November 11, 2011
Written By Chloe Lutts Jensen
“Just about every energy producer sells both oil and gas. They each favor one over the other. And most have been tilting toward oil over the past couple years. But Encana Corp. (ECA – yield 3.80%) makes no bones about being a natural gas specialist and is an outspoken industry advocate. Natural gas accounts for fully 96% of the company’s production mix (versus 4% for oil). … That skewed weighting puts Encana at a disadvantage in the current pricing environment. But if you’re looking for a well-managed pure play that is perhaps the most leveraged to rising natural gas, this is it.
“The Canadian company has secured 11.7 million acres to explore and develop. Much of that land lies north of the border in the Bighorn, Cutbank Ridge and Horn River gas basins in Alberta and British Columbia. But the firm also has a major presence in some of the top U.S. plays, most notably the Haynesville Shale in Louisiana and East Texas. Encana has acquired nearly 430,000 acres in the Haynesville Shale, which overtook North Texas’s Barnett Shale last year as the nation’s top producer with production rates now topping 5.5 billion cubic feet (Bcf) per day. The company was an early mover in the play, in keeping with its strategy of quietly beating other rivals to the punch and scooping up land before hype drives up lease costs and royalty rates. Encana’s latest target is Michigan’s Collingwood Shale, which underlies the Utica Shale in spots. The company has recently amassed 250,000 acres in this region for just $150 per acre, mere pennies. The value of this shrewd move is just now becoming obvious. According to Morningstar, recent Collingwood auctions have been closing as high as $5,500 per acre. With dominant positions in low-cost supply basins throughout North America, Encana has built up a massive base of 14.3 trillion cubic feet (Tcf) in proved gas reserves—23 Tcf if you include reserves characterized as probable. … The company can easily accelerate production growth if it wants to. But there’s no sense in rushing to get gas out of the ground today for less than $4 per Mcf [million cubic feet]—not when you can wait and sell it tomorrow for $6 per Mcf or more. So management is targeting slow but steady 5% to 7% annual growth for the time being.
“In the meantime, profits aren’t exactly suffering. Last quarter, the company generated $1.2 billion ($1.57 per share) in cash flow, amply covering the $0.20 per share dividend. And that’s with rock-bottom prices. Imagine the bottom line potential when those 3.5 Bcf per day are being sold at more favorable prices. For now, Encana isn’t stuck just taking what the market will give. Management has locked up more than half of its 2012 production (2.0 Bcf/day) at an average NYMEX (New York Mercantile Exchange) price of $5.80 per Mcf. That’s a hefty 48% premium to the going rate.
“Looking ahead, Encana also has several additional catalysts on the horizon. First, the company just pocketed $800 million with the sale of a gas plant and other midstream assets, money that will be deployed into more profitable upstream projects. On that front, management is plowing $1 billion into liquids-rich plays from Mississippi to Colorado—and daily production of higher-priced oil and NGLs [natural gas liquids] is expected to double from 25,000 barrels to 55,000 barrels over the next three years. Elsewhere, Encana has a 30% ownership stake in the Kitimat LNG facility, which recently received an export permit from Canada’s National Energy Board. This is one of just a small handful of LNG export hubs in North America, and the facility will be equipped to ship 1.4 Bcf of gas per day to Pacific Rim customers. Finally, Encana is also an emerging leader in natural gas transportation fuels. … If natural gas prices turn higher, Encana will be among the biggest winners. The company has a high-quality asset base and a 50-year inventory of low-cost drilling sites to juice future production and earnings. As an added bonus, the shares offer a nice 3.6% dividend yield, roughly double their peer group average.”
Nathan Slaughter, Scarcity & Real Wealth, 10/31/11