The struggle is real. Since 2008, Encana Corporation (TSX:ECA)(NYSE:ECA) has hit multiple headwinds while attempting to transition from a gas to an oil producer. Over that period, shares have consistently sunk lower, now down roughly 80% over five years.
While Encana is still predominantly a natural gas company—75% of production is natural gas—the company’s management team hopes that oil will become the major driver of future profits. In just three years, oil has grown from 5% of production to nearly 20%. Oil generally has better market conditions and, based on Encana’s cost of production, would come with higher profit margins.
Can Encana successfully evolve into an oil company?
Focused on boosting oil output
Oil should increase its share of company output based on two factors: concentrated capital spending and asset sales.
This year, management reduced its capital budget by 55% with spending now focused on just four core areas (Eagle Ford, Permian Basin, Montney, and Duvernay). Because those properties are largely oil producing, Encana’s output should slowly shift away from natural gas. By 2018, natural gas will likely comprise less than 50% of production, down from 82% in 2014.
Last month, Reuters reported that Encana is “exploring the sale of more non-core assets in the United States and Canada that could be worth about $1 billion.” The company already sold $2.8 billion in assets last year, but sources now say that it’s open to offers on every one of its non-core assets. Any additional asset sales will likely be focused on natural gas properties, boosting Encana’s oil exposure.
Asset sales and streamlined spending could transform Encana into an oil producer fairly quickly, resulting in a more profitable business. As long as energy prices rebound over the long term, the company may be setting itself up for a massive turnaround.
Oil has better economics
At $50 a barrel, most of its major projects would generate attractive returns. Its four primary assets are projected to have 30% returns at $50 oil and $3 natural gas. Already, oil and liquid production increased 36% in the final quarter of last year. Boosting production adds leverage to higher oil prices. Higher oil production should result in a higher share price.
Financially, Encana should have no problem continuing to afford its evolution. 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. Over 75% of long-term debt isn’t due until at least 2030, and no debt matures until 2019. It also still has access to $4.5 billion in fully committed, unsecured, revolving credit facilities.
With no significant debt maturities over the next few years, a renewed line of credit, permanent cost savings taking hold, and an ongoing transition towards oil, Encana should have no issues surviving another dip in energy prices. When oil markets sustainably rebalance and move higher, Encana shares will likely follow.