Oil and gas prices were higher during the third quarter than they were earlier this year, which provided an added lift to oil producer profits. However, the improvement in prices was only part of the reason why Encana (OVV 0.17%) reported a surprisingly strong quarter. The real standout performers this quarter were its falling costs, exceptional well results, and a big decline in net debt.
The unexpected profit
Analysts didn't expect too much from Encana during the third quarter, with the consensus that the company would lose about $30 million, or $0.04 per share. Encana, however, turned in a surprising profit of $32 million, or $0.04 per share. Fueling that standout result was a 5% reduction in operating expenses and transportation and processing costs compared to last quarter, with those costs now down 30% year over year. Those cost reductions helped push cash flow up to $252 million, or $0.29 per share, which was 38% higher than the second quarter.
Wall Street vastly underestimated the ability of shale drillers to keep their costs in check while at the same time delivering excellent well results. That's evident in the wide divergence between consensus estimates heading into the quarter and the results reported by several top drillers. For example, analysts expected Chesapeake Energy (CHKA.Q) to report a loss of $0.03 per share; however, it trounced expectations by reporting a surprise profit of $0.09 per share. Fueling Chesapeake's first profit in six quarters was its ability to push down costs.
Top-tier well results
Aside from falling costs, one of the other drivers of Encana's strong third-quarter showing was robust production from recently completed wells. In fact, the company reported several standout wells during the quarter, which delivered initial 30-day production rates of at least 1,900 barrels of oil equivalent per day (BOE/d).
In the Eagle Ford shale, for example, Encana completed its first two Austin Chalk wells, which delivered initial 30-day production rates of 2,000 BOE/d and 3,100 BOE/d, with the latter well representing one of the top wells drilled in the play to date. Meanwhile, in the Montney, the company noted that four recent wells delivered initial production rates of 1,900 BOE/d. Finally, in the Duvernay, Encana has drilled 63% of the top 40 wells in the play. These excellent well results are enabling Encana to deliver more production for less money, which has it on pace to meet -- if not exceed -- its 2016 guidance.
Dwindling debt level
The best number Encana reported during the quarter, in my opinion, was a $2 billion reduction in its net debt, bringing it down to $3.5 billion. Driving this decline was a combination of asset sales, an equity issuance, and cash flow. Overall, total debt has decreased by $3.5 billion since the end of 2014, meaning the company has virtually cut leverage in half over the past two years.
Encana has done an exceptional job improving its balance sheet during the downturn. For comparison's sake, it made more progress than Chesapeake Energy, which has been chipping away at its enormous debt load. In fact, over the past year, Chesapeake's debt is down by about $3 billion, or roughly 25% of the $11.7 billion it had last September. Encana's substantial progress on debt reduction puts it in a much stronger position than most other drillers, including Chesapeake, which still has to address a significant amount of near-term debt maturities.
There were a lot of positives in Encana's third-quarter report. Most notably were the fact that its falling costs and robust recent well results fueled a surprising profit, and that the company achieved a meaningful amount of debt reduction. The report clearly shows that the company can do more than just survive on lower oil prices, which puts it in a position to thrive in the years ahead, even if prices don't budge all that much.