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Encana Cautious on Natural Gas Price Recovery

October 29, 2012
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Encana Corp. CEO Randy Eresman, whose company is one of the largest onshore producers in North America, said last week the company remains "cautiously optimistic about our natural gas price recovery this year. We continue to see evidence on both the demand and supply front that supports this assertion."

The CEO and his management team talked about the company's third quarter earnings report with analysts, and he also shared some insight into what the company sees ahead for natural gas prices. Encana remains one of the biggest gas-weighted independents, although it is transitioning to more liquids production.

From the demand side, said Eresman, "we see an increased use of natural gas it continues to displace coal-fired power generation. Relative to 2008 levels, we estimate that approximately 8 Bcf/d year-to-date of natural gas demand has been gained from coal to gas displacement. This has contributed significantly to reduce storage inventories surplus, relative of five-year average, from about 927 Bcf at the end of the winter to about 250 Bcf today.

"While demand from displacement may recede to some degree as natural gas prices rise, we expect to see a year-over-year increase in weather-sensitive demands with a return to more normal winter weather," he said. "On a year-over-year basis, North American natural gas supply has reached the plateau with declines in more mature or conventional basins largely offsetting growth from new plays.

"This year, we've seen a more than a 50% drop in gas-directed rig counts in North America. And while rig completion efficiencies have improved relative to a few years ago, if this reduced rig count trend continues, there should be an impact in 2013 natural gas production levels."

Encana reported a $1.24 billion net loss in 3Q2012, primarily from the impact of low natural gas prices. The company recorded a $1.19 billion after-tax impairment charge against net earnings in the quarter, which led to the loss. Operating earnings totaled $263 million (36 cents/share), down from $389 million (53 cents) a year ago. Cash flow declined to $913 million ($1.24/share) from $1.2 billion ($1.60) in 3Q2011.

Average natural gas production volumes declined to 2.9 Bcf/d, which was about 460 MMcf/d lower than in 3Q2011, which Encana attributed to voluntary capacity reductions, divestitures and natural declines. In the U.S. division, the lower gas output was partially offset by a successful drilling program in the Piceance Basin, while in Canada, solid drilling programs in the Bighorn and Cutbank Ridge areas helped to partially offset declines there.

In the first half of this year, when gas prices were at their lowest level, Encana shut in or curtailed about 500 MMcf/d of production. Beginning in August, Encana began bringing the volumes back online, and with "production volumes now largely restored, the company reaffirms its 2012 production guidance of 3.0 Bcf/d."

Liquids volumes average more than 30,000 b/d in the latest period, an increase of almost 6,000 b/d from a year ago.

There's "some upside potential in gas prices and continued volatility around regional North American oil and natural gas liquids prices," but "we believe that the price ratio between oil and natural gas will be maintained at a level which far exceeds the historical average," said Eresman. "Therefore, we believe that there will continue to be strong driver to increase liquids in our portfolio even as natural gas prices rise."

Encana's business model is built around cost reduction, Eresman said. "Regardless of commodity prices, our aim has always been to optimize our operations and drive down cost thereby increasing margins and returns. Recognizing the technology advancements has irrevocably transformed the energy business, we continue to strive to retool our business to thrive in a fundamentally different macro environment than we had a few years ago. This means a continuous focus on optimization and cost reduction across our business regardless of whether we are developing natural gas, oil or liquids-rich natural gas assets."

Eresman took several minutes to discuss the status of Encana's ongoing joint venture (JV) proposals, some of which have been in the works since early 2011

The company, which is ready to deal on many of its vast onshore holdings, already has secured partners in several of plays, most notably one with Mitsubishi Corp. for a stake in Cutbank Ridge, as well as another with a unit of Toyota Tsusho Corp. in the Horseshoe Canyon coalbed methane play (see NGI, April 23; Feb. 20). Last year Encana also expanded a Horn River Shale farm-out agreement with a Canadian subsidiary of Korea Gas Corp. (Kogas) at Kiwigana in northeast British Columbia.

"First let me say that we have a high degree of confidence that we'll meet or exceed our 2012 net divestiture target of $3 billion and be nicely positioned for 2013 with at least $2.5 billion of cash on our balance sheet," Eresman told analysts. "Our preliminary goal for 2013 is to bring in an additional $1 billion to $1.5 billion of upfront joint ventures or divestiture cash receipts. This $1 billion to $1.5 billion is partially dependent on the 2012 year-end cash balance, our 2013 capital program and our 2013 estimated cash flows."

Encana, Eresman said, has had "tremendous interest in all of our joint venture offerings to date and fully expect to meet or exceed our targets. However, there are significant assets available for joint venture in both the Canadian and U.S. marketplace. As such, this may limit the size of the packages that can be dealt on and extend the time that it may take to complete a transaction.

"For example, we've been advised that our combined Tuscaloosa Marine Shale, Eaglebine and Mississippian Lime package may be too large for most interested parties at this time, and so we are allowing the plays to be bid on individually. The value of Encana's joint venture offerings and asset packages greatly exceed the $1.5 billion to $2 billion net divestitures needed to meet our combined 2012 guidance and 2013 target, allowing us to be highly selective in the deals we choose to transact on."

The company's decision to complete JV transactions "varies depending on the assets involved," said the CEO. "In the case of the Duvernay [Shale], [and] our early light oil plays in the USA division, the primary driver is to de-risk our capital program and accelerate the pace of which we can reach commerciality. With partnerships such as those that we've fostered with Kogas and Mitsubishi, the plays involved have been largely delineated and the majority of the exploration risk has been removed. In other words, we achieved immediate value recognition for reserves and contingent resources associated with these types of assets."

The ultimate goal is to transition the company to a more diversified portfolio with more balanced cash flow generation, said Eresman. He noted that at the company's investor day in June Encana had provided initial projections for 2013 capital, production and cash flow. The initial projections remain "valid," assuming that the company would continue to invest in new liquids plays and leverage JVs to support and accelerate the pace of development.

Encana's initial 2013 cash flow estimates were based on a New York Mercantile Exchange gas price of $3.50/MMBtu. "The price that is roughly, today, roughly 50 cents below next year's forward market," the CEO said. Encana has increased its natural gas hedge position to about 1.2 Bcf/d for for 2013 at an average price of about $4.50/Mcf.

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