Last year, Encana (OVV 0.17%) unveiled a multiyear growth strategy that it expected would not only drive production higher but lead to a meaningful increase in earnings and cash flow. That plan started paying dividends in the first quarter, when the company's focus on drilling liquids-rich shale wells fueled a significant improvement in margins and earnings. Those results put it on pace to meet or exceed its ambitious 2017 targets.

Drilling down into the numbers

Encana reported adjusted first-quarter earnings of $104 million, or $0.11 per share, which was $0.08 per share ahead of analysts' expectations and a vast improvement from last year's first quarter, when the company reported an adjusted loss of $130 million. Several factors drove results above expectations.

A natural gas drilling rig at dawn in a snowy field.

Image source: Getty Images.

First, production averaged 317,900 barrels of oil equivalent per day (BOE/d) during the quarter, which while down 17% versus the year-ago period due to asset sales and underinvestment last year, was ahead of its 2017 plan. More importantly, however, Encana is increasingly getting production from higher-margin liquids wells due to a focus on drilling in liquids-rich shale plays. Because of that, it delivered a meaningful improvement in margin per BOE during the quarter, which increased $2.92 per BOE versus the year-ago period to $9.72 per BOE. That puts it on the path to delivering full-year margins of more than $10 per BOE.

Finally, the company continues to keep a lid on expenses. While rising drilling activities across North America is starting to inflate costs, Encana got out ahead of that by locking in 60% to 70% of its drilling costs this year through self-sourcing as well as securing contracts at the end of last year. Because of those smart moves, as well as continued efficiency gains, it expects to hold drilling costs roughly flat with last year. Meanwhile, operating expenses were down 20% in the quarter while transportation and processing costs fell 21%, which means it should meet or exceed its full-year cost guidance.

Drilling better wells

A driver of Encana's strong first-quarter results was its ability to deliver better well performance through innovation. In the Eagle Ford shale, for example, the company started using an advanced completion design late last year that's producing remarkable results. Three wells completed with that technique delivered average production rates of 1,300 BOE/d during the first quarter while five more recently completed wells averaged 2,150 BOE/d, which is well above the roughly 900 BOE/d projection for these wells. Meanwhile, this well completion design delivered production improvements of up to 60% across several wells in the Montney play in Canada. 

One of the important story lines over the past year is that shale drillers are continuing to tweak well designs, which are often delivering significant improvements in productivity. Bakken-focused driller Whiting Petroleum (WLL), for example, produced monster well results in the first quarter due to its latest well completion design. Whiting Petroleum used a combination of higher sand volumes as well as additional frack stages and diverter agents, to complete a three-well pad that should deliver 50% more production than wells completed with its previous design. Because of that, Whiting expects to achieve higher production than its initial guidance this year without spending more capital.

In addition to tweaking its well completions, Encana is working on several other innovative drilling approaches that are also yielding excellent results. In the Permian Basin, it completed its first full-scale development using the Cube Encana approach that targets multiple shale layers from a single location to reduce costs and optimize recovery. That first pad was Abbie Laine, which targeted five different zones through a dozen wells. Each delivered initial production rates of more than 1,000 BOE/d, with peak production from the pad reaching 14,000 BOE/d.

Because of these successful well results, Encana should meet its full-year production expectations to deliver 20% core growth and a 35% increase in liquids output by the end of this year. 

Investor takeaway

Encana's first-quarter results make one thing clear, which is that its growth strategy is working. In some regards, it's working out even better than expected because its latest innovations are delivering exceptional results. Because of that, the company remains on pace to reverse its production slide by midyear, which should fuel explosive earnings and cash flow growth over the next few years even if oil prices don't budge.