Steel manufacturer Nucor Corp. said it will spend more than $700 million during a two-year period on natural gas drilling in order to meet its contractual obligations with Encana Corp. for a supply of low-cost natural gas.
Last November, in an effort to insulate itself from volatile natural gas prices, Nucor agreed to take a half-stake in some of Encana's gas wells in the United States and signed a contract for more than 20 years (see Shale Daily, Dec. 17, 2012). The companies began their relationship in 2010 with a smaller onshore gas drilling agreement that increased the number of Encana wells.
Charlotte, NC-based Nucor plans to use gas from the Encana wells, and others, to supply its $750 million direct reduced iron (DRI) plant in St. James Parish, LA. The facility, located near Convent, LA, is expected to come online in September and will have a capacity of 2.5 million metric tons per year.
During a conference call with financial analysts to discuss Nucor's 2Q2013 earnings, CFO James Frias said the company was pleased with the Encana deal so far. The $700 million-plus for gas drilling would be spent in 2014 and 2015.
"The performance of wells completed over the past two years has exceeded the projections we used to justify this capital allocation decision," Frias said Thursday. "That, of course, translates into lower gas cost and high returns from our drilling investments.
"We also expect our natural gas investments to be cash flow positive by 2016, meaning the cash generated from sales will exceed the cost of drilling new wells."
Responding to questions, Frias denied that the all-in cost number in the Encana contract was $4/MMBtu. "We've never said a number, so I'm not sure where $4 came from," he said.
CEO John Ferriola added that Nucor "has a great deal of flexibility in the contract. We have some flexibility in the volume and in our drilling. We do have a threshold price, which if the price of gas drops under, we are not obligated to continue to drill. It's at a level in which we feel very comfortable in being able to get a return, even at that threshold level.
"Over the course of the drilling program, we feel very good about the returns that we're going to be getting in this investment and the variability and flexibility we have on drilling."
Frias said the company hasn't disclosed when it expects to be fully hedged with its natural gas needs for both DRI and steel production, but he estimates Nucor could reach that goal within three or four years.
"It really depends on a number of factors," Frias said. "One factor is if we continue having the success in volumes coming from each well we drill. We've been performing better than we modeled when we first made the investment. Another factor is the timing of when we build our next DRI facility, and we haven't made a commitment to when we're going to do that yet."