As a major dry gas producer, Encana (NYSE:ECA) has suffered for years under the weight of low-margin natural gas.
In the process, its peers sprinted forward by drilling for liquids. Well, the company made a dramatic switch and has completely refocused its operations squarely on oil and gas liquids. It’s been selling and buying like mad, and it has now become one of the top players in the space.
But is this a foolhardy act?
The oil and gas sectors have been churned up recently, and jumping headfirst into a new market may not be the safest move. So readers should be hyper critical of this company before investing.
Setting Up the Shale Hand
In June, Encana spent over $3 billion acquiring land, assets, and wells in the Eagle Ford shale formation. Last week, it announced the purchase of Athlon Energy for $6 billion. This week, it announced a major asset sale, turning its Clearwater assets in Alberta over to Ember Resource for C$605 million.
And just a few days ago, Encana said that it divested a major asset in Alberta Bighorn for around $1.8 billion.
Now, Encana is not fully ridding itself of dry gas; it still has major holdings. But they pale in comparison to the four major “liquids” plays that it now owns. Two of its new plays are in Canada – Duvernay and Montney. They’re both liquid and condensate plays that are considered to be among the best in North America. The others are in Texas, specifically in the Eagle Ford and Permian basins. Those are considered the two top plays in the United States for oil with natural gas liquids as by-products.
On top of that, the newly acquired Athlon Energy is a major player in the Permian Basin. Encana paid a 25% premium to Athlon’s share price, and the $58.50 offer was almost three times its 2013 initial public offering price.
Based on current production, that means Encana paid around $200,000 per barrel of oil. However, it estimates that there are more than three billion barrels of oil sitting under the land it bought, bringing the per-barrel costs down to the single digits (if things go as planned). From Encana’s point of view, this shift was a no-brainer. It estimates that the liquids space will produce a net-back margin of $55 per barrel of oil equivalent from its acquisitions, versus around $20 per barrel of oil from its dispositions. That’s quite a trade-off.
But here’s the problem…
A Dangerous Gamble
Encana’s assumptions are based on the prices of oil being $10 and natural gas being 15%, higher than where they are today…
With the recent developments in Saudi Arabia and the continued increase of U.S. oil production, the prices that we’re seeing, even today – under $90 per barrel – may seem a little high going forward. Of course, oil and gas insiders are also looking at longer-term trends when they make these types of major acquisitions.
But if you think they have access to information that we don’t, then you’re wrong. Ask Exxon (NYSE:XOM) how its purchase of a gas giant at the top of the natural gas market worked out. Hint: not well.
Encana is certainly sitting on some of the best quality assets in North America – and a lot of them. With all of its new assets, Encana is now considered a major producer. If the oil and gas market turns, it could be a steal at current depressed levels. The company has a great balance sheet and a strong cash flow. But what it doesn’t have is the ability to accurately forecast where the price of the commodities that it produces will be in the next five or 10 years. As a natural gas player, it learned that it was in the wrong place at the wrong time…
Now, only time will tell if it made the same mistake again by buying into the shale plays at a time when oil production looks to be creating a glut.
And “the chase” continues,
BY Karim Rahemtulla