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EnCana CEO Morgan Plans to Step Down; Earnings Slip 32% on Hedging Losses

A day after its founder and CEO announced plans to step down at the end of the year, EnCana Corp. reported a disappointing 38% drop in third quarter net earnings from continuing operations to $266 million (30 cents/share) compared to $432 (46 cents/share) in 3Q2004. Making matters even worse, the company slightly lowered its production forecast.

Wall Street analysts had been expecting earnings of $1.10/share. As a result EnCana shares plunged nearly 8% to end the day on Wednesday at $48.02, and proceeded even lower on Thursday to $45.56 after the company announced the sale of its NGL business to Provident for $586 million. ECA shares had been trading near $60 at the beginning of the month.

EnCana Corp. founder Gwyn Morgan stunned the investment community on Tuesday by announcing that he will step down as CEO and president of the company at the end of the year. Morgan said he will remain executive vice chairman for 2006, working mainly as an advisor for the new president and CEO, Randall K. Eresman, who currently is COO of the company.

At a news conference, Morgan discounted rumors that EnCana's board was pushing him out because he refused to negotiate a sale of the company. EnCana released a statement last week saying that it knew nothing about a possible takeover bid by Shell or any other producer (see NGI, Oct. 24).

"It's amazing what can be created out of the ether, and we made it as clear as anybody could last week that there never has been any discussions," Morgan said. "There never has been any substance that we know of. We know of nothing. Nothing."

EnCana said the company's board and management team believe the independent's "continued independence" was the best way to create long-term value for shareholders.

"When EnCana Chairman David O'Brien and I announced the creation of EnCana Corp. three and a half years ago, our vision was to build a flagship, Canadian-headquartered energy company that would be one of the strongest in our industry," Morgan said in a statement. "The name EnCana was chosen from the words 'energy Canada.' Since that time, investors have realized a total shareholder return of approximately 200% as employees delivered top-tier production and reserves growth."

With these achievements in mind, Morgan, 59, apparently believes his time has come to step down. During the call last week, he said that he and his wife, Pat Trottier, agreed last summer that ending his career at the company in his 30th year would be a good decision.

Morgan joined EnCana predecessor Alberta Energy Co. (AEC) in October of 1975 and was responsible for drilling the wells that resulted in AEC's first production. Morgan was head of AEC's oil and gas division until his appointment as president and CEO in 1994. In early 2002 he led the merger of AEC and PanCanadian to form EnCana (see NGI, Feb. 4, 2002). The company is now North America's largest gas producer and independent oil and gas company with an enterprise value of US$50 billion.

EnCana's Chairman David O'Brien said Eresman is the "natural and capable successor" to Morgan. Eresman is a petroleum engineering graduate from the University of Wyoming, who joined AEC in 1980. He played a key role in the building of AEC and was appointed COO of EnCana soon after its creation. He is credited with leading the development of EnCana's "resource play" strategy of focusing on unconventional onshore gas resources in North America.

While many of the largest oil and gas companies have bolstered their overseas operations and sold off North America assets, EnCana has steadily sold off its international assets to focus on unconventional gas and oil sands in Canada and the United States. Its production, meanwhile, was expected to grow about 25% this year to 3.7 Bcf/d from 2.97 Bcf/d in 2004. However, on Wednesday, the company scaled back that prediction.

EnCana's third quarter net earnings were 30 cents per share diluted, or $266 million, which included an unrealized after-tax loss of $604 million due to mark-to-market accounting of all hedges and an unrealized foreign exchange after-tax gain of $166 million on translation of Canadian issued U.S. dollar debt. Net earnings in 3Q2004 were 42 cents/share, or $393 million.

EnCana said 60% of the quarterly loss related to its 2004 acquisition of Tom Brown Inc. All of the Tom Brown hedge positions expire at the end of 2006. EnCana said next year about 82% of its gas sales are fully exposed to price upside.

Morgan said the company was aware of the hedging impact when it bought Tom Brown last year but also was aware that the production from the Tom Brown assets would continue to grow for years to come.

The company's total natural gas sales in the third quarter increased to 3.22 Bcf/d, up 3% compared to the third quarter of 2004. Production in the third quarter from EnCana's onshore resource plays was up about 3% from the second quarter to 2,235 MMcfe/d, and up 13% from the same quarter last year. Third quarter cash flow per share increased 51%. Total operating earnings per share increased 33%. Other positives include the expected sale of its interests in Ecuador for $1.42 billion by the end of the year, which will put EnCana squarely onshore in North American and focused on unconventional resource plays.

"Our third quarter was marked by strong cash flow and operating earnings, plus steady growth from continuing operations in North American natural gas production -- up 4%, or 126 MMcf/d, since the third quarter of 2004," said Morgan.

However, he also said the company will miss previous production guidance for the year. "Record setting wet weather in key Western Canadian producing regions and industry activity levels in the North American oil and gas service sector have restricted access to land and equipment in an unprecedented way this year," Morgan said. "As a result, we have drilled fewer wells to date this year than planned and our gas production volumes are lagging forecast rates. EnCana also has wells capable of delivering about 225 MMcf/d of natural gas production waiting to be tied in to gathering and sales pipelines.

"With more than 120 operated rigs active in our gas fields, we are expecting to exit 2005 with gas sales of about 3.4-3.5 Bcf/d. The difference between our reduced 2005 production outlook and the midpoint of our original guidance range amounts to about a two-month delay in the ramp up of gas production," he said. "Our 2005 average gas production is now forecast to be in the range of 3.25 billion to 3.30 Bcf/d, slightly below our original guidance range, but about 9% higher than average 2004 sales."

EnCana's 2006 gas sales are forecast to rise 7-11% to 3.50-3.63 Bcf/d. Total North American sales are forecast to be between 4.43 Bcfe/d and 4.59 Bcfe/d, an increase of 5-9% from the midpoint of the updated total North American sales guidance range for 2005.

"We expect that 2006 will be characterized by continued high industry activity levels and inflationary pressures, which are the product of the strong commodity prices that are generating robust netbacks," said Randy Eresman, who will become the company's new CEO at the end of the year.

"Given these conditions and the learnings we've gained from this year's experience, we have moderated our North American production growth rate to between 5% and 9% -- a measured pace that's aimed at more efficiently converting our proved reserves into sales growth and our unbooked resource potential into proved reserves as we generate substantial free cash flow."

On Thursday the company announced the sale of substantially all of its natural gas liquids (NGL) business to Provident Energy Trust for C$697 million. The sale is expected to close by the end of the year. It includes four NGL units in Empress, AB, which make up 60% of the EnCana Empress Plant. EnCana plans to retain a 10% interest in Empress, but has an put option to sell the interest to Provident for $12.6 million (C$15 million). Other Empress plant stakes to be sold include a 33% stake in the BP E1 plant, a 8.333% stake in the Conoco Empress plant, and a 12.4% stake in the ATCO plant.

EnCana also is selling its 100% stake in the Debutanizer, a 50% stake in the Kerrobert Pipeline and Storage Facility, and an 18.26% interest in the Superior Storage Facility and the Depropanizer. It also will divest its interests in the Sarnia fractionation and storage facilities, sell its 49% interest in the Marysville Underground Storage Terminal and sell 100% interest in Kinetic Resources, which markets NGL.

EnCana also has agreed to provide up to $63 million (C$75 million) in support, via a gas sales contract, in the event the commodity price relationship impacting the NGL business (fractionation spread) drops below historic averages over the next two-year period. EnCana has the opportunity to recover any support drawn over that two-year period plus one additional year.

The sale is part of EnCana's previously announced divestiture program to allow it to focus on its North American natural gas and oilsands resource plays, the company said in a statement. Proceeds fare expected to be directed to debt reduction and "potentially" the continuation of EnCana's share purchase program. TD Securities Inc. served as an adviser to EnCana on this transaction.

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