Shares of Encana (NYSE:OVV) have been on fire this year. To date, the stock is up a remarkable 91.6%. While rebounding oil and gas prices ignited that rally, the company's ability to beat its 2016 targets is what pushed the stock up near triple digits this year. Here are the seven factors driving that stunning performance.
1. Cash costs are crashing
One of the ways oil and gas producers are battling weak prices is by pushing operating expenses down. Encana has done a remarkable job on this front, with its operating costs down 11% this year. Overall, the company expects to save $100 million over the course of the year. This is driving a meaningful improvement in its operating cash flow, which was up 100% from last quarter alone after excluding gains oil hedges.
2. Drilling and completion costs are falling
Not only are operating expenses falling but so are drilling and completion costs, which are down 30% to 40% across its core plays. Because of this, Encana can drill more wells for the same amount of money. In the Permian Basin, for example, its average completed well costs are down 31% from last year to $4.3 million. For perspective, that is well below leading Permian driller Pioneer Natural Resources (NYSE:PXD), which has well costs in the $6 million range. That said, Pioneer Natural Resources typically drills longer wells averaging 8,500 feet compared to around 7,000 feet for Encana.
3. Drilling returns are rising
By pushing its drilling costs down, Encana is boosting its drilling returns. As a result, its average after-tax rate of return in its core plays is more than 35%. While that is an excellent return, its drilling returns are not quite on par with Pioneer Natural Resources, which drills at higher cost but with more productive wells that have an average before-tax internal rate of return over 60%.
4. Production is heading higher
Not only are declining drilling costs enabling Encana to drill more wells without boosting spending, but drilling innovations are driving production past expectations. For example, wells in the Montney were expected to produce 1.1 million barrels of oil equivalent (BOE) over their lifetime. However, recently drilled wells are trending above that estimate due to Encana's decision to drill longer laterals and employ other production-enhancing innovations. These innovation-led production gains enabled Encana to boost its full-year production guidance from an average of 330-350 MBOE/d to 340-360 MBOE/d.
5. Capital-efficiency gains are needle-moving
The company's efficiency gains are truly moving the needle. After announcing two asset sales, Encana decided to increase its 2016 capex budget by 20%. However, that capital will enable Encana to drill 50% more wells than before.
6. The balance sheet is getting stronger
Like most energy companies, one of Encana's goals during the downturn was to improve its balance sheet. The company continues to make progress on that goal, with total debt down by $2 billion since the end of 2014. In the first quarter alone it repurchased $489 million of senior notes for just $400 million, which will save it $30 million in annual interest expenses. Additional debt reduction is likely after the company sold its Gordondale and DJ Basin assets for roughly $1.1 billion.
7. The company is getting ready to grow in 2017
While a substantial portion of those asset sale proceeds are going toward debt reduction, Encana did boost its capex budget by $200 million. However, roughly 75% of that money will be spent in the fourth quarter to give the company's production a boost in 2017. Furthermore, with an improving balance sheet, falling costs, strong drilling returns, and an improving energy market, Encana is in an excellent position to grow production in 2017. Because of that, it will rejoin other growth-focused peers like Pioneer Natural Resources, which expects to increase its production by 13% to 17% next year after delivering more than 13% production growth this year.
Encana is making substantial progress on its financial and operational goals in 2016, which fueled a sharp rally in its stock price. However, because it still has some work to do to catch up with rivals, the company also still has plenty of upside potential. While another double probably is not in the forecast, Encana carved out an excellent position in four key shale plays that positions it to drive solid long-term returns for investors.