These days, the market is pretty clear on what it likes from companies engaged in horizontal drilling: core positions and high margins. Perhaps more importantly, the market prefers companies with eggs in several baskets. Upstream unconventional drillers with these three components usually get higher valuations and lower costs of capital than those of their peers.
Which companies fit this bill? Think about Whiting Petroleum (NYSE: WLL ) , which has not only one of the biggest core positions in the Bakken but also a nice 70,000-plus acre position in some of the better parts of the Niobrara. Even more so, EOG Resources (NYSE: EOG ) has large core positions in both the Wolfcamp shale and the Bakken and is easily the biggest producer in the Eagle Ford shale. These multiple shale names have safety in diversity that the 'one-shale wonders' are missing.
One company that seems to have caught on is EnCana (NYSE: ECA ) . A Canadian-based company, EnCana is refocusing itself on North America's newest shale plays in a bid to become a sort of EOG in the newer shales.
The big five
This year, EnCana launched an ambitious, $2.5 billion capital plan to harness the potential of what management believes to be the five highest quality new shale plays in North America. The first two plays are right in the Canadian company's backyard: the Montney and Duvernay shales of Northern Alberta and British Columbia. These two plays have been dubbed 'megashales' because both rival, and perhaps exceed, the tremendous gas reserves in the Marcellus shale.
Unfortunately, those gas reserves have yet to be harnessed. However, EnCana will allocate between six and eight rigs on each of these two plays in order to develop the considerable liquids reserves both shales provide. EnCana has a large, contiguous acreage position in the Montney. Both plays should provide an internal rate of return, or IRR, of between 60%-100%.
Further south along the Rockies, EnCana will deploy two to four rigs in both the San Juan basin in New Mexico and the Niobrara in Colorado. The San Juan basin is a new shale actually discovered by EnCana, and it is very oily. Well costs are quite low: $4 million-$5 million. EnCana's Niobrara acreage is in the core Wattenburg field, and returns should be an impressive 55%-85% here. With proven profitability and in-place infrastructure, the Niobrara is the safer bet, but the San Juan has interesting potential.
The fifth shale play is the Tuscaloosa Marine Shale, or TMS, in Louisiana and Mississippi. With more than 300,000 acres, EnCana is one of the three big players in this brand new shale play. Encana will employ one to three rigs here in 2014. Currently, management estimates returns of between 40%-50%, but that number has big upside if well costs continue to decline. Unlike the other shale plays listed here, the TMS has a 100% oil cut. The TMS could easily become EnCana's most profitable shale.
The big picture
EnCana has been reorganizing itself in an attempt to be more capital efficient, and movement into the shale is a big part of that effort. As you can see from the chart above, management is letting its less profitable base assets decline and is replacing those lower-margin assets with production from the 'big five.' Even with the steep base decline, management expects compounded production growth of 10% until 2017.
EnCana is reorganizing itself into a multiple-shale heavyweight. Currently the company trades at about 3.2 times book value. That's certainly not cheap, but it's not too expensive, either. This is just a $17 billion company, so there is plenty of opportunity for needle-moving growth. Development of the TMS as well as successful liquids production and price realization in the Montney and Duvernay plays are the real keys to EnCana's future success. If all three of those plays work out, EnCana could be a much larger company by 2017 and beyond.
There's still plenty of money to be made from the shale revolution
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