Gas to Oil

- June 26th, 2012

Canada’s largest natural gas producer has decided to accelerate its shift into the liquids market in an attempt to increase revenue on the back of decade-low gas prices.

Encana Shifts Focus from Natural Gas to OilDespite a volatile crude market, both oil and gas producers remain bullish on commodity prices and are continuing to invest.

In a quarter that has seen crude prices plummet, the longer-term outlook for both oil and gas remains uncertain. This sentiment was echoed recently by news that Canada’s largest natural gas producer has decided to accelerate its shift into the liquids market.

Encana to invest $600 million

Encana (NYSE:ECA) has stated that during the remainder of the year it plans to invest an additional $600 million in order to take advantage of positive results achieved at a number of its oil- and liquids-rich natural gas plays. In addition, the company has increased its expected total liquids production for the year to 30,000 barrels per day (bbls/d) – an increase of 7 percent.

Encana projects that liquids production in 2013 will range from between 60,000 bbls/d to 70,000 bbls/d, of which 40 percent is expected to be comprised of oil and field condensate, according to a press release. At the same time, its natural gas production is expected to remain near current levels of approximately 3 billion cubic feet per day (bcf/d) for 2012 and 2013. The move has surprised many as the operational shift is set to exceed the company’s cash flow for at least 18 months.

Shift becoming increasingly popular

The shift from natural gas to liquid plays has become a common occurrence as natural gas prices trade at ten-year lows on the back of a surge in supplies and increasingly efficient methods of extraction. While some feel that the commodity is likely to rebound, not all companies are as optimistic, with many shifting their initiatives to liquid oil.

The move has not only been evident on the production side; TransCanada (TSX:TRP) recently announced that it is “actively” pursuing a move to ship oil rather than natural gas along a key pipeline network as prices for Alberta gas plunge.

“More balanced portfolio”

“Our stated goal is to transition to a more balanced portfolio of production and cash flow generation and to do so as prudently as we can,” said Randy Eresman, President and CEO of Encana. “We plan to increase the pace at which we develop our liquids-rich natural gas and oil plays while minimizing our investment in dry natural gas plays to largely preserve their value.”

The sentiment of many natural gas producers was clear when he added, “[a]s an almost pure-play natural gas producer, Encana has been most affected by the low price of the commodity caused by the continued excess of supply.”

The company expects that dry gas output at its Haynesville shale gas play in Louisiana, Greater Sierra project in British Columbia, and coalbed methane fields in Alberta will decline as it cuts off capital funding as a result of low prices.

Negative outlook

Despite the move, executives remain optimistic that North American gas prices could start to recover later this year. However, this view is in sharp contrast to that of the Canadian National Energy Board, which outlined in a recent market outlook that prices for natural gas have declined over the past few months, averaging US$2.53/MMBtu at Henry Hub, US$2.96/MMBtu at Dawn in Ontario, and $2.12/GJ at AECO in Alberta. It added that prices for the next three months could also move lower due to reduced demand and an excess volume of gas in storage.

The shift in Encana’s focus has been deemed a high risk by many; however, if energy prices recover, the Calgary-based company’s spending could be well-timed. A rebound in prices could see Encana rapidly boost spending on ten oil-prone plays at which it plans to drill between 115 and 120 wells this year – a marked increase on the 40 to 50 wells announced under its previous plans for 2012.

Too little, too late

At the same time, some feel that the company’s shift has come relatively late compared to the rest of the industry, and believe that the move is too risky considering prices may not recover. Low prices and uncertain industry conditions will almost certainly also disrupt Encana’s ability to sell assets.

Regardless, the shift in focus by a company of this magnitude remains significant. As both crude and natural gas prices are on the decline and have less-than-stellar outlooks in the longer term, many question the move. In a note to investors, CIBC analyst Andrew Potter said that he views the move by Encana as both good and bad, stating: “[w]hile deals have been relatively easy to come by during the last two years, in the current environment (collapsing NGL [natural gas liquids] prices and rapidly declining oil prices) we are more cautious on deal flow or the parameters at which deals get done.”

He recently gave the company a “mixed” rating, noting that Encana is bucking the industry trend by increasing spending as oil prices fall and gas remains locked at near-record lows.

Only time will tell whether Encana’s move is well timed, but the fact remains that investors are facing a markedly more high-risk market environment than they did in the past. A tense market, high crude inventory numbers, and increased production levels suggest that this high-risk market environment is here to stay – at least in the oil and gas sector.


Securities Disclosure: I, Adam Currie, hold no direct investment interest in any company mentioned in this article.

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