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 last week.

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. 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.

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. Ironically, it was less than two years ago that Encana shifted to become a pure play gas producer by splitting off its integrated operations into Cenovus Energy Inc., which claimed the oilsands business and most of the integrated oil assets (see NGI, Nov. 30, 2009).

However, Encana was left with most of the land, and a lot of it contains liquids and oil, particularly in parts of Canada, where the bulk of the redirected spending will go.

“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, he noted.

“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,” Eresman 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.”

The company’s “liquids-prone” lands extend from Canada’s Montney Shale into the Niobrara Shale of the Denver-Julesburg (DJ) Basin, on into the Mancos and Collingwood shales. In recent months Encana also has assembled close to 190,000 net acres in the Simonette and Kaybob areas of the Duvernay Shale in Alberta, adding to its existing 380,000 net acres of liquids-rich lands in the Alberta Deep Basin and 495,000 net acres in the Montney in Alberta and British Columbia. Costs were not disclosed.

In Colorado Encana holds about 240,000 net acres in the Piceance and DJ basins, where the company has identified liquids potential in the Niobrara and Mancos shales. This year Encana also plans to expand evaluation drilling on its 425,000 net acres in the Collingwood Shale in Michigan.

“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 the Encana chief. “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 NGL production.”

Encana remains open to bringing aboard joint venture (JV) partners, particularly in its gas plays, to share the costs. Earlier this year the company agreed to sell a half-stake of the gas-heavy Cutbank Ridge assets in Alberta and BC to PetroChina International Ltd. for $5.4 billion (see NGI, Feb. 14).

Additional JV partners may be taken on for “selected assets” in BC’s Horn River Basin, where a farm-in agreement already is in place with Korea Gas Corp. on a portion of the acreage. In addition, Encana could partner or even sell “a portion” of its producing Greater Sierra lands, Eresman told analysts. RBC Capital Markets and Jefferies & Co. Inc. have been retained to conduct the potential deals.

“As Encana continues to sharpen its focus on resource plays, a greater proportion of total production is included in its key resource plays — the core value creation assets in the company’s portfolio,” said Eresman. “As a result, Encana has realigned the producing assets contained in some of its resource plays and the most noted adjustment is the merger of the East Texas and Fort Worth resource plays into the Texas resource play. Other adjustments have been made to reflect additional incremental realignment of Encana’s key resource plays, which now make up about 97% of the company’s total production.”

Activity in the Haynesville Shale also is undergoing a transition to “expedite natural gas development and optimize efficiencies by enabling the drilling of numerous horizontal wells, each containing multiple completion stages, from a single pad location, which results in a lower environmental impact,” said Eresman. As it shifts its focus from lease retention drilling to optimizing its drilling program, Encana is seeking regulatory approvals to drill longer laterals in the Haynesville.

“In the first quarter of 2011, the shift to resource play hub activity resulted in about a 25% reduction in drilling costs from a lease retention program. Further cost reductions are expected through the deployment this year of fit-for-purpose pumping equipment and service supply agreements.”

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