Encana's natural gas hedges dry up next year

The good news: Encana Corp. posted a $12-million (U.S.) first quarter profit Wednesday morning, much better than the $361-million loss in the same period last year.

The bad news: its hedging program contributed $358-million in after-tax gains, and this insurance policy dramatically dries up next year. 70 per cent of the company's 2012 natural gas production is hedged at a natural gas price of $5.80 per thousand cubic feet. In 2013, just 19 per cent will be hedged at $5.24

In case you need a reminder, natural gas is currently trading around $2.

Encana is well aware of this. Earlier this year, it tried to hammer home that it is expanding its natural gas liquids production. But will this materialize fast enough?

RBC Dominion Securities analyst Greg Pardy has run the numbers, and he expects 2013 oil and liquids production of 45,000 barrels per day. Not bad, but in his mind, not enough. He wants Encana to consider a "liquids-weighted rifle shot acquisition that would augment its grass roots strategy with a more immediate and concentrated development fairway which plays to its execution strength."

"In a nutshell, the acquisition would serve as an insurance policy as it navigates 2013, and would afford it with the time to more fully delineate its emerging liquids plays, which should enable it to capture greater value in a JV," he added.

Yet finding the perfect asset won't be easy. "The hard part is uncovering that acquisition at a reasonable cost, but our analysis illustrates that the right deal could improve [Encana's]relative outlook," Mr. Pardy noted.

For the time being, Encana intends to protect its balance sheet. At the moment it is well placed to fund its common dividend of 80 cents per share, amounting to $589-million annually. But who knows what 2013 will hold.