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Encana Sees 'Prolonged Environment' for Low Gas Prices

Faced with "unsustainably low" natural gas prices, onshore independent Encana Corp. will redirect up to $1 billion of its 2011 capital spending from dry gas output to natural gas liquids (NGL) and oil production, CEO Randy Eresman said Wednesday.

Even with a hedging program in place to soften the blow, low gas prices pummeled the Calgary producer in the first three months of this year, slicing into quarterly profits by 95% from the year-ago quarter. Gas-weighted output, all in the North American onshore, was up by 4% year/year.

Net income in 1Q2011 totaled $78 million (11 cents/share), versus $1.49 billion ($1.96) a year ago. Cash flow after taxes totaled $138 million (19 cents/share), which Encana said was higher than it would have generated without price hedging. Production totaled 3.34 Bcfe/d, up by 70 MMcfe/d from the first three months of 2010.

The past year hasn't played out as expected, and Encana now sees a "prolonged environment" for low gas prices, Eresman told financial analysts during a conference call.

"Roughly a year ago we announced that we would increase the pace of development over the next five years" to double production and increase shareholder value, he said. "We thought at the time that it was a very aggressive plan but achievable...through joint ventures, the sale of noncore assets...At that time, a full economic recovery was expected to be imminent" and Encana anticipated higher gas prices in response.

"Unfortunately, the recovery wasn't as expected and gas prices fell further...Through a combination of factors, it's had a major impact on Encana's near-term ability to generate cash flow, and it's impacted our program economics and long-term development plan."

Eresman said "in response to reality, we have lowered our natural gas price expectations." Encana for the long term plans to model expectations based on a $6/Mcf New York Mercantile Exchange price. The producer also has "aggressively added" to its hedging program to better align with its ability to generate cash flow.

"We have not abandoned our goal to double our size on a per-share basis, but we have accepted that it may take longer to achieve it," said the CEO. "Despite the trough in gas prices, Encana is positioned well."

In addition to returns from higher oil and NGL prices, the "tipping point" that led Encana's management team to embrace wetter output was successful technology transfer, said Eresman.

"We have seen that technology that was used in shale gas plays, that has been applied to more liquids-rich plays, areas of shale gas plays, appears to be working quite well," he said. "We were a little bit cautious at first, but with our land position, we do not have to buy...from scratch. We have optimism that we can apply the same technology that we have used for natural gas."

Encana's North American land base, which stretches across 1.7 million net acres, has "liquids-prone" lands that extend from Canada's Montney Shale into the Niobrara Shale of the Denver-Julesburg Basin, on into the Mancos and Collingwood shales, the CEO noted. In addition, Encana recently has assembled close to 190,000 net acres in the Simonette and Kaybob areas of the Duvernay Shale in Alberta.

"Initial drilling results and indications in each of these highly prospective formations show promise as we step up our evaluation and identification of the liquids potential," said Eresman. "Our multi-pronged approach to boosting liquids production from our liquids-rich assets has the potential, over the next few years, to deliver substantial volumes of NGLs production."

In 1Q2011 Encana's total output averaged 3.34 Bcfe/d. Gas production was about 3.20 Bcf/d, while NGL and oil output reached about 23,000 b/d.

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