Encana Corp.'s $3.1-billion (U.S.) shale-oil acquisition shows it's serious about diversifying – sort of. What it is serious about is finding assets that can turn around its profit picture, fast. Yet it seems less committed to moving away from shale plays, despite the expensive lessons that they have already taught the company.
It was less than five years ago that Encana spun off its oil business (into Cenovus Energy Inc.) in order to focus its attention, and that of its investors, on unconventional natural gas plays – chiefly, U.S. shale gas. To put it mildly, the strategy didn't go well. Low natural gas prices made notoriously expensive shale production unprofitable, while the high depletion rate of shale gas wells resulted in slumping output.
By the end of 2013, Encana's U.S. natural gas production had fallen nearly 30 per cent in two years, its once multi-billion-dollar annual profits had been reduced to a trickle, and its stock was down nearly 40 per cent from where it was immediately after the Cenovus spinoff.
Encana's new strategy – unveiled by rookie CEO Doug Suttles last November – to focus on rebuilding its portfolio of oil and liquids-rich assets and reduce its exposure to natural gas, was both necessary and welcome. Wednesday's news, that it is buying a 46,000-acre shale oil property from Freeport-McMoRan Copper & Gold Inc. in the rich Eagle Ford deposit in Texas, is a substantial step in this new direction.
Yet it's hard not to notice that Encana is sticking to its taste for shale plays. While there is some near-term logic, this may prove more a $3.1-billion Band-Aid than part of the long-term strategic cure.
Encana's expertise is in large-scale unconventional plays, such as Eagle Ford, and it is certainly familiar by now with shale extraction techniques. Shale oil, unlike shale gas, can be produced profitably at current prices, and Freeport-McMoRan's property already produces 53,000 barrels of oil equivalent a day – providing instant cash and profits.
But in assessing the purchase, consider Freeport's rationale for selling. In its own news release on the deal, it talked about freeing up funds to focus on assets "with superior margins and growth characteristics."
This hits at the root of the problem with shale oil. Much like its shale-gas sibling, it's expensive to produce (all-in break-even costs in Eagle Ford run around $60-$80 (U.S.) a barrel, roughly double the cost of conventional oil), and its wells deplete their supplies much faster than conventional wells (in Eagle Ford, production typically drops off by about 35 per cent in the first year alone). From both a return-on-investment and a long-term growth standpoint, that's a tough sell.
In the Freeport-McMoRan property, nearly half the identified drilling locations have already been drilled. On the upside, that means they are already producing, which greatly lessens Encana's development costs. (Wells in the Eagle Ford cost about $6-million to $8-million each to drill; the property already has 355 wells in place.) But given the rapid depletion rates, it also means a significant amount of the property's potential has already gone.
Add it all up, and Encana is buying an immediate upgrade to its bottom line while skipping a lot of the up-front costs to get there. It will nearly double its oil and liquids output overnight, and add more than 50 per cent to its quarterly cash flow (based on 2014 first-quarter figures). It helps change the course of a problematic company in a hurry, and delivers immediate results from the new CEO.
But in the longer term, shale oil doesn't look like the right answer. Encana might not want to go too far down a path that has some of the same perils as its previous wrong turn.