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This Oil Stock Is Thriving Through Innovation

By Matthew DiLallo - Oct 18, 2017 at 4:31PM

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This shale driller has displayed a breathtaking improvement in just the past year.

After several years of hard work driving down costs and repositioning its portfolio, Canadian shale driller Encana ( OVV 6.24% ) announced its return to growth mode last fall by unveiling a new five-year plan. Underpinning that strategy was a vast inventory of premium return drilling locations across four core shale plays, which the company believed could grow production and cash flow at a rapid rate as long as crude averaged $55 per barrel. However, thanks to continued innovation and efficiency gains, Encana recently updated its five-year plan, which shows it becoming a cash flow machine in the coming years even if oil doesn't budge.

What a difference a year makes

Last October, Encana outlined its five-year growth potential at its investor day. The shale driller noted that it had built up an inventory nearly of 10,000 premium return well locations across four core regions, which Encana defined as those that could deliver a 35% after-tax rate of return at $50 oil. While that was below the rate of return EOG Resources' ( EOG 4.03% ) premium wells would earn at that level, it was still high enough to fuel significant growth over the five-year plan. Encana anticipated that it was on pace to increase cash flow 300% by 2021 as a result of drilling these higher-margin wells, which would double its corporate margin as production rose 60%. All the company needed to meet this goal was for oil to average $55 per barrel, which would enable it to start living within cash flow by 2018.

An oil worker holding a laptop near a pump jack.

Image source: Getty Images.

However, thanks to continued innovation and exceptional well results, Encana is well ahead of the pace of that plan. In fact, the company announced last quarter that it could achieve cash flow breakeven at just $50 a barrel. Due to that step-change in improvement, the company updated its five-year plan at this year's investor day. The most noteworthy change is that the company is further shifting its focus toward cash flow growth as opposed to just increasing production, which is the focus of most rivals these days. As such, Encana's aim in the next five years is to grow cash flow at a 25% compound annual growth rate, which will enable the company to generate a whopping $1.5 billion in cumulative free cash flow by 2022 as long as oil averages $50 a barrel. That excess cash gives the company plenty of options, including further improvements to an already strong balance sheet, boosting its paltry dividend, or buying back stock.

How technology is driving the thriving

While Encana's prime acreage positions across several top-tier shale regions are playing a critical role in its ability to thrive at lower oil prices, that's only part of the story. Another crucial factor is the company's culture of innovation, which is helping it to get more oil and gas out of the ground for less money. The driller has collected a massive amount of proprietary data from its wells over the years, which it's using to design models for the shale reservoirs below its acreage. It then develops a customized solution to optimize recovery from each region.

For example, one of its latest developments is "the cube" in the multilayer Permian Basin. Under this approach, the company uses large multiwell pads to drill tightly spaced, stacked wells that target each formation. By drilling all the wells in the section at one time, instead of the old method of drilling a few wells per section initially and then going back and completing in-fill wells at a later date, the company can more uniformly develop each section. This approach minimizes the risk that newer wells underperform older ones due to a depleting reservoir, which helps optimize recovery and maximize returns.

These technological advances also helped Encana increase its inventory of premium return locations without acquiring more acreage. When the company started last fall, it had 9,280 premium locations out of a total of roughly 20,000 future wells. However, by converting more of those to premium through further innovation gains, Encana now has 11,070 premium wells remaining even after drilling more than 200 over the past year. That's similar to EOG Resources, which has grown its premium drilling inventory from 3,200 locations last February to 7,200 this past May, due in part to "applying industry-leading technology and geoscience to our acreage," which is enabling the company to drill longer, more tightly spaced wells. Because of these increasing inventories, both companies can continue growing at a rapid pace well after their current plans end, while also potentially accelerating their rate if the price of oil rises.

Moving into an elite class

Thanks to the innovation gains over the past year, Encana can deliver double-digit growth in production and cash flow for the next five years as long as oil averages $50 a barrel. That puts it into a select group of oil stocks that can thrive at that low price point. Investors seeking a low-risk, high growth oil stock should take a closer look at Encana because its five-year plan puts it in position to create tremendous value even if oil doesn't recover, with accelerated upside potential if it does.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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