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Encana Sees Red on Natural Gas Writedowns

Encana Corp. last week reported a net loss in 2Q2012 of $1.5 billion, nearly all from one-time charges on falling 12-month average natural gas prices. The Calgary-based producer earned $383 million in the year-ago period.

Canada's largest gas producer, and one of the top U.S. gas explorers, recorded a $1.7 billion after-tax charge in the latest quarter on low gas price. Operating income, which excludes the one-time items, fell 44% to $198 million (27 cents/share) from $352 million (48 cents). Cash flow, considered a key indicator of the ability to pay for new projects, plunged 27% year/year to $794 million. Because of financial hedges in place, realized gas prices were $4.79/Mcf, versus $5.09 a year ago. Realized liquids prices were $80.32, down from $92.66 in 2Q2011.

"Given the current pricing environment, the company expects that further declines in 12-month average trailing natural gas prices will likely result in the recognition of future ceiling test impairments," Encana CEO Randy Eresman said.

North American natural gas production fell 15% from a year ago to 2.8 Bcf/d from 3.3 Bcf/d on voluntary shut-ins, divestitures and natural declines.

Encana plans to continue to keep its eye on the "highest-return plays" in North America, which for the near term means more liquids and oil development and no natural gas drilling, Eresman said. Some of Encana's gas wells were shuttered early this year, and there are no plans to bring the output back online until prices signal otherwise, he said.

"If the environment were to continue for prices, we'll reduce our investments in natural gas until the market is back in balance," said the CEO. The company's management team has been "encouraged by the recent increase in gas prices but they would need to be "more stable" before any of the company's shut-in wells are brought back online. Shut-ins at some of the U.S. and Canadian operations were put in place early this year.

Encana has been repositioning its North American-only operations on liquids targets to offset low gas prices, and it paid off in the latest period with liquids output up 17% to 28,000 b/d from 24,000 b/d. The company had expected 2012 average liquids output would be about 28,000 b/d.

"We will continue to advance our strategic shift toward achieving a diversified portfolio of production and a more balanced stream of future cash flows by accelerating our development of oil and liquids rich natural gas plays and creating value by investing in our highest return projects," said Eresman. "We are taking a low risk approach to increasing our production of oil and liquids as we focus on the extraction of more natural gas liquids [NGL] from existing streams using third-party facilities and accelerating the development of new plays targeting light oil."

The growth in liquids production volumes primarily came from increased royalty interest volumes received and a successful drilling program in the Peace River Arch. NGL volumes would have been an additional 5,000 /d higher in 2Q2012 were it not for operational issues by the third-party owned Musreau facility, which was down over the period.

The 2012 guidance for total liquids production was increased this year by 7% to 30,000 b/d and the company now plans to spend an additional $600 million in the second half of the year "to take advantage of positive initial results achieved in a number of light oil and liquids rich natural gas plays." With the increased investment, projected average daily liquid production in 2013 is expected to be 60,000-70,000 bbl, about 40% of which is to be comprised of liquids.

"The increased 2012 investment and our initial projections for 2013 capital in the range of $4-5 billion are a reflection of the tremendous operational success we've had on our oil and liquids rich plays and the confidence we have in our ability to execute divestitures and joint ventures," said Eresman. "We will be disciplined in our approach and only spend the projected 2013 capital when we have secured proceeds through cash flow or completed divestitures and joint ventures. It remains a priority for us to maintain balance sheet strength and investment grade credit ratings."

Data rooms are open for investment opportunities in the Alberta Duvernay Shale portfolio and a 10% interest in the Cutbank Ridge partnership. In addition, a portion of U.S. liquids-rich plays is on the market in the Tuscaloosa Marine Shale, the Mississippian Lime and the Eaglebine. Technical presentations on these assets are ongoing and "there has been strong interest from potential partners," said the CEO.

Some of Encana's liquids properties are on the market to help defray development costs. However, only portions of the leaseholds would be sold so that projects "will come to commercialization at a faster pace and in a period of time when there are higher costs in the early part of the play, said Eresman. "We can move at a faster pace by reducing a small component of ownership, and we still would have lots left over for ourselves in substantial liquids drilling over time."

In June a report by Reuters alleged that Encana had colluded with competitor Chesapeake Energy Corp. to suppress land prices in Michigan (see NGI, July 2). Encana's board is looking into the allegations, but the management team wasn't able to offer any details because an investigation is ongoing, said Eresman. "Encana takes compliance with the law very seriously, and we are committed to ethical conduct in all that we do," he said.

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