One of the biggest reasons for the precipitous drop is Alberta’s crushing oil supply glut. With limited pipeline and transportation infrastructure, record-setting production had nowhere to go, and companies like Encana were forced to bid more aggressively than ever to reserve capacity. At its worst, Canadian producers needed to sell their oil for $15 per barrel at a time when U.S. producers were fetching $60 per barrel.
“There is no doubt that operators are running their projects at a loss right now,” the Canadian Energy Research Institute reported.
Before this latest setback, Encana’s management had forecasted generating $3 billion in cumulative free cash flow by 2022. With shares at the same levels as they were in 2005, the market seems to be pricing the stock as if current conditions will be the norm over the next few years. But upon closer inspection, conditions are changing quickly.
Previous to the recent crisis, Encana shares were roughly 100% higher. When the market realizes that the company’s current problems are temporary, a snap-back is a strong possibility.
Things on the ground are improving quickly
While it will take years to improve Alberta’s energy infrastructure, like building pipelines and terminals, several short-term solutions are clearing the biggest issues quickly.
After the Alberta government instituted mandatory 9% supply cuts across the board, Canadian crude prices in the area doubled within days. In January, the discount between Canadian and U.S. oil prices continued to narrow, thereby suggesting that the effects from production cuts are holding steady. The new rules reduce the provinces production by roughly 325,000 barrels per day and should last until the supply glut is eliminated. Once that milestone is achieved, reductions will narrow to just 95,000 barrels per day until the end of 2019.
Production cuts alone solved most of the issues that caused Encana’s 50% drop, and with early evidence showing that they can have a long-term impact, conditions look much brighter than in late 2018.
Other solutions are in the works to narrow the discount of Canadian oil even further. Alberta Premier Rachel Notley noted that the government could still give crude oil priority access to rail networks over agricultural products. Alberta’s government also plans to institute additional rail cars to improve transportation capabilities.
About 15,000 barrels per day of capacity will be available in 2019, while a lifesaving 120,000 barrels per day of capacity will come online by 2020. Current estimates show that Alberta is producing roughly 250,000 barrels per day more than can be shipped using existing infrastructure, so this move alone should help dramatically.
Long term, the government is looking to build permanent refinery capacity, which will reduce the need to export the region’s production for processing in the first place. On December 12, 2018, the first calls for proposals were released. “The more that we can upgrade the product we own, the more we can return to Albertans,” noted Premier Notley.
Good things come to those who wait
Already, the impacts of the supply glut have been mitigated by 50% or more. This year, additional crude by rail capacity will ease stress further. By 2020, the last half of the glut can be cleared with 120,000 barrels per day of new rail capacity.
Once the glut is completely cleared, expect Encana’s stock to trade back near its pre-glut levels of $18 per share, representing roughly 100% upside.
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Fool contributor Ryan Vanzo has no position in any stocks mentioned.