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Encana BC Shale Deal Rumored to be Near

A decision by Encana Corp. to pull out of an investor conference this week ramped up rumors that the natural gas giant may be close to a joint venture agreement with China National Petroleum Corp. (CNPC) to develop its vast British Columbia (BC) shale holdings.

Encana and CNPC last June signed a memorandum of understanding (MOU), or heads of agreement, that outlined a framework to negotiate a joint venture (JV) to develop Encana's holdings in the Horn River, Greater Sierra's Jean Marie formation and in the Montney Shale's Cutbank Ridge formation (see NGI, June 28, 2010).

The Calgary-based producer's share price jumped 3.5% on Thursday on the CNPC rumors. In a note to clients, Canaccord Genuity Research analysts said a multi-billion-dollar deal could be imminent.

"Investors on both sides of the border in North America speculated that the cancellation was due to a possible announcement of the long-awaited potential JV with CNPC," said analysts in a note to clients. "After making no mention of the discussions in its [3Q2010] release, the company has started to briefly discuss the potential JV at recent broker conferences, leading the market to believe that the negotiations have once again gained momentum.

"Many have speculated that the potential JV could be as large as $5 billion in size, and the company has recently stated that it is looking to create a deal that is larger than the one it has with KOGAS ($1.1 billion over five years). If this is the case, the questions become over how many years and on how much acreage/resource potential? As seen with past announced JVs, these types of announcements can result in a short-lived share price jump."

Encana, whose focus is North American unconventional gas, has attracted more than $4 billion of JV capital commitments in the United States and Canada, with about $900 million invested in 2010. Encana CEO Randy Eresman last year said the company was targeting annual JV investments of between $1 billion and $2 billion, and a JV with the Chinese producer "could contribute significantly towards achieving that investment target."

The producer's Greater Sierra leasehold is spread across an estimated 275,000 net acres of land that cover the Devonian shale formation in its Horn River play; about 1.7 million net acres are within the Jean Marie formation. The Cutbank Ridge leasehold is an estimated 720,000 net acres of land within the Montney Shale. Combined production from these key resource plays last year was more than 535 MMcfe/d.

Encana management on Friday was unable to respond to market rumors but said negotiations with CNPC were "ongoing." Mike Graham, who helms Encana's Canadian Division, hinted at a prospective transaction last Tuesday when he spoke at the BMO Capital Markets 8th Annual Unconventional Resource Conference.

If Encana were to agree to bring in a JV partner to help defray costs for its BC holdings, Graham told the audience that it could be "an order of magnitude bigger" than a JV agreement with KOGAS Canada Ltd., an affiliate of South Korea's Korea Gas Corp.

KOGAS agreed to invest C$565 million over the next three years to earn a one-half stake in 154,000 net acres in Encana's Horn River and Montney shales.

The JVs, as Encana and other gas-focused producers have learned, have become a go-to source of revenue to defray service costs and to deal with low gas prices. In addition, Encana has an advantage of owning more than three million hectares of "fee lands" in Canada in which it holds subsurface rights. For those fee lands, which were granted to Canadian Pacific Railway in the 1800s, Encana pays no royalty fees to the Crown. However, Encana may charge royalties to other companies for as much as 38%.

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