Don't let it get away!
Keep track of the stocks that matter to you.
Help yourself with the Fool's FREE and easy new watchlist service today.
Encana (NYSE: ECA ) , one of Canada's largest natural gas producers, is embarking on a radical change in its strategy to improve shareholder returns. The company is now targeting liquids-rich North American shale plays, while selling off dry natural gas assets. Let's take a closer look at some of the pros and cons of this new strategy.
Encana's shifting strategies
In November 2009, Encana made the bold decision to spin off its oil assets into a separate entity known as Cenovus Energy (NYSE: CVE ) . Once the split was completed, Cenovus took over Encana's joint venture projects with ConocoPhillips, which included oil sands properties in northern Alberta, a stake in two Conoco-operated U.S. refineries, and various oil and gas assets in western Canada.
Now, less than five years later, Encana is looking to get back into oil drilling in full force. Late last year, the company outlined its new strategy, which involves focusing on five oil- and liquids-rich North American resource plays, improving its cost structure, and unlocking additional value for shareholders through asset sales and a potential spinoff of its Canadian Clearwater assets into a new public entity.
Most recently, the company announced the sale of its stake in certain natural gas properties in Wyoming's Jonah field to Texas-based private equity firm TPG Capital for $1.8 billion. The properties being sold span a producing area of roughly 24,000 acres and include 1,500 active wells. Encana plans to use the proceeds from the transaction, which is expected to close in the second quarter, to pay down debt, invest in its capital program, and for general corporate purposes.
Doubling down on liquids
As the company whittles down its dry gas portfolio, it will focus about 75% of its 2014 capital budget on developing five core liquids-rich resource plays: the Montney and Duvernay shales in Canada, the DJ Basin in Colorado, the San Juan Basin in New Mexico, and the Tuscaloosa Marine shale in Louisiana and Mississippi.
By ramping up activity in these plays, the company hopes to diversify away from natural gas, which accounts for roughly 90% of current production, and boost margins and cash flow. Encana reckons that liquids will account for roughly 75% of its upstream operating cash flow by 2017 and expects increasing liquids production to drive 10% compound annual growth in cash flow per share through that year.
So far, the company's new strategy is panning out well from an operational perspective, as fourth-quarter liquids volumes surged 82% year-over-year to average 66,000 barrels a day, while development costs have fallen sharply in just a matter of months.
Despite progress, uncertainties linger
For instance, in the DJ Basin, the company was able to achieve a 34% reduction in costs from July to November of last year by transitioning to floodwater completion fluids and using zipper fracs, which allows multiple wells to be fractured simultaneously.
Similarly, in the Duvernay, Encana reported well cost reductions in excess of $1.5 million per well thanks to greater use of multiwell pad drilling and lower water handling costs.
However, despite this initial progress, a host of risks and uncertainties remain. As an example, much of the company's acreage in the Duvernay and Tuscaloosa Marine shale is still in appraisal mode, which means the size of these fields' reserves and production rates are yet unknown. If appraisals prove disappointing, Encana's drilling results in these plays could be poor or hard to predict, impacting rates of return and cash flow forecasts.
Even though the company expects strong returns from these plays, ranging from 40%-50% in the Tuscaloosa Marine shale to 60%-100% in the Montney, investors should realize that the lack of extensive and reliable data presents considerable uncertainty.
While Encana's transition toward liquids-led growth has seen initial success, there are still a host of lingering uncertainties. Investors should keep a close eye on the company's appraisal results in the Duvernay and Tuscaloosa Marine shales, as well as its progress in driving down costs and accelerating liquids growth in these plays. If the economics of these plays don't pan out as Encana expects, its cash flow outlook could fall woefully short.
Boost your 2014 returns with The Motley Fool's top stock
While Encana is poised to deliver stronger cash flow growth in the years ahead, there's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.