With oil and gas assets across the Montney, Duvernay, Eagle Ford and the Permian Basin, Encana Corporation (TSX:ECA)(NYSE:ECA) saw its stock price fall significantly along with nearly every other energy producer. From a high of $26 in 2014, shares fell as far as $4.14 this year. Since February, however, shares have nearly doubled to $8, buoyed by higher oil prices.
Now that oil is drifting lower again, is the rally done for Encana?
A proxy for oil
It shouldn’t be surprising that Encana’s share price is heavily influenced by price swings in oil. Over the past 12 months, the relationship between oil prices and Encana’s stock is fairly strong. The recent rally has been fueled by oil popping to $40 a barrel.
If oil continues rising, the company could be in an enviable position. Its four primary assets are projected to have 30% returns at $50 oil and $3 natural gas. Boosting production adds leverage to higher oil prices. Oil and liquid production increased 36% in the final quarter of last year. Higher oil prices will continue resulting in a higher share price.
What if conditions deteriorate?
While Encana needs higher oil prices to survive over the long term, management has positioned the business well to survive another oil rout. Last year the company generated $400 million in capital and operating efficiencies, beyond the initial target of $375 million. Cost savings helped Encana reduce debt by roughly 30%, or $2 billion. Management believes it can achieve another $550 million in savings this year.
With no long-term debt maturities until 2019, a renewed $4.5 billion line of credit, and permanent cost savings taking hold, the company should have no issues surviving another dip in energy prices. The rally would almost surely be over but, long term, patient shareholders can still benefit.
$50 oil this year?
With the capital and financing in place to survive a continued multi-year downturn, Encana shareholders simply need oil to rebound over the long term. At $50, most of its major projects would still generate attractive returns.
Many still contest that Encana is a natural gas company (75% of production), but oil will be the major driver of future profits. In just three years it’s grown from 5% of production to nearly 20%, all with higher profit margins. As it strengthens its focus on just four core properties, oil production should continue to grow its share. Fortunately, the oil markets are starting to rebalance.
Kuwait, which exports about 2.1 million barrels per day, expects the price of crude oil to rise to $50 per barrel by the end of 2016, citing “increased demand and shrinking supply” as the reason for the expected rise. Right now, global oil production is about two million barrels per day above consumption.
By 2017, the EIA expects this gap to close and be completely eliminated by the end of the year. The last time the market was completely balanced, oil was at $100 a barrel. Long-term investors should be set holding Encana shares.
