Heading into the second quarter, analysts expected that Encana (OVV 1.82%) would turn a marginal profit, with the consensus being that it would earn $0.04 per share. However, thanks to excellent production results and expanding margins, the company blasted past those expectations, reporting net earnings of $331 million, or $0.34 per share. As a result, the company is not only well ahead of its five-year plan, but its remarkable progress makes it much more likely that it can achieve those ambitious goals.
Drilling down into the results
Production out of Encana's core assets averaged 246,500 barrels of oil equivalent per day (BOE/d) during the second quarter, which was up 9,200 BOE/d from the first quarter. More importantly, higher-margin liquids production, which includes oil, natural gas liquids, and condensate, jumped 14% to 124,900 barrels per day. That higher-margin growth pushed the company's corporate margin up to $12.10 per BOE during the quarter, which is an increase of 25% from the prior quarter despite lower commodity prices.
One of the drivers of this high-margin growth was Encana's ability to get more production out of its newest wells by applying the latest innovations. In the Permian Basin, for example, the company's most recent wells outperformed expectations by 20%. One of the factors driving that outperformance is the company's cube wells, which use large, multiwell pads, advanced well completion designs, and detailed planning to more efficiently use equipment and infrastructure above ground while optimizing recovery below ground.
The industry is finding that innovation is the key to unlocking more production out of shale plays for less money. Earlier this month, for example, Devon Energy (DVN 1.92%) achieved the highest initial production rate in the STACK play of Oklahoma "by a wide margin." Fueling Devon's stunning well result was a combination of innovations, including drilling a nearly two-mile horizontal lateral and implementing an enhanced well completion design that enabled the company to maximize the value of its resource.
Three extraordinary numbers you won't want to miss
These innovations are having a noticeable impact on not just current results but future expectations. Because Encana is getting more production out of each well for lower costs, it has been able to convert more of its total drilling inventory into premium return locations, which the company defines as wells that can deliver a 35% after tax return at $50 oil. Because of that, the company now has more than 11,000 premium locations remaining. What's remarkable about that number is it means the company has not only replaced all of the sites it has drilled since launching its plan last October, but it has added 1,000 more without spending money to acquire additional acreage.
Further, the improvement in production and margins that the company has captured this year positions it to achieve its five-year plan to grow production from its core assets by 60% and cash flow by 300% while living within cash flow at $50 oil instead of $55. That $5 a barrel improvement is a game-changer for the company and puts it into an elite category since few oil companies can grow output at such robust rate at that oil price. Devon Energy, for example, expects to increase its oil production 13% to 17% by the end of this year, and another 20% in 2018. However, the company needs oil to average $55 in 2017 and $60 in 2018 to achieve those growth rates while living within cash flow. Meanwhile, Pioneer Natural Resources (PXD 2.20%) is on pace to expand its output by a 15% compound annual rate for nearly the next decade. That said, Pioneer Natural Resources currently needs $55 oil to make that plan work.
Given the dramatic improvement in Encana's margins and the recent sale of its Piceance assets, the company is on pace to get its leverage ratio down to just 2.0 times this year. While that's roughly the shale industry's average this year, it's a dramatic improvement for Encana, which has had to climb out of a hole after going on a debt-fueled acquisition and drilling binge during the shale gas boom. However, through a series of asset sales and operational improvements, the company has gotten its leverage down to a much more comfortable level, which gives it more flexibility to navigate through the currently uncertain commodity price environment.
A brightened outlook
While Encana's expectation-thrashing earnings were nice to see, the real highlight of the quarter is the dramatic improvement in the company's growth prospects thanks to increasing well productivity. The company now only needs $50 oil to fuel its ambitious growth plan, which gives it a competitive advantage over rivals by making its growth forecast all the more achievable given where crude is these days. Further, that accomplishment means the company has even more upside to a future oil price recovery, which could fuel big-time returns for investors.