Will Encana’s New Strategy Pay Off?

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Encana (NYSE: ECA  ) , Canada's largest natural gas producer, yesterday announced its eagerly anticipated new strategy to help it become a leaner, more focused energy company.

As outlined in a news release, Encana's new strategy entails focusing capital on five oil- and liquids-rich North American resource plays; reducing its cost structure; diversifying its commodity mix away from natural gas; and unlocking more value from its portfolio through asset sales and a spinoff of its Canadian Clearwater assets into a new public company.

But will that be enough to compensate for Encana's heavy concentration in natural gas? Let's take a closer look.

Encana's new strategy
Encana is clearly serious about trimming its capital budget. Earlier this year, it said it planned to achieve cost savings and efficiency gains of $100 million-$150 million over an 18-month period. By the end of this year, the company reckons it should be able to achieve about $110 million of that target.

As part of its new strategy, Encana will slash its workforce by 20%, reduce quarterly dividend from $0.20 per share to $0.07 per share, and shutter its office in Plano, Texas. It will also drastically reduce capital spending to just $2.5 billion next year, down from an expected $2.7 billion-$2.9 billion this year, $3.5 billion last year, and $4.6 billion in 2011. 

Encana is just the latest energy exploration and production company to announce a drastic reduction in capital spending. Chesapeake Energy (NYSE: CHK  ) , for instance, has slashed its capital budget for the year by almost half as it seeks to reduce its cash flow shortfall. This year, the company expects to spend just $7.2 billion, compared to $13.4 billion last year.

Diversification away from gas
Like Chesapeake, Encana relies heavily on natural gas, a commodity whose price has been depressed since 2010. So far this year, gas has accounted for roughly 90% of the company's production, leaving it particularly exposed to depressed prices. Indeed, Doug Suttles, a former BP (NYSE: BP  )  executive who took over as Encana's CEO in June, identified the company's excessive reliance on natural gas as one of its key vulnerabilities.

To amend the situation, the company plans to devote roughly three-quarters of its reduced capital budget toward five liquids-rich plays: Canada's Montney and Duvernay shales, Colorado's DJ Basin, New Mexico's San Juan Basin, and the Tuscaloosa Marine shale in Louisiana and Mississippi.

Other pure-play gas producers are also employing similar approaches. Last month, Ultra Petroleum (NASDAQOTH: UPLMQ  ) announced that it would purchase oil-producing assets in Utah's Uinta Basin for $650 million in order to to diversify away from natural gas and gain exposure to a highly cash-generative asset base.

Foolish takeaway
Since taking over as CEO, Suttles has been working adamantly to make Encana a smaller, more efficient company. His unrelenting focus on capital efficiency and cost-cutting seems to be paying off, judging by the company's higher-than-expected third-quarter earnings and cash flow, as well as its impressive 92% year-over-year increase in liquids volumes during the third quarter.

However, at this point, I think it's still unclear whether the new strategy will continue to pay off. While layoffs and a decrease in the quarterly dividend should help the company improve its balance sheet, it remains to be seen how successful the company will be in further growing liquids volumes from its five core liquids-rich plays, which aren't exactly the most sought-after or lucrative prospects out there.

Encana isn't the only company trying to cash in on the record oil and gas production that's revolutionizing the United States' energy position. That's why the Motley Fool is offering a comprehensive look at three energy companies set to soar during this transformation in the energy industry. To find out which three companies are spreading their wings, check out the special free report, "3 Stocks for the American Energy Bonanza." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free.


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